The Pensions Ombudsman has warned pension fund trustees that they must understand their investment risks. Nyree Stewart assesses their evolving role

In his 2007 annual report, published last November, the Pensions Ombudsman Paul Kenny reminded trustees of their need to take more responsibility for decisions in the investment area. He revealed that his office had received a number of complaints during the year “in the area of investment” and pointed out that “trustees need to recognise their obligations in the investment area and carry them out conscientiously”.

A number of complaints arose from monies that were meant to be invested on a defined contribution (DC) basis but were mixed up with a sponsor’s main defined benefit (DB) fund, and in one case a complainant was awarded €35,000 after trustees failed to consider disinvesting funds representing additional voluntary contributions (AVCs) during the wind-up period of a scheme, which resulted in a “significant loss”.

Kenny says that in many cases “trustees rely on the notion that they can sit back and await instructions from scheme members, who often have no up-to-date information on how their funds are invested”.

But he warns: “Except under certain prescribed conditions, the sole responsibility for investment lies with trustees, and it is time that all trustees, but particularly professional trustees, woke up to their responsibilities to members.”

Deborah Reidy, from Hewitt Ireland’s global investment practice, points out that trustees of most large pension schemes have already taken steps over recent years to understand the investment risks and diversify. In addition, these funds have taken steps to “remove the Irish bias that has always existed”, as around one-third of an average schemes’ portfolio has been invested in Irish equities and property.

However, Reidy highlights that many small and medium schemes have adopted a managed funds model - a one-size-fits-all approach - that still has that Irish bias, although recent underperformance by the domestic market in the last 18 months has meant the weighting has reduced from around 20% to 8%.

She says Hewitt is “finding more trustees are becoming aware of the risks they are running” and that they are taking action to address these. But she warns that “some are in a Catch-22 situation”, as the market volatility means they could lock in losses if they try to de-risk now.

To replace the Irish bias in pension investments, Reidy reveals that trustees of small to medium schemes are switching to euro-zone equities as there is no currency risk, a trend that was originally expected when Ireland joined the euro in 1999. “But the rise of the ‘Celtic Tiger’ meant people were comfortable leaving their money in place,” she adds. “The other option is to go global and hedge currency, but this is really only appropriate for medium to large schemes; the smaller ones are going for euro-zone.”

“Trustees won’t have had time to take the Ombudsman’s comments on board and will not have done anything in response to it yet,” says Martin Haugh, partner at Lane Clark & Peacock (LCP) Ireland. “But the issues he raised are live ones for trustees at the moment regardless”.

Haugh highlights a move in DB investment towards meeting liabilities rather than targeting outperformance, but suggested more focus will be placed on DC investment and the recent trend of “trustees forcing investors to take risks they wouldn’t otherwise take”.

He adds: “This is likely to lead to DC trustees being more prudent in the choices they offer and more focused on the default fund. They will also need to offer more information to allow members to have informed choices, so there’s a need for education for both parties.”

The Social Welfare and Pensions Act 2008 that came into force last year introduced for the first time a formal requirement for trustees to undergo training within six months of their appointment, and then at least every two years afterwards, with on-the-spot fines for breaches of the regulations.

“It is hoped this training will mean that trustees will become more educated in general about pension schemes,” Haugh says.

Jerry Moriarty, director of policy at the Irish Association of Pension Funds (IAPF), agrees that the compulsory training should improve things, as “the problem is partly that we have an awful lot of small schemes where trustees are not sitting down and considering choices, they’re just choosing a provider and delegating it to them”.

The Ombudsman’s comment on trustees taking responsibility was a warning about trustees “not giving appropriate choices to members and also trustees giving members choices and then thinking they don’t need to do anything else”, he adds. “Investment is becoming more of an issue for people who hadn’t considered it before. Things are so extreme it has made people sit up and take notice. Although many larger schemes are more aware, when smaller schemes and members are realising they’re losing 30-40% in value, it becomes a priority.”

However, Haugh suggests that the investment management industry should be taking some responsibility and coming up with more creative solutions for DC investment, such as better profiling or risk reduction techniques, to address the needs triggered by growing awareness of the “lottery of DC schemes”.

He adds: “What the Ombudsman is getting at is there should be no difference whether you retire at a good or bad time in the markets. We almost want this commentary when the market is good, and have people lock in gains as when markets are rising is when you take the risks. It’s a bit late in the day to de-risk now. The problem is investors don’t know what they’re doing and so are trusting trustees to do it for them.”

A possible alternative to managed funds for smaller schemes is diversified funds, “with some assets in alternatives such as commodities and a better risk profile. It remains to be seen how the take-up is although it’s not a new concept,” Haugh adds. “But in the meantime we will see more interest in absolute return funds for DC schemes.”

“There has been a significant increase in the number of meetings and projects coming out of them around investment strategies and reducing risk,” says Reidy. “But for small to medium funds the biggest issue is education - there is a real need for more education.”

Reidy also argues that “there is a big difference between generic training and specific training, particularly for DB investment, so trustees need to be careful that the training they’re receiving is adequate”.

She agrees that the Ombudsman was right to highlight the need for more investment responsibility, but points out that “the larger schemes already do this. In general the small and medium funds are the ones that need to focus more on risk, they are the ones that need more hand holding and education”.

“Trustees need to have a structure in place for how they deal with investment issues,” says Moriarty. “We’ve issued guidance on this already, which is pretty basic stuff about taking advice and discussing investment matters at least once a year.”

“Training is first priority, but the next trend could be delegated consulting,” says Reidy. Also known as fiduciary management, this is where trustees enter into an arrangement that is either directive - where they tell the consultants what to do - or they delegate the whole day-to-day business to the consultants.

“Fiduciary management has not really taken off here, it’s not a model that has been accepted but I think that’s going to changes,” Reidy says. “If it had been in place increased risk reduction and diversification would already have happened and a lot of the damage caused could have been avoided.”

Haugh says he can see the logic behind a fiduciary management approach, to lessen the responsibility on trustees. But warns: “You’re almost adding an element of risk by allowing someone to make decisions and you would have to incorporate that into the risk budget and profile. So you would need to be confident that you get some reward for that risk.”

Moriarty agrees that it is something that people will look at in the future, but highlights other potential problems. “It means different things to different people and there is an issue for smaller firms on how to access this type of solution without much resources,” he says. “I do think people are starting to realise you can’t always rely on the market, particularly to get out of trouble, so they will be looking at how to make sure this doesn’t happen again. Sitting back and waiting for the markets to change is not an option.”