​Will AFM independent directors make a difference?  We look at a recent case study

The deadline for authorised fund managers (AFMs) to appoint independent directors is just over four months away on 30th September 2019.  In order to balance the interests of AFM investors and shareholders the FCA, in April 2018, implemented its proposal that all AFM boards should have a minimum of 25% independents. The recent spat over Woodford Investment Management’s transfer of £73m of unquoted assets from Woodford Equity Income Fund (WEIF) to Woodford Patient Capital Trust (WPCT) makes an interesting case study.  WEIF was a ‘forced’ seller in the sense that it needed to reduce its unquoted holdings to stay within the rules.  The deal was done at ‘fair value’, but sweetened for WPCT shareholders because WEIF paid 100% of nav for the WPCT shares they received in return for the assets as opposed to the approximately 20% discount in the market. WEIF, as an authorised open-ended investment company (ie. analogous to a fund but a corporate structure) is controlled by an authorised corporate director (ACD), Link Fund Solutions Limited, which receives a fee of up to 1% per annum for administering the company.  The ACD has six Directors, of which only one is non-executive and potentially independent.  WPCT is an investment trust falling under the usual corporate rules.  It has six independent directors. Both WEIF and WPCT’s investments are managed by Woodford IM, so the potential for a conflict of interest is clear.  Shareholders of both companies were concerned by the deal.  WEIF shareholders were worried that they were investing in WPCT shares at 20% higher price than they needed.  WPCT shareholders thought they might be being stuffed with stale WEIF assets at high prices. Our point here is not that the deal was bad for either company or that Woodford IM has behaved in any improper way.  The price may indeed have been a fair one, and the deal good for both WEIF and WPCT.  Our point is that neither company were able to provide shareholders with any real assurance that their Directors had looked after their interests.  After being pushed, WPCT’s chairman commented that “The Board sought advice from a range of parties and had the companies, which we already own and know well, independently valued.’  The ACD made no comment to WEIF shareholders but Woodford IM commented ‘The potential conflicts of interest have been thoroughly assessed and managed in terms of both sets of shareholders, not just by Woodford, but by all parties involved in the transaction.’  At Linchpin, we don’t think either of those comments add to anything more than unverifiable assurances.  They are not good enough. The question then arises whether independent Directors in place at WEIF or Woodford IM would have made any difference to WEIF shareholders.  On the evidence of WPCT, they might still have been fobbed off with a bland assurance.  But independent directors would at least bear some accountability for protecting shareholder interests and could be questioned at AGMs.  We view that as an improvement.  One final comment: we are aware that some AFMs are simply going to past executives to fill the new positions.  We rather doubt that they will be perceived as truly independent.  The need above all is for someone who can bridge the gap between investment and governance but with an independent mindset.  We can think of people who fit that description well.   To find out more, please click here.​

Exclude or be a responsible investor? You can't be both

Responsible investment – ie. nudging (or more) investee companies towards sustainable business models - is at the heart of modern institutional share-ownership.  It relies on being a shareholder in a business, which is why many investors in the LGPS and elsewhere state in their investment policies that they prefer to engage rather than to exclude.  Shareholders who care are more likely to persuade companies to alter their behaviour than those who don’t. In contrast, charities tend to exclude companies whose activities are opposed to their own objectives, and campaigners put pressure on other investors to exclude sectors such as tobacco, armaments and fossil fuels.  The argument is that if demand for a share is lower, the price will fall, making it more expensive for the company to raise money through bond and equity markets (and incidentally sending executive share options into negative value). At Linchpin we see some significant inconsistency here.  If you don’t own alcohol shares, for example, how can you influence them to behave better?  If you don’t own oil shares, why would they listen to your views about climate change?  Are companies such as Sports Direct going to listen to non-shareholders? Reality is of course not black and white.  There are some activities which are generally beyond accepted social acceptance and sometimes banned by international conventions (eg. some kinds of munition manufacture).  Exclusion is hardly controversial here: the question should be why a listing authority permitted the company to list. For charities with a specific focus, there may well be justifiable concerns that donors will be put off.   Could an anti-tobacco charity hold a tobacco company?  We would still argue it will have more influence from the inside but the reputational risk argument may understandably carry more weight with its trustees. At Linchpin we are firm believers in investing responsibly and we would challenge those who exclude simply because it’s easier.  The effect of exclusion on companies is often to push them towards becoming private again.  They may then be out of sight but their behaviour won’t have changed.  We think responsible investment, and here we mean engagement, is both more likely to effect change and add value.  Compared to exclusion, that is win-win for investors. Our message for investors would be to consider carefully the reasons for any exclusions.  Find out how Linchpin can help you here.​

Is your organisation really smart?

