Pool skills, not assets
Anthony Ashton dispels some of the hot air surrounding global pensions asset management
The list of potential benefits to a multinational company of managing its pension assets on a global basis rather than country-by-country is long and impressive: economies of scale; reduction in fund management fees; better reporting; increased performance, improved control and risk management.
This article focuses on three different strategies that clients have used to achieve a truly global structure.
The most important first step is to concentrate on fund management structure, rather than fund structure. The hype surrounding the pan-European pension fund" and the publicity given to pension fund pooling vehicles have only served to confuse matters and divert attention from the real issues. It is not yet possible to have a single unified fund for all pension plans across the globe because of the differences in legal structures and the absence of reciprocal recognition by regulatory authorities worldwide.
Therefore, the key to achieving added value from global pension asset management is not to have a single fund but instead to use fund managers to implement a consistent investment strategy in a coherent way. Companies should focus on:
q pooling fund management skills rather than pooling assets;
q what fund managers can actually deliver, rather than what they say they can deliver;
q achieving a more rigorous and coherent investment strategy.
The following approaches represent the three main variants which have emerged in recent years and useful comparisons can be made between them. The three boxes summarise the different management structures, their advantages and their disadvantages.
Global active manager
This is where a single manager runs the entire portfolio of pension fund worldwide and has an active brief. Pooling of assets is not necessary: it is feasible for the manager to run each portfolio entirely separately.
Some multinationals find this approach the easiest to put in place since it is often the case that the various pension funds are already being managed on an active basis, although usually by different managers. The switch to global management involves no more than substituting a single global manager, with no change in approach.
Because no actual pooling of assets takes place there may be no obvious economies of scale. However the chosen fund manager will usually offer some reduction in overall fee rates in recognition of the total volume of business gained. Of course, the scale of the fee reduction depends on how keen the fund manager is to gain the business and also on how well the client negotiates during the selection process.
Since only one manager is used worldwide the multinational company has greater control over the investment strategy and can ensure a consistent approach is adopted in each country. The global manager should also offer a consistent level of reporting in each country and be able to consolidate reporting for the multinational headquarters.
However, the advantages of the global active manager arrangement are limited in comparison with the alternatives outlined below. Although some clients have found that this approach can bring significant improvements, at the moment it is unrealistic to expect a single manager to be able to deliver a credible service with truly active management in more than a few countries. If the plans in those countries are relatively small, the cost of mediocre performance in the plans in other countries may outweigh the fees saved.
And even those fund managers that claim to have a global capability may have a limited active management service - based on "large cap" stocks. As an example, consider the large number of different asset classes involved in only three countries: UK, Netherlands and Hong Kong. These include UK equities, UK bonds, Dutch equities, Dutch bonds, Hong Kong equities, Hong Kong bonds, overseas equities and overseas bonds. A single manager is unlikely to be the best active manager in each of these classes.
Global indexed manager
If the multinational is prepared to adopt an indexed approach in each asset class then the possibility of achieving efficient management on a worldwide basis is significantly increased. A multinational might adopt an indexed approach if, for example, it does not feel confident that active managers can provide sufficient extra performance to justify their higher fees. This fits naturally with a passive approach to pension asset management, although a tactical asset allocation overlay can be added.
Indexed funds are more straightforward for fund managers to provide and therefore offer a more credible approach than expecting to be able to achieve active management across the globe. A single manager can run all the index funds for each country and the consequent pooling of assets can bring economies of scale, although these are not always passed on to the client and fee negotiation is necessary.
Typically, such a global manager would also offer some consistency in the level of reporting of the separate plans around the world and also some consolidation of the reports for the corporate headquarters. The quality of the reports is often a great improvement on the level of reporting received from local managers in particular countries. However, it may well still fall short of the level of reporting received by the corporate headquarters for its domestic plans.
The process of choosing a single worldwide manager and negotiating terms and conditions provides an ideal opportunity to separate the fund management and custodial functions, and to do so efficiently. And the time to negotiate reduced fees to reflect a separate global custodian is before the fund manager's appointment - if the fund manager is appointed as global custodian from the outset he will be very reluctant to reduce his management fee scale if a separate global custodian is appointed subsequently. The fund manager will be conscious that he is hired or fired primarily on the basis of his performance and not on the basis of his fees:
q If his performance has been good he will feel confident that his services will be retained even if he does not reduce his fees.
q If his performance has been poor he will feel fairly sure of being fired anyway.
But there are still only a limited number of major providers.
Half global/half local
In this approach, local assets (such as domestic equities and bonds) are managed by local managers in each country, but the overseas sections of all the funds are managed by a single global manager. For the overseas portfolio, perhaps 30-40% of the total assets, there is an opportunity to benefit from some economies of scale.
This approach is a compromise between global and local management and may be suitable if the multinational does not wish to go fully indexed everywhere but would like to pick and choose some areas for active management. Our own experience is that, with a diligent selection process, the use of active management can be a significant source of added value, particularly in the European equity and bond markets. These markets are less well researched than the equivalent US markets, so there is an opportunity for active managers to add value from their own research.
With this structure, the multinational is able to select the best manager for each asset class, both on a domestic basis and internationally for the overseas portfolios.
For example, investment houses in continental Europe would not normally feature in selecting a manager for an overseas brief, but may be successful in their own markets. They are generally far smaller than in the US or in the UK and their local funds typically have smaller overseas allocations.
This structure is flexible and can accommodate many different approaches:
q tactical asset allocation can be excluded by fixing the weightings of the various asset classes in advance;
q tactical asset allocation can be included either by using an overlay or by giving the local managers an active brief which allows them to determine the relative proportions invested in domestic and overseas assets;
q passive or active briefs can be used for the overseas portfolios.
An added benefit is that the use of local fund managers may help ease political difficulties and obtain "buy-in" from local subsidiaries and trustee bodies.
Which approach is best?
To summarise, each of the three approaches outlined above has its advantages and disadvantages: there is no universally "right" answer. But there are some key factors worth considering:
q the amount of assets in each country's plans and in total - smaller plans (less than $5m) are often handled most easily on an indexed basis, using a broad-brush approach to asset allocation. So if the bulk of non-HQ pension assets is in smaller plans then the "global indexed" approach could be appropriate.
q the countries in which the multinational corporation has funded pension plans - if there are sizeable amounts of assets in the multinational's pension plans in Europe then it should be possible to improve performance by choosing good active managers for the various asset classes. The "half global/half local" approach could be best in this case.
q the preferred investment strategy - realistically, multinationals will only be able to adopt a "global active" approach if there are only a few major countries involved - and there is a fund manager which is strong in all these countries.
At the moment multinationals need to be realistic and set their priorities according to what is achievable. The fund management industry will have to consolidate further before the largest multinationals can benefit from truly global active management of their worldwide pension funds.
In the meantime, significant benefits can still be gained from a co-ordinated approach to global pension asset management by ensuring that:
q investment strategy is appropriate to the corresponding pension liabilities;
q funding vehicles are the most cost-effective available;
specialist management is used where possible;
q fee structures are reasonable, and
q manager selection and performance measurement are conducted diligently.
Anthony Ashton is an international actuary with consultants Bacon & Woodrow"