“Fiduciary management has turned into a sophisticated exercise of managing increasingly complex investment value chains”
Since its inception in the early 2000s in the Netherlands, the concept of fiduciary management has undergone significant change. The global financial crisis of 2008 and beyond, the regulatory response and the transition from defined benefit (DB) to defined contribution (DC) constitute the formative influences on the way fiduciary management is perceived and practiced in different countries.
Plunging funding levels have alerted regulators and forced trustees to focus on matching risk. Re-negotiating and re-engineering the pension deal has become common in boardrooms and at pension trustee meetings. Whether seeking deficit repair contributions from the sponsoring employer or having to cut pension benefits, pension trustees face difficult choices and negotiations. Regulatory lenience has given way to a far more proactive and interventionist attitude on behalf of the regulatory authorities who focus ever closer on protecting consumers who have lost trust in the financial service sector in general. The costs of reporting to the regulatory authorities and communicating to the consumers have soared, while the enduring low-yield environment is driving pension funds into ever more complex asset classes and investment strategies in the search for returns.
For pension fund trustees and their service providers, these trends are driving the optimisation of the investment governance and client service models, which enable them to deliver the best possible results for their respective clients. An important consequence is the search for scale that underlies both the consolidation of pension markets and the increasing demand for fiduciary investment solutions.
For fiduciary solutions providers this is a mixed blessing. Large consolidated pension organisations have the resources to improve quality internally; they have higher buying power and lower dependence on external providers. Smaller pension funds increasingly seek support but, unsurprisingly, the focus on costs has sharpened, resulting in a margin squeeze for providers.
In our recent European market study assessing the business potential of various fiduciary investment solutions we distinguished the following activities:
● Delegated CIO.
● External investment consultant.
● Dynamic risk overlay manager.
● External manager selection liability-matching assets.
● External manager selection liquid growth assets.
● External manager selection illiquid growth assets.
The business potential for each of these activities varies per market and market segment, depending on the above mentioned driving forces.
The UK market is the largest in Europe but is fragmented, with the highest number of pension funds and assets under management. The market is dominated by large investment consultants with some fiduciary tendering activity going on, limited to the smaller segment below £500m (€600m). With the Financial Conduct Authority stepping in, the regulatory environment might change. Increasingly pension funds are investigating consolidation alternatives.
The Dutch market is highly saturated with low margins. Many commercial fiduciary mandates include liability-driven investment (LDI) management. Consolidation has materialised and has, perhaps, overshot, with over 70% of pension assets managed by only four fiduciary providers.
The German market offers interesting business potential for various forms of tailored fiduciary investment solutions. Overall, the German market for funded pension provision offers solid growth perspectives. However, the landscape is highly diverse, a corporate contractual trust arrangement (CTA) differs distinctively from a strictly regulated Pensionskasse. The number and role of investment consultants – who are all too often the trusted advisers, effectively acting as delegated CIOs – have, up until now, been more limited than in other European markets.
Across Europe and the UK there is a large variety of pension funds (and insurance companies), which differ by factors such as size and complexity, and which are subject to different regulatory frameworks.
Against this background, a key question is: what is the optimal investment governance and client servicing model, given the specific situation of a pension fund?
One approach is to help trustees make an informed decision when considering the costs versus benefits for different investment governance models.
As a simplified example, consider the following three investment governance models:
● Traditional model with investment consultant and some internal support;
● Bespoke internal delegated CIO;
● Bespoke outsourced delegated CIO.
For each of these models one can distinguish various levels of complexity, depending on the level of diversification, active management and dynamic risk overlay management. As mentioned earlier, the enduring low-yield environment is increasingly driving pension funds into more complex investment structures in the search for ways to outperform liabilities. The level of complexity is further influenced by whether the pension fund is regulated or unregulated.
It is worth remembering that there are many levels of fiduciary services. While in principle the fiduciary can do everything, including the actual asset management, the pension fund may insist that other managers be selected for specific tasks. For the pension fund, fiduciary management has turned into a sophisticated exercise of managing increasingly complex investment value chains with a growing number of strategic partners in an adverse environment. Independent advice is an important and valuable resource. For the provider, successfully offering fiduciary management requires a focus on solutions and smooth service from a consumer-focused perspective. While scale is essential to drive down cost, the trend towards de-bundling and the extension of the investment value chain offers interesting business prospects for specialist providers both in the mainstream and in the niches of the still segmented European pension fund market.
The authors are partners at Avida International