I attended an interesting breakfast seminar at the consultants, Redington, last week about minimising mistakes. The starting point was that ‘stupid people don’t learn from their mistakes; smart people do; really smart people learn from other people’s mistakes’.  Two speakers, from KKR and 24 Asset Management, gave a short description of what they had done to make sure their organisations fell into the last category before a more general discussion.  Some of it is fairly obvious, at least to those of us who have been around for 30+ years: it is largely cultural and has to be led from the top; owning up to mistakes should be encouraged, not penalised, so long as the knowledge gained is shared; senior people should go out of their way to give time to dissenting views and always speak last at meetings; diversity of decision-makers is good; careful analysis both beforehand and afterwards (was the decision a good one?) is helpful. However, it is much easier said than done, particularly for younger organisations and staff.  The hard question came from the audience: if a junior employee makes a mistake which costs the business money, but owns up to it and shares the lessons learned with their colleagues, what do you do with their bonus?  Reduce it on the basis they made a mistake?  Leave it alone, on the basis that they behaved well?  Or increase it as a signal to encourage colleagues to learn from the mistake. One shared conclusion was that the behemoths among us, whether civil service or investment bank, don’t usually fall into the very smart category.​

Linchpin wins new business

We are delighted to announce that Linchpin has recently signed two new contracts.  William Bourne has been appointed after a public procurement as one of two Independent Advisors to Teesside Pension Fund for a six year contract.  And we have separately been appointed to provide advice to the General Pharmaceutical Council on an investment governance project which they are undertaking.  We are pleased to be working with both these prestigious clients to assist them with investment and governance advice.​

Pooling guidance

MCHLG has issued an informal consultation around updated guidance on pooling for LGPS funds.  The previous guidance was issued in 2015, prior to the establishment of most of the eight pools, and much has since changed.  The consultation is also welcome, so long as MCHLG is willing to listen to what it hears. Four years on, the case for pooling is not proven, except in the important sense that it has led to significant fee reductions.  It could be argued that this would have happened anyway but there is no doubt that the imminent arrival of the pools concentrated asset managers’ minds.  Aside from this, in our view the main benefit, again not unimportant, has been the increase in resources which can be directed to areas such responsible investment and, through collaboration, infrastructure. On the negative side, there have been significant costs in the setting up of the pools, both in the higher staffing levels and the need for legal and other advice.  How long it takes to recoup this is almost impossible to estimate but it certainly should be measured in decades, not years.  It also puts the Funds which are large enough to achieve economies of scale already in a dilemma: can they agree to transferring assets to the pools while fulfilling their fiduciary duty? The guidance proposes that they should take into account the benefits to members across the pool and indeed the whole LGPS, but we find it difficult to reconcile that with 101 Committee members’ duty to their local members and employers.  In our view, if the pools are indeed beneficial in the long term, they need to demonstrate that.  101 Committees can then make their own decision (we are tempted to add in their own time) on the basis of whether it is good for their own members without invoking parties further afield.  That would be clearly consistent with their fiduciary duty. Read Linchpin’s full response to the consultation here.​

What elements are needed for good governance over shared services?

All the eight asset pools mandated by the Government are now up and running, which is a tribute to the hard work of many people within and outside the LGPS.  There is an accompanying drive to share other non-investment services in order to gain economies of scale.  It is a sad fact of life that some of these ventures will succeed, while others will run into problems.  This is where good governance structures are essential. Delineation of the different bodies - where interests overlap, where they are aligned and where they are less so - is the first requirement.  The Government is about to launch a consultation over whether to separate funds from administrating councils.  This would be a move in the right direction but there also needs to be recognition that even services with shared interests are not always aligned. For example, the pension fund may wish the emphasis to be on service quality, while the council’s focus is on saving money.  In the case of the pools, which are in most cases separate entities, Board members may have their own agendas which diverge from their customers.  There should always be a service level agreement between the fund and service provider, both to set out expectations and a process for resolving conflicts and problems such as non-performance.  Key Performance Indicators (KPIs) are an important monitoring mechanism but on their own insufficient.  In the private sector sanctions tend to be imposed or the relationship is terminated if the service-provider fails to meet the agreed targets.  With shared services identifying effective ones is more difficult.  Any financial penalty ends up penalising either the pension fund member or the local tax-payer.  Termination is difficult, perhaps impossible, if the shared service has been agreed at council level or, as with the pools, is the result of a Government directive. There are two other vital elements of good governance over these complex relationships.  The first is a body with clear powers to effect change in the event of non-performance, whether that be to terminate the relationship or to replace senior management.  The second is sufficient resources to achieve this in practice. Most of the pools have put the elements described above in place, albeit they are so far untested, and the funds are in many cases short of governance resources.  However, my big question is whether the shared service arrangements which MHCLG is encouraging are doing the same. Find out more about our services here.​

