The Government has announced proposals to reform the Local Government Pension Scheme (“LGPS”) into what they term megafunds, but most of us understand as a continuation of the existing pools. The outcomes, whether returns or costs, are likely to be little different from historic ones. More professional management may sweep up some of the stragglers, but most LGPS funds, whether through luck or judgment, have over the past ten years, delivered just as good outcomes as their international peergroup of funded public sector schemes.
The driving force behind the Government’s reforms is the desire for pension funds to invest more in the U.K., in the interest of increasing growth. Paragraph 65 explicitly states that “growth is the number one mission of this Government.” But their proposals come up against the rock of fiduciary duty in a number of important ways. This article looks at the issues behind that.
What is fiduciary duty?
The concept of fiduciary duty is a legal concept which goes back to English common law. It operates where one party has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.* It is connected to the concept of equity rather than law, i.e., the sense that the outcome of any legal process should be fair, and at its heart is the concept of acting loyally in the beneficiaries’ interest. Over the past 150 years, with the growth of trust and fiduciary arrangements, it has become central to some aspects of modern law, including those around administering a pension fund. However, it is not a law in itself, and that means it cannot be legislated away.
The Law Commission opined in 2014** on what fiduciary duty means in the context of administering a pension fund: “Most importantly, trustees must not ‘fetter their discretion’. They must genuinely consider how to achieve a pension for their members and must not simply apply a pre-existing moral or political judgement.” (paragraph 6.12).
In the more specific context of the LGPS, which comes under different legislation, Nigel Giffin QC’s 2014 Opinion stated that “the administering authority’s power of investment must be exercised for investment purposes, and not for any wider purposes.” In the light of the pressure from Government, the Scheme Advisory Board has recently asked him to consider whether there are reasons to refresh this opinion. The interpretation of fiduciary duty has evolved over the years, and there may be reasons to reinterpret it in the light of modern society. But, in my personal opinion nothing has changed to require reinterpretation and Giffin’s 2014 opinion still stands.
Conflict between LGPS reforms and fiduciary duty
The LGPS consultation proposals potentially conflict with fiduciary duty in two important ways. The most obvious is the Government’s desire to have pension funds invest more in specific asset classes or in the United Kingdom. I recognise that the proposals do not mandate investment, which would be a clear conflict with fiduciary duty. But the setting of targets, with presumably an expectation that at some point in the future they are met, does, in the Law Commission’s words, ‘fetter the discretion’ of funds to invest in the beneficiary’s best interest.
The second conflict with fiduciary duty arises because the Government has proposed that the administering authorities (“AAs”) should transfer all investment decisions including the setting of strategic asset allocation and implementation to the pools. They state (paragraphs 28 and 30) that AAs will have fulfilled their fiduciary duty when they have set high level investment objectives.
However, they go on in the following paragraphs to say that AAs will have the duty to monitor the pool’s asset allocation and implementation. The big question here is who has fiduciary duty? Has it passed to the pool, as it would to a private sector fiduciary manager? Or does it continue to sit with the AA, in which case they are left in the awkward position of having responsibility, but no direct levers to control how funds are invested. Their only sanction if the outcomes are poor is the indirect one as shareholders that they can fire the pool Board.
The example of AIMCO in Canada
Here, there is an interesting recent example of the Alberta Investment Management Company (AIMCO) which runs funded public sector pensions in the Canadian province of Alberta. In November 2024 the provincial government fired the whole Board of AIMCO as well as the CEO and other senior executives. The stated reason was not poor performance, but to ‘reset the investment corporation’s focus’ in the light of costs which had risen by over 70% in four years.
As context over ten years to March 2024 AIMCO delivered an annualised return of 7.3% vs its reference index of 6.9%, i.e., outperformance of 0.4%. Costs rose from 47bps to 66bps, primarily because of higher performance fees. If these are excluded, costs rose from 31bps to 41bps.
Partner funds need to act as owners
One of the Government’s proposals is that the pool Boards should have one or two shareholder representatives. I understand why they propose this, but best practice around the world is to have a completely independent board with neither executives nor shareholders on it. The reason is the obvious one that it is easier for the Board to hold management to account if there are no executives, and easier for shareholders to fire the Board if they believe that to be necessary.
The conclusion I draw from this is that attention needs to be paid to how the partner funds who own the pools govern them. It is their role to set the overlying mission for the pools and to ensure they have the resources. It is the pool’s role to deliver that objective. Especially where there is a large number of funds, most obviously the London CIV, agreeing an overall objective and acting in concert becomes challenging.
I would argue that we need more behaviour like Alberta’s. Where pools are not delivering, in the interest of their beneficiaries the AAs as owners collectively need to step up. It is part of their fiduciary duty to do so.
---
* Squire Patton Bloggs: Fiduciary Duties under English Law: What Do They Mean For Business Owners? 2021.
** 2014 Law Commission’s Report into the Fiduciary Duties of Investment Intermediaries.
Commentaires