Four steps to unlock greater LGPS investment in UK growth

Richard Tomlinson, CIO at Local Pensions Partnership Investments (LPPI), argues that the Local Government Pension Scheme (LGPS) can be an engine for economic growth in the UK. But to do so, the government must deliver a step change in policy. 

We’re now more than a month into the start of the new parliament and the ‘securenomics’ of new chancellor Rachel Reeves have been largely welcomed by UK PLC.

As the new resident at number 11 has acknowledged, her big challenge will be reconciling her ambitions to get the UK economy roaring again with the sombre reality of public finances.

For those ambitions to be realised, much of the growth the government hopes to stimulate will need to be driven by investment. Attracting more of it will be key to the UK’s transition to net zero, improving public infrastructure and building more homes – all factors seen as essential to economic growth.

Inward investment will, undoubtedly, play a role here. But a complex geopolitical environment means that relying on this is difficult. Looking closer to home for the capital needed to boost growth is arguably a safer bet and aligns with more UK investors prioritising domestic opportunities.

The government has already recognised that unlocking greater pension fund investment in UK assets is an effective way to drive growth. That, presumably, was the thinking behind the chancellor’s recently announced plans to introduce a more ‘Canadian’ style approach for the LGPS.

The Canadian Maple 8 system is widely held up us an example of how to do pooling well, so emulating their model sounds pragmatic.

However, learning lessons from Canada, and indeed other nations where public pension investment is arguably ahead of the UK, is only one part of the puzzle.

There is considerable scope within the LGPS to increase investment in the UK. With around £360bn[i] in assets under management, it’s the largest scheme in the UK and one of the largest in the world, offering huge scale in terms of deployable capital.

And, like most pension funds, the LGPS’ primary responsibility is to generate sustainable risk-adjusted returns for client funds so that they can pay their members’ pensions in full and on time. This makes it well-positioned to invest in long-term assets, such as infrastructure and real estate, that will drive growth while seeking to deliver steady, inflation-beating returns.

The problem – or, more accurately, the opportunity being missed – is that LGPS investment is being held back by a number of systemic barriers. To fully unlock LGPS investment in the UK, the government should consider four key steps.

1. Reduce execution risk

LGPS capital wants to back UK investments, but the balance of risk and reward is often unfavourable.

The government could make more projects investable by reducing risk for investors – time, uncertainty and cost are all factors, particularly when it comes to infrastructure and building projects, that can switch investment managers off.

Planning reform, if executed well, could be a game changer in building investor confidence and making it easier for potential backers to map out the returns offered by a project. Ultimately, investors want certainty that a project will be realised and not become bogged down in overly complex bureaucratic processes.

2. Prioritise pension fund-ready opportunities

There are a number of geopolitical factors – from international conflict to economic instability – that could encourage UK pension funds to take a more domestic approach to investment strategy.

Likewise, surety of supply, over simply cost, is becoming a strong driver of strategic decisions for core sectors like energy and transport. Wind farms, grid upgrades and flexible manufacturing facilities are fast becoming crucial growth areas in need of funding – we see many countries developing new industrial strategies that acknowledge this.

These are the types of investment opportunities the government needs to focus on providing for the LGPS. They often offer an appropriate risk level and the longer-term investment horizon that pension funds require. Domestic projects with UK inflation participation also support pension fund managers in making inflation-linked benefit payments to members.

3. Incentivise investment in the UK

The launch of a National Wealth Fund is designed to crowd in private sector investment in the industries of the future, but the new government should also consider more formal incentives for pension funds that invest in critical infrastructure and, by the same token, avoid disincentives.

For example, the recent increase to the windfall tax on energy producers could deter investment in the renewable energy projects needed to support the UK’s clean energy transition.

4. Identify what is actually good about the Maple 8

The Maple 8 system – an umbrella term for Canada’s eight largest public pension funds – is the Canadian model that Rachel Reeve’s wants to emulate.

The Maple 8 has outperformed LGPS overall, although slightly underperformed LPPI alone in recent years (five-year performance to 2022 and 2023, LPPI v average of Maple 8 – see table), and invests far more of its capital than the LGPS does in private markets – 48% compared to 20% – and in infrastructure where it allocates more than double the LGPS.

At LPPI, we have always adopted a similar approach to the Maple 8, which prioritises private markets asset classes. We allocate 41% to private markets and 14% to infrastructure, compared to the LGPS average of 6% for the latter.

Our five-year investment performance was 34% higher than the overall LGPS for 2023 (7.9% vs 5.9%) and 13% higher for 2022 (8.0% vs 7.1%). If this was emulated across the scheme, it could boost capital available to pay the pensions of tomorrow. The table shows how LPPI and the rest of the LGPS compare to the Maple 8 on performance and asset class allocations.

However, what makes the Maple 8 so successful isn’t just consolidation or a better balance of asset classes. It is also more independent. The LGPS is complex and needs parliamentary approval to enact any rule changes, the Maple 8 is “free from political interference”[ii].

That independence also breeds more confident leadership and fosters more forward-thinking strategic decisions.

The changes described here cannot be implemented overnight, nor are they 100% free of risk.

Doing more with less will become increasingly important as the government looks to galvanise the economy without tearing a hole in the public purse. A modernised, more ambitious and agile LGPS could be instrumental in unlocking investment capital and kickstarting projects that deliver growth and bring the UK economy closer to a sustainable net zero future.

Past performance is not an indication of future performance. Investments can go down as well as up.

Source: Investment performance indicated is based on net returns. Sources: Local Pensions Partnership Investments, Canada Maple 8 fund reports, Pensions and Investment Research Consultants, Eduard van Gelderen, International School of Management (France), February 2024.

[i]  Source: UK Government – Chancellor vows ‘big bang on growth’ to boost investment and savings

[ii]  Blake Hutcheson (OMERS) – Canada’s Maple 8 ‘couldn’t be more different’, says OMERS

Richard will be speaking at Room151’s annual Investment Forum on 5 November. Further information about the event can be found here.