LGPS is close to full funding in aggregate but will contribution levels still have to rise?

The 2016 Section 13 report on the LGPS by the Government Actuarial Department is at long last published.  It provides a more consistent basis for comparison between funds and follows the ‘dry run’ published in 2017 on the 2013 valuation.  One major purpose of the Section 13 report is to review the long-term viability of the Scheme and highlight where measures need to be taken.  Given benign asset markets and higher contributions, it is no surprise that there has been a marked improvement here.  On GAD’s best estimate basis (without the level of prudence embedded in local actuarial valuations), the LGPS as a whole was 106% funded in 2016 and roughly 2/3 of individual funds had funding levels of over 100%.  Since March 2016, of course, funding levels will have risen substantially higher. The second purpose of the report is to promote consistency so that comparisons between funds are easier.  Here their major comments are aimed at the four actuarial firms who serve the LGPS, and they focus particularly on the range of discount rates and mortality contributions used.  Their major point is that these seem to be done not on justifiable local differences but simply according to which actuary is used. The report distinguishes between ‘presentational’ and ‘evidential’ consistency.  It is hard to argue against the former and GAD suggests a dashboard approach.  The latter is more complex: the actuaries argue with some reason that enforcing a single methodology would reduce innovation and evolution.  We would also argue that there is some systemic risk if all actuaries are forced to use the same model, as they have for example in the private sector. The Section 13 report also provides an Asset Liability model to try and identify whether contributions might need to go higher.  It concludes that in about 75% of scenarios there will be a rise.  However, this is based on explicit assumptions which we would argue are unrealistic, primarily that the conditions prevailing in March 2016 (ie. extremely low bond yields and, after seven years of QE, very low asset price volatility) would continue.   With asset prices nearly 20% higher, gilt yields no lower and secondary contributions falling away, we would challenge the report’s assertion that higher contribution levels will be needed generically.  If the GAD report does turn-out to be correct, and contributions have to rise when the Scheme appears fully funded, top class employer communications are going to be vital.


The news this week that the Department for Business etc (BEIS) intends to crack down on using pre-pack administration to avoid corporate pension liabilities is good.  Over the past ten years, directors of companies large and small have used, or abused, the legislation to close down their company and set up a successor or ‘phoenix’ company to take on its activities but crucially without the pension liabilities or debts. Somebody has to pay, of course, and the normal course of action is for the Pension Protection Fund to take over the pension liabilities.  According to a report this week, 17% of the PPF’s clients are there through a process of pre-pack administration.  The pensioners concerned ‘pay’ through a reduced pension, but so do all pensioners because of the Pension Protection levy which is charged on all eligible DB schemes.     Such behaviour by directors is reprehensible, of course, but the underlying problem is the inability of companies to finance their pension contributions - Carillion’s collapse earlier this year demonstrates an alternative and equally unattractive outcome.   The real problem behind this is the huge increase in longevity over the past 30 years, vastly higher expectations for living standards and very low discount rates.  The rate of increase for the first two may well be slowing down but is unlikely to reverse significantly.  Discount rates could be raised but only if there is a break from the current methodology of using bond yields as their basis.  And there are too many large firms with their own agendas involved for that to happen quickly. The focus at government level is all about finding ways to increase contributions and, indeed, the Centre for Political Studies issued a paper this week with sensible suggestions to do this.  But isn’t it missing the other half of the argument – that, though it may be unpalatable, we may all need to adjust our expectations for our retirement?  Company directors’ unedifying behaviour with pre-packs is a symptom of the problem, not the cause, and BEIS’s reaction simply a sticking-plaster.