Anton van Nunen, Van Nunen & Partners
The first fiduciary contracts were drafted some 7-8 years ago, and now more than three quarters of externally managed Dutch pension money is under fiduciary management. It is time to evaluate the rapid development and, in particular, to correct aberrations that have occurred since.
In the period 2001-05, an insurance company (VGZ) and a pension fund (Campina) assigned me to remodel their investment policy in such a way that the link with liabilities was core, returns were maximised within an explicitly defined risk budget and the board was in control through an adequate delegation of tasks and clear reporting. These contracts grabbed a lot of attention and many institutions followed their example after a lag caused by the slow, conscientious, decision making process that arose from the organisational implications of such a dramatic change in operation.
There is a confusion about terminology and I cannot escape some blame. I derived the ‘fiduciary management' label from Ambachtsheer and Ezra's ‘Pension Fund Excellence' and in using the term I may have caused people to think it suggests more than it implies. It was my intention to find a label that would describe my approach pithily and the label does that.
It refers to the fact that having a third party engaged in important matters requires faith in that party. Sadly, however, some pension funds have used the overall concept to delegate tasks that cannot be delegated and to leave important decisions to the fiduciary manager. Decisions with respect to the size of the risk budget, the strategic portfolio, the importance of active risk, the benchmark specification and the like cannot be delegated by the board. Dutch law prohibits that and, frankly speaking, the fund should not want to consider this delegation at all.
Versions of fiduciary management
Ripples, however, have especially occurred because consultants have joined the ranks of fiduciary managers after realising that they were losing market share. This caused a creation of consultancies advising on the same concept but with conflicting interpretations. Trying to stop this dilution, I defined fiduciary management in my book as the integral set of five tasks: advice, portfolio construction, manager selection, monitoring and reporting, supplemented by an educational element that has gained in importance along the way. It is an overall concept.
I conceptualised and defined fiduciary management at the time, maybe not optimally in terminology, but it suffices. Other approaches may have their followers, but they should label their product differently.
Also, the belief that the axis between liabilities and assets has only recently become the focal point of the fiduciary approach (‘version 2.0') is incorrect. From the first contracts, the fiduciary has targeted ‘surplus at risk' and only if the consultant or client wants a different approach will the manager advise on an ‘asset-only' policy.
Origins of the concept
This short history is a good opportunity to settle accounts with some parties who claim to have offered fiduciary services for a long time. I do understand that this is a nice marketing technique; it is, however, in sharp contrast with reality. Most parties claiming this pedigree have been approached by me at one time with an RFP and I have received answers ranging from an indication that they could not deliver, to statements that the thing that I was looking for did not, and would never, exist.
Now that the concept has proven to be a success, those parties want to distance themselves from their previous views. They skillfully use the following distorted reasoning: fiduciary management has proven to deliver a substantial contribution to good pension fund governance and some fiduciary managers claim to have provided these services for a long time because they are a well-run pension fund by pedigree. Asset managers, after buying a pension fund or merging with one, claim fiduciary management to have been offered in their organisation for a long time and suggest that it is new wine in old vessels. It is a pity that clarity in origin and content has disappeared in this way.
It would have been more efficient when attention was directed toward a correct definition of what they offer.
Really new development
The Dutch regulator has also contributed to the development of the concept as well - not in its conceptual framework but in its actual appearance. As the fiduciary usually constructs a far more complicated portfolio than there was before and uses instruments not used before, the investment process has grown more intricate. As the regulator requires the board to be in control of the detail, this implies a heavier burden for the pension fund board. That is why many suppliers have elevated the educational part of their offering. This is a very positive development, enabling fiduciaries to distinguish themselves.
Perhaps most controversy exists with respect to the results fiduciary management has accomplished: are they better? This question can be answered with an unconditional ‘yes'. As I might be regarded as biased, this verdict needs to be substantiated.
The most important results have been reached at the qualitative level. In all contracts (known to me), risk management has improved strongly through systems which were previously unattainable, adequate monitoring, deliberations in which risk is central, and with good reporting.
As for the quantitative results, they can be split between those either stemming from portfolio construction or from manager selection. The emphasis on the link between assets and liabilities is clearly revealed by the strategic decision to hedge the interest rate risk, when not present already. In this context, it is important to see that this decision was rightfully taken out of the tactical field. It is not the interest rate level that should determine whether or not to hedge but the fund's objectives and its risk budget. Next to this, improved portfolio construction has increased diversification which has also led to a better use of the risk budget. The long-term benefit of that is evident.
Less positive are the results from active investment policies. Manager selection and the use of other active policy components, in general, have not brought positive results in the last few years. This should be held against fiduciary managers, and it is only small comfort that other managers did not fare better. These results of course do not have a connection with the fiduciary concept as such, but they do play a role in evaluating managers in general and thus should also be used to evaluate fiduciary managers.
All in all, fiduciary management has contributed strongly to the idea that risk is really the only asset an institutional investor has at its disposal and that adequate measurement and efficient use of it is the only way to realise objectives.
Anton van Nunen is principal of Van Nunen & Partners and the author of ‘Fiduciary Management: Blueprint for Pension Fund Excellence'