Why pension funds should invest locally to generate impact and returns
Common arguments against pension funds investing in their local economies do not stand up to scrutiny – location-based impact investing strategies outperform the after-fee FTSE
Over the past 12 months, we have analyzed data obtained through access to information requests on UK Local Government Pension Scheme (LGPS) fund holdings. This was part of our research for the recently released white paper, Increase institutional investment for a territorial impact. The aim was to explore whether pension funds could generate appropriate financial returns by allocating capital closer to home so that investments could be better suited to the development needs of member communities – what we called Place -Based Impact Investing (PBII).
To make this happen, we would need compelling evidence to show that PBII could stand up to scrutiny of some familiar refrains – we knew we would encounter age-old arguments about higher costs, fiduciary conflicts, added complexity, and greater risk. high without any guarantee of higher returns. In short, we would need to question the well-established logic used to explain why capital is so consistently allocated in global markets.
Our analysis of LGPS holdings revealed how much money put into LGPS funds is reinvested in the local economies from which it comes – let alone when it comes to allocations with a real intention contribute to local economic growth.
As of March 2020, only 2.4% (£ 7.7bn) of the total LGPS funds of £ 326bn was allocated to sectors that we consider most capable of boosting local economic development, such as housing , SME financing, clean energy, infrastructure and regeneration.
“Investing in listed funds in key sectors – those that are well placed to stimulate local economic development and upscaling – has generated superior performance”
Additionally, we were only able to identify 1% of LGPS’s total assets (£ 3.2bn) that were directly invested in these sectors in the UK. It was striking to compare this investment to the £ 10 billion allocated by LGPS funds to FAANG holdings (Facebook, Amazon, Apple, Netflix and Google).
“Place” is rarely factored into the investment strategies of LGPS, one of the UK’s largest pools of institutional capital. Of the 98 funds, we only identified six with investment intentions hinting at the placement. Only one pension fund, Greater Manchester, had made a specific target allocation for local investment.
However, during our research – through surveys and interviews – LGPS funds overwhelmingly adopted the concept of PBII. It was understood that if the PBII could lead to more prosperous economies and local communities, local government incomes would improve, generating a virtuous circle of good pension fund returns and strong local multiplier effects.
In the long run, this could help ensure inclusive prosperity and sustainability, stronger local economies and greater financial stability for local government members of pension funds.
There is a clear and well-received sustainability case to be made for PBII, but that wouldn’t make sense unless we can present a compelling financial case. We could not lose sight of the fact that LGPS funds and pension funds more broadly have responsibilities, first and foremost, to their members as pension fund managers.
In March, sections of the pension industry made these age-old arguments in response to a government proposal to make it easier for trustees to invest in sectors such as private equity and venture capital by relaxing the cap on fees charged by asset managers.
While a territorial perspective would consider these sectors ideally placed to provide financing likely to stimulate local sustainable development, it has been suggested that additional performance fees would make them more expensive than fixed costs on listed assets and that this would ultimately be passed on to savers with no guarantee of return.
But this point of view is not supported by the figures (see table). Our analysis has shown that investments in listed funds in key sectors – those that are well positioned to drive local economic development and upscaling – have generated superior performance. Indeed, it indicated very attractive risk-adjusted returns, offering 1.5 to 2 times the FTSE 100 with less variability, even after fees.
Far from inhibiting returns, these investments would be more attractive than traditional assets. In addition, many of them would be cash-generating and counter-cyclical, offering portfolio diversification benefits for pension funds.
This establishes a compelling financial case for adopting a place-based lens, which could prove to be beneficial for the UK economy and the communities it is expected to serve. As our White Paper points out, place-based inequalities are more extreme in the UK than in most comparable economies and have existed for generations. Meanwhile, the pandemic, coupled with Brexit, has placed this seemingly intractable reality at the center of public debate.
The government has responded through its upgrade program, some of which estimate the cost of its delivery to be £ 1 billion over the next 10 years. It therefore seems essential to develop a clear rationale and path for how private capital can be mobilized alongside public investment.
One of the conclusions of our white paper was that if all LGPS funds allocated 5% to local investment, this would unlock £ 16 billion for local investment, which is more than the equivalent public investment in the local investment fund. leveling of £ 4.8 billion and associated government initiatives.
The decentralized geography of the LGPS, as well as the local investment decision-making powers of each fund, seem to make this pool of institutional capital extremely well suited to this endeavor. PBII is emerging with a growing wave of interest in how capital flows can improve ESG performance and contribute to the SDGs.
Those who cling to the old refrains that have served to legitimize a disconnection between “capital” and “place” seem ready to get their money’s worth.
Sarah Forster is the CEO of The good economy