Advisers or advisors?

The requirements of MIFID2 are now centre screen for firms on all sides of the asset management industry.  The newspaper headlines focus on the requirement to unbundle and pay separately for research, but for LGPS Funds the categorisation by default as retail clients has caused the most angst.  Most, if not all, will wish to ‘opt up’ to professional status, so that they can continue to invest in lower fee vehicles.   After many months and heavyweight representations to the FCA, there is now a template which they can complete to ask fund managers to opt them up, which contains both quantitative and qualitative criteria.  The latter are intended to ensure that there is sufficient expertise present that the client can understand the advice and information given by the fund manager. As always with something done in a hurry against a deadline, in this case 3rd January 2018, there are some anomalies and unintended consequences.  The first question is who needs to opt LGPS funds up.  Managers do, of course, but what about consultants and advisers?  In theory any firm or individual providing regulated advice (FCA definition) on specified investments should do so.  As pool subfunds will be included in this definition, and individual LGPS Funds will continue after pooling to be responsible for allocating between them, there is a clear argument to say that any entity assisting them with advice in this area needs to be FCA regulated and to opt their clients up.  However, asset allocation and general advice are not regulated activities, and the funds’ investment activities are, according to the guidance on pooling provided by the Government, explicitly restricted to asset allocation.  Which suggests that there is no need.Despite the arguments both ways, the direction of travel is fairly clear and I would expect anyone providing specific advice on individual subfunds - as opposed to commenting on, for example, an investment consultant or pool’s choice of them - to end up requiring to be FCA regulated, and having to opt his/her client up.  Personally, I am going to rely on the wording in my contract which defines my duties as providing ‘general’ advice. To confuse matters further, what the industry knows as the consultant is the adviser from the template’s perspective and vice versa.  This is because it refers to the entity advising the firm on its Investment Strategy Statement (ie. ‘advising’ as per the LGPS regulations and not in the FCA meaning of the word).  Where both investment consultant and independent adviser are present, that will be the former, so the latter has to be put down as consultant. Then there are the qualitative criteria, such as longevity of tenure.  An Officer at one of my clients has 38 years in post and we are joking that MIFID2’s requirements mean he will not be allowed to retire because they need to keep the average years of experience up.  There’s also the form’s usage of the American ‘advisor’, whereas my LGPS contracts use the English form ‘adviser’.   I could go on and on, but I have to go and feed my dog her morning meal.  I must be careful not to get the MIFID2 ‘opt up’ process muddled up with what I normally give her!

Environment, social and governance (esg) is an opportunity for the new lgps pools

Almost every investment and governance conversation I’ve had in the past six months has, to a greater or lesser extent, mentioned ESG.  And almost every investment house, bar the hard-core profit-maximisers, have included ESG in their marketing in some form or another.   One driver is the pressure groups arguing for divestment.  Increasingly, they are moving away from demonstration tactics towards using financial arguments, such as the potential downside from being invested in stranded assets and the unsustainability of poor working practices.  They may still only be presenting one side of the argument but their voice is now heard at the table.  For example, a recent LGPS Strategy Day I attended focused on ESG and invited the local climate activists to attend to state their case. A second is the growth of funds focusing on sustainability.  Their argument is that it is better to focus on what works in the long term rather than explicitly excluding ‘sin’ stocks.  By virtue of their process, they argue, the latter will be excluded anyway. A third is the public scrutiny around certain ESG issues such as executive remuneration and, increasingly, the realisation that shareholders can have significant influence through engagement.   The LGPS can take some pride that, via LAPFF, it has been at the forefront of engagement with some notable successes.  The debate between these three different approaches - whether to engage, divest or simply look elsewhere - is at the centre of today’s ESG policies.  There is, of course, unlikely to be a perfect answer and different companies will need different approaches.  Persuading a tobacco company to disengage from tobacco is always going to be a hard sell and yet mechanical divestment rules can easily lead to artificial (and potentially costly) investment decisions. Given the LGPS’s longstanding focus on ESG, this is something which all the pools currently being set up will have to embrace.  Some are already setting up sustainable or ethical funds.  If done well, it could be a major selling point to those participating Funds who are perhaps less convinced by the financial arguments for pooling.     At Linchpin we are ready to help - find out more here. 

william bourne attends cipfa local pension boards conference

On 28 June 2017, William attended CIPFA's 'LGPS Local Pension Boards Two Years On' conference in London.​

William Bourne on Room 151 - local pension Boards - practical steps towards effective performance

Local Pension Boards have the tools they need to function effectively; meddling should be discouraged. To read more please visit Room 151. 

Smooth sailing or stormy waters for the LGPS? William Bourne comments on the 2016 LGPS Annual Report

The LGPS 2016 Annual Report was published recently.  In many ways it shows a success story.  The number of employers is up 22% and, despite almost zero return in the year to March 2016, the long term investment returns show a healthy 3% real return annualised over 20 years.  However that is not a reason for complacency, on a whole range of fronts.    The rise in employers is largely driven by councils outsourcing jobs and the creation of academies.    The volume of the latter, which tend to be of relatively small size without dedicated HR departments, is undoubtedly putting pressure on fund administration departments.  The solution has to be some form of pooling, whether of academies into multi-trust academies, assets and liabilities into a single entity (as was done with The National Probation Service), or at the fund administration level. The 20 year investment return has, in contrast to private sector schemes, been driven by equities.     Some 35% is invested in equities directly, compared to 5% in bonds.  Pooled investment vehicles account for 44% and, while these cannot be categorised from the information available, the message is clear that equities comprise most funds’ major ‘growth’ asset class.  In contrast, private sector schemes have over 50%* invested in fixed income and, when LDI strategies are taken into account, the true number is probably closer to 70%.  In both cases, the level of return over the next five years is likely to be lower: government bonds yielding 1.5% over 10 years will by definition return that annualised figure if held to maturity; while equities would have to go to even higher valuation levels than at present to return more than their dividend (3% today) and the level of long term real economic growth (assume 2%). Paradoxically that may help funding levels.  Regardless of the precise discount rate valuation methodology used, either a fall in the valuation of bonds or equities, or higher inflation will lead to a lower estimate of the liabilities.  The 2016 Report, which used individual Fund valuations, gave an average funding level of 85% , whereas the Government Actuary’s Department’s Section 13 valuation of the whole Scheme based on standardised assumptions will, if we can judge by the anonymised 2016 valuations already published for each fund,  be closer to 100%.  If we allow for market movements between 31st March 2016 and today, the Scheme is almost certainly fully funded. However, funds are still going to have to make a choice between accepting lower returns from traditional asset classes such as bonds and equities, or branching out into newer asset classes in the search for higher returns.  It would be a mistake to be too complacent on the investment side. The 2016 report also shows that the cashflows from members - ie. contributions minus pension pay-outs - has, for the first time, tipped into the negative.  This has been long flagged up and has been delayed by the inflow of active members entering the Scheme from new employers.  However, the trend can only accelerate in the future.  In the near term, investment income (1.7% in aggregate) will comfortably cover the gap but not forever - now is the time for funds to plan for that eventuality. Finally, I turn to governance.  With less than a year until April 2018, when funds are supposed to turn their investment implementation over to the pools, governance arrangements will need to change.  Because Funds will effectively be outsourcing a large part of the investment management, they will need to put in place a clear framework to monitor and govern the arrangements between the various parties, including the Pools, the Section 101 committee, any connected body which has delegated responsibilities, the Pension Board, and outsourced service providers such as actuarial and investment consultants.    In my view, rather than trying to carve up the work between the 101 Committee and the Pension Board, clearer accountability will come from giving them separate functions.  The Section 101 Committee should be responsible for all functions including the governance of the various relationships, while the Pension Board’s role should be one of scrutiny and challenge.  They should ensure that appropriate governance processes are in place and followed, and provide challenge where they believe there are gaps. I haven’t even mentioned the General Data Protection Regulation, which comes into force in exactly a year’s time on 25th May 2018 but, while there is plenty of work to do, from a funding perspective the LGPS is not in a bad place.  Private sector schemes are reaping the consequences of de-risking: investing in low risk assets results in low returns and, except where schemes are sufficiently well funded or mature, sponsors are having to increase their contributions.  In contrast, the LGPS is beginning to look more sustainable in the long term.   * Source: Purple Book 2016, p. 42  

japanese corporate governance

At a seminar a couple of weeks ago, I heard an ESG expert call the standard of corporate governance in Japan ‘extraordinarily low’.  I challenged him at the end of the session, pointing out that Japanese corporates tend to make decisions based on the very long-term, which was precisely the behaviour we are trying to encourage.  I also reminded him that in 2015, as part of the Abenomics reforms, Japan adopted a Code of Corporate Governance which is almost identical to the UK’s. The Japanese, unlike some nations, tend to obey laws. In the ensuing debate it was pointed out, quite correctly, that Japanese boards tend to have little diversity and rarely include foreigners; that shareholders are still some way down the pecking order, compared to in the US or the UK; but that governance in Japan is improving faster.  I would add that Japanese corporates do not have the same incentive to boost profits since corporation tax, rather than executive pay, is based on reported earnings per share; as a consequence that number tends to be conservative. The empirical evidence is in Japan’s favour too.  When we look at where the world’s major scandals and governance problems have come from in the past 20 years, they have almost all emanated from the US: Enron, subprime, the banking crisis… There will always be rogue companies, and Japan is no exception, but there has been an interesting shift over the past few years.  The Olympus scandal which broke in 2011 - where management had been misreporting profits over many years - was only uncovered when a gaijin (ie. a non-Japanese) manager took over.  It was an old-style Japanese governance failure, ie. management covering something up to avoid personal shame or embarrassment.  However, the Toshiba debacle this year was much more similar to bad governance in the West - poor decisions were made based on incomplete, ineffective or non-existent corporate governance procedures, but not for personal reasons. While an ‘extraordinarily low’ corporate governance standard is certainly not the case, how are shareholders treated in Japan today?  The level of buy-backs in 2016 at 5.3tr yen was some 60% higher than in 2015 and dividends at 11tr yen were 10% higher.  The buy-backs were generally done out of cash reserves and not via increased leverage, as is so often the case in the West.  It is also worth noting the increased level of mergers and acquisitions as zaibatsu slowly unwind the links of the last 70 years by selling or buying in quoted subsidiaries.  What’s more, these transactions tend to be done at premiums, which historically was not always the case. Japanese corporate boards tend to reflect the society, which is more male-dominated and certainly more homogenous (call it xenophobic if you prefer).  The corporate structure will always be closer to the European model where shareholders are one of a number of important stakeholders rather than the US one where shareholders are the top priority.  However, I would have more trust in the sustainability of a Japanese company’s earnings than its equivalent American one, simply because Japan still has its long-term culture in place.  I do also buy the argument that improvements in Japanese corporate governance are accelerating which, at the margin, is likely to lead to improvements in share ratings. 


From 15th-17th May 2017 William attended the PLSA Local Authority Conference at De Vere Cotswold Water Park Hotel in Gloucestershire​

WILLIAM BOURNE ATTENDS bnp paribas esg series event

On 4th May 2017, William attended the BNP Paribas and PRI - ESG Series 'Responsible Investing for Tomorrow' at the BNP offices in London​