At the heart of long-term investing
You can tell if an idea in the pension fund world holds any water by the number of asset management chiefs who are around to lend their time and support.
On this level, the landmark long-term/responsible investment mandate competition organised this year by the UK’s Universities Superannuation Scheme (USS) and consultant Hewitt Bacon and Woodrow, was a resounding success.
The USS competition: “Managing pension fund assets as if the long term really did matter,” was eventually won in September by Henderson Global Investors with an entry that proposed a “dynamic benchmark” approach.
But far from that being the end of the affair, the great and good of the European asset management scene gathered in Amsterdam at the end of October at a seminar organised by the European Pension Fund Investment Forum (EPFIF) to dissect the shortlisted entries.
That they came in numbers lent considerable weight to the notion that relationships between institutional investors and their investment managers are changing, and need to change, if the idea of ‘sustainable’ pensions, in both the ethically responsible and financial sense, is to mean anything going forward.
The competition, launched in March 2003 and judged by a panel comprising seven senior industry experts, had sought entries from asset managers and individuals who could successfully respond to an imaginary E30bn mandate “that operated in a genuinely long-term and responsible manner”.
The final entry tally of 88 entries (56% corporate and 39% individual) was no mean figure, undoubtedly due to the zeal of two of the leading lights behind the competition, Raj Thamotheram, senior adviser, responsible investment at USS and Sally Bridgeland, an associate at Hewitt Bacon & Woodrow.
Explaining the process behind the judging, Bridgeland explained that the first stage had been to filter out entries that were not practical or just rehashed old ideas. The judges then gave feedback to shortlisted parties in a bid to get more complete solutions and fill in any gaps in the entry.
Final interviews for the competition, she emphasised, were carried out anonymously to ensure a level playing field. As Bridgeland put it, the marketing “pizzazz” was out: “We didn’t want to put off newcomers that are unfamiliar with the game that is currently played!”
Nonetheless, the competition fell slightly short of its aim to be a truly global endeavour. Almost four fifths (78%) of the entries were from Europe, with around 30% from the UK alone. More interesting perhaps was the fact that there were nine entrants from Australia yet only six from the US.
And as David Chynoweth, the former chief executive of USS and an advisor to the fund, noted in his opening speech to the seminar, the history of the competition was a response to a perceived disconnect between pension funds and their investment managers, whereby: “investment mandates had become disjointed from the work of the pension fund”. Pension funds, he said, could no longer see the direct link between investment and the payment of pensions.
Chynoweth pointed to the number of entries as a sign that this sentiment was not exclusive to USS.
“The fact that there were 88 entries proves that there are people out there who are willing to work outside the tracks. Other firms who did not enter are now also entering into the debate.”
Clearly the judges believed that Henderson’s entry was the closest to bridging this divide. Quite literally, in fact, as one of the major highlights raised by the judges from the Henderson proposal was that of having an ‘implant’ from the pension fund working with the asset manager.
This ‘partnership’, said Arno Kitts, head of UK institutional at Henderson, presenting the company’s winning entry, would be directed by an investment committee comprising senior executives from the fund, investment managers and relevant external experts. The ‘implant’ – paid for by the pension fund – would work directly on site with the asset manager to monitor day-to-day investment activities.
While a reading of the Henderson winning entry is necessary to flesh out all the nuances (see *below), Kitts explained that the approach was largely to be a true long-term investor, unconcerned by peers or benchmark returns and with the focus solely on meeting the liabilities without taking undue risk.
The Henderson entry proposes taking the long-term time horizon of the pension fund and seeking to produce superior returns relative to risk-free assets over the long-term on a rolling five to 10 year basis rather than to beat market-based benchmarks over a shorter timeframe.
Chynoweth explained that the judges had been impressed by the integrated approach to the mandate, which “puts together the best of existing practices”.
Another factor that had marked Henderson out, he said, was the ‘scaleability’ of the proposal: applicable to the whole portfolio of a pension fund not just a selected portion of the assets.
The idea of a “bespoke benchmark” had also won the judges approval, Chynoweth noted.
However, he added that the winning entry had not been blemish free. The judges, he said, had wondered whether the monitoring process outlined by Henderson was too traditional and whether appropriate performance targets could actually be decided upon.
Another question, he pointed out, was whether such a joint board structure would be able to take ‘difficult and timely’ strategic decisions.
Other shortlisted candidates amongst the corporates included Schroder Investment Management with a proposal for a dynamic asset allocation for pension funds, and Sustainable Forest Systems with a plan to develop high-value tropical hardwood to meet pension scheme liabilities.
The individual category was recognised as having produced some of the most innovative and occasionally ‘off-the-wall’ entries.
The shortlisted individuals, however, belonged very much to the former. Among the shortlisted entries, Jonathan Heller of Heller Associates, proposed a shared risk approach to responsible private equity, which was deemed an innovative way of purchasing private equity that could broaden the appeal of the asset class to pension funds, albeit with the caveat of being “rather complex” and unclear regarding the implementation of a genuinely responsible element.
Paul Hodges, chairman of management consultancy firm, IeC, backed an investment strategy based on influencing and supporting good management in small to medium sized companies. The judges noted that this challenged traditional ways of investment with the accent on small and medium cap investments and responsible investment through clear signals to company managers from investors. The judging panel said it saw no reason why this strategy could not be set up very quickly.
Peter Webster, executive director of Ethical Investment Research Services (EIRIS), looked at how pension funds could take responsibility for influencing their peers and the supply chain by creating a common investment vehicle. The judges particularly commended Webster’s innovative thinking about ageing populations and investment.
For Chynoweth, the competition had revealed a need to marry more innovators with established practitioners in the pensions and investment arena. “What we really need is a two-way learning process between clients and partners to move things outside the comfort zones of each party.”
His view was shared by Hewitt’s Bridgeland, who said she hoped that the energy and innovation sparked by the event could be carried through to the longer-term with the development of a blueprint for a real mandate via a real pensions consortium.
Bridgeland told the seminar: “I think you need qualifying conditions for the pension funds as much as the fund management side of things because the kind of relationship we are talking about involves a close working relationship and commitment between pension funds and the fund management world.”
Bridgeland said she would, however, like to make the competition a regular fixture for individuals in the hope of bringing in further ideas from outside the fund management domain:
“I would like to have the competition for the individuals again, although I’m not sure it would be an annual event. I think it would encourage thoughts from outside of the industry and the regular players to come in.
“Also, it might help bring thoughts out from within the industry like this year where we had thoughts from our competitors and from fund managers which individuals helped to bring to the surface.”
This future vision was picked up by USS’ Thamotheram, who reminded the seminar that resting on laurels was no recipe for change. He noted that the big challenge now was how the lessons/ideas of the competition could be introduced into ‘our core processes’. “Unfortunately, very few of the proposals picked up on the fact that as large pension funds we own UK plc, for example. Also very few picked up on the ‘fiduciary responsibility’ of being a responsible investor.
“The competition has come up with some great ideas but the way forward is probably not through another competition but in creating even better frameworks for innovation.”
*All the shortlisted entries can be found on the USS website at http://www.usshq.co.uk under ‘competition’