Still a need to stick to principles

The pensions landscape might have changed greatly since the Myners principles were set out seven years ago, but David White finds that they are as relevant as ever

Seven years after Paul Myners' review of institutional investment in the UK, it is easy to forget the main reason for the exercise. The government was worried that UK pension funds were not investing enough in private equity, and therefore not doing enough to help the UK's enterprise economy.

The scope of the review soon broadened as it  found that the disinclination to invest in private equity was part of a wider failure to invest in the full range of available asset classes.

The weak governance and decision-making processes of institutional investors in particular, and occupational pension funds in general, were blamed for this. Myners concluded that pension fund trustees simply did not have the investment expertise to be able to work on the same level as investment consultants and fund managers.

The result was the Myners principles - guidelines designed to encourage better investment decision-making and governance. Now, as the UK government prepares to update these principles, it is worth asking whether they have had the effect that Myners intended.

The principles were intended to be the accepted code of best practice in investment decision-making and governance, and this intention has stood the test of time. The principles now represent a gold standard of governance.

Yet the principles reflect the times in which they were drafted. They do not reflect current concerns about risk. Trustees must now take account of the risks attaching to their scheme. In particular, they must now take account of the strength of the scheme sponsor covenant and the risk that a sponsor might default.

The principles also focus almost exclusively on one side of a pension fund's balance sheet - assets - and take little direct account of liabilities.

Some of the principles have been subsumed by legislation or regulation. For example, the 2004 Pensions Act places a duty on trustees to ensure that, within six months of being appointed, they have the appropriate knowledge and understanding to fulfil their duties.

Finally, events have overtaken the principles. The UK National Association of Pension Funds (NAPF), reviewing the application of the Myners principles over the six years since they were introduced, points out that the investment world had changed significantly in this period.

Pension fund priorities have changed. In 2001 many schemes were considering how to distribute their surpluses. By 2007 they were puzzling over how to reduce their deficits.

The NAPF also noted that trusteeship had become more complex as a result of a harsher financial environment and more regulation. In a poll, trustee chairmen estimated that the time trustees commit to their responsibilities is now around 20 days a year, compared with eight days a year in 2001.

More important, the immediate demands made on trustees, such as plugging scheme deficits, assessing the strength of the sponsor covenant, and taking part in corporate decisions in the event of take-overs, had pushed investment decision-taking and governance - the very issues that the Myners principles were designed to address - into the background.

Paul Trickett, (pictured right) European head of investment consulting at Watson Wyatt, says this downgrading of governance was inevitable: "The pensions landscape is now very different from 2001. It is more complex and there are tighter regulations, enforced by a stronger regulator. Trustees have understandably focused on the principles enshrined in new laws first and then in turn on governance, performance and assessment."

There has also been a shift in emphasis in the objectives of the Myners principles, from ensuring that trustees do not impede the operation of the investment process to ensuring that they are an active part of it.

In 2001 the UK government was concerned chiefly about ensuring the efficiency of the ‘investment chain' - in other words, encouraging trustees to channel investments into a broader range of asset classes.

Six years on, the focus is on the ‘trustee decision-making chain' - equipping trustees for their role as schemes' fiduciaries.

All this suggests that while the principles have not changed, the landscape has. Guy Willard, investment consultant at Hewitt Associates, says the underlying aims of the Myners principles remain as relevant as when they were introduced. However, the economic and investment backdrop has changed markedly since their inception.

"UK pension scheme trustees are being faced with more and more complex investment-related decisions and the range of options available to them continues to multiply. This also means that governance issues have increased in importance and we believe it is right that the principles should be updated to reflect this."

Trustees themselves are worried by the investment decisions they have to make. Watson Wyatt says its biennial trustee self-assessment survey found evidence of concern among trustees at their ability to cope with managing their pension fund investments. In particular they were concerned about their skills in being able to assess the effectiveness of their investment decisions.

Trustees are also embracing more complex investment strategies. Lloyd Raynor, a consultant at Russell Investments, says that in response to widening deficits, some trustees have been moving towards liability hedging, alternatives and alpha-oriented approaches

"These responses require enhanced decision-making and oversight resources, in terms of both expertise and time available. Funds run the risk of implementing more complicated fund structures while not enhancing their governance structures adequately, creating a ‘governance gap'."

Raynor says the updated Myners principles should encourage funds to match their governance structures to their investment approaches. "At present there is a risk funds are trying to do too much with the governance arrangements they have in place."

He also suggests that there is a need for more professionalism. "We feel it would be helpful to see pension funds being run more like companies to help fill any governance gap. The efficient management of companies requires executives to be fully empowered by the non-executive oversight function, and we believe parallels apply to the management of pension funds."

Jonathan Berman, partner and head of the investment unit at the law firm Sackers, argues that updating the Myners, principles will be ineffective if it is not backed by investment in decision-making and governance. "Regardless of the proposed changes to the principles, an insufficient governance budget still presents a major barrier to effective investment decision-making by trustees," he says.

Nor will improved training of trustees, by itself, guarantee better decision-making and governance. In its response to the government's consultation, Watson Wyatt says that it believes the Pensions Regulator will not be able to deliver its risk-based approach to regulation if it relies on increased trustee knowledge and understanding alone to improve the investment governance of occupational pension funds.

Similarly, Russell Investments says in its response that "trustee training, while necessary, is not sufficient in our view to achieve the levels of professionalism required in today's complex investment environment.

"We are not optimistic regarding the ability of training of existing trustees, by itself, to fill the governance gap. If trustees wish to adopt more strategies requiring more governance, we believe delegation to internal executives and external specialists to be a sensible approach"

Hewitt acknowledges that the Myners report's introduction of trustee knowledge and understanding has established "a minimum standard of knowledge". However, it says that pension scheme trustees are still finding it hard to keep pace with changes in the investment industry and the pressures put on their time. "It remains difficult for trustees to effectively challenge and adequately monitor more complex investment areas, such as those involving derivative strategies."

The main thrust of an update of the Myners principles is the return to the original course of encouraging good investment decision-making and governance, which trustees have been blown away from the storms of the past few years.

The government has placed governance at the centre of the proposed updates to the Myners' principles through the introduction of a joint government/industry Investment Governance Group (IGG). The IGG will co-own the Myners principles, monitor their effectiveness and the quality of reporting against them and make recommendations for improvements to investment decision-making and governance.

Paul Trickett says the proposed ICG "effectively moves institutional investor decision-taking in the UK up the regulatory agenda while highlighting the value and benefits of good investment governance".

Piers Bertlin, principal in Mercer's investment consulting business, suggests the real beneficiaries will be the trustees. "Investment decision-making is one of the most technical and demanding areas of trustee activity, and improving its effectiveness will benefit the relationship between sponsors and trustees, UK pension funds and the wider economy."