Berkshire: Straight talker
The UK's Royal County of Berkshire pension fund has slashed long-only equities and hedged its longevity risk. The manager of the fund, Nick Greenwood (pictured), told Brendan Maton about his strategy
Royal County of Berkshire Pension Fund
Invested assets: £1.25bn (€1.43bn)
Fund structure: Final salary defined benefit
It is no wonder ordinary trustees have only the vaguest idea what professional investment managers mean when they present to pension schemes: the investment world is so cluttered with jargon that most people turn away to focus on things they can understand.
‘Positive liquidity events' (profit); ‘challenging headwinds' (recession); ‘turning down the risk-dial' (selling equities); ‘the sustainable escape velocity of GDP growth' (economic growth). Unless you believe in obfuscation, there is no need for such expressions.
Once in a while, a pension scheme manager comes along who sweeps this jargon away. Usually, but not always, the manager in question works wonders for his or her scheme because out with the jargon goes timid acceptance of what consultants and commercial asset managers serve up as their costly, standard fare.
A select few pension managers have reminded the European pensions industry of the value of plain language.
Nick Greenwood, pension fund manager at the Royal Borough of Windsor and Maidenhead, the administering authority for the Royal County of Berkshire Pension Fund, certainly belongs to them. Perhaps it is because of the northern English upbringing, but Greenwood calls a spade a spade and a shovel a shovel.
"The bane of my life is investment manager agreements. I take a red pen and put a line through all the spurious amendments they make," he says. "At the end of the day, I remind them that I am the client and most of these additions are there only to reduce their business risk, not mine."
It sounds aggressive but in preliminary tender processes managers are asked to present how they will run the money. In other words, the appropriate time to insert any unusual conditions comes far earlier than the final signing. Greenwood's style is firm but fair. It appears abrasive only because the number of knowledgeable pension fund straight-talkers is low.
Greenwood can challenge spurious amendments because he has 30 years of experience in the investment industry. A third of his working life has been spent as a stockbroker. Almost a half as an asset manager, mostly in equities, including seven years as in-house equity manager for the pension fund of asbestos manufacturer Turner & Newall. Since 2004, he has been responsible for investment strategy and manager selection, first at the pension fund of the UK's Environment Agency, and since 2007 at Berkshire.
This relevant variety of experience explains why Greenwood's current employer has achieved so much in under three years. As a confident, competent individual he entertains and evaluates new ideas rapidly. It is stockbroking thinking on his feet.
Thus the £1.25bn (€1.43bn) local government scheme, covering employees in Berkshire, has implemented a truly diversified asset allocation strategy, slashing long-only equities from 70% to 22.5% and replacing them with private equity, commodities, hedge funds, indirect global property, infrastructure, high yield and emerging market bonds.
An investment working group has been formed to swiftly seize on market opportunities, avoiding the inefficiencies of the formal tender process.
Berkshire is also the first public body in the world to hedge its longevity risk: eleven thousand retired council workers have their pensions insured with Swiss Re.
All these feats merit public recognition, including a gong at the 2009 IPE Awards for its approach to commodities.
But perhaps the most telling comment comes from a member of the scheme's general board, known as ‘the panel', who told Greenwood that after 14 years in the post he never heard the scheme's liabilities being discussed, let alone discussed how to manage them.
How that practice has changed. Berkshire now has a monthly assessment of assets and liabilities. It is easy for ‘the panel' to compare the two.
"The panel was used to comparing investment manager performance against an index or the scheme's position in a universe," explains Greenwood, with a shake of his head. "That was the primary function of meetings in the past."
He makes an interesting contrast with stockbroking. "I never even mentioned the market in monthly reports to clients, let alone some peer index. We discussed the stocks they held and their value with some recommendations to buy or sell."
While many pension scheme panels and boards still spend far too much time on performance per se, Berkshire has escaped. All that matters for now is how the assets are doing versus the liabilities.
The revolution began with Greenwood's reading of the regulations governing local authority pension schemes (there are 89 administering authorities in the UK but the regulations are the same for all). "There is nothing explicit in the rules requiring us to be 100% funded, although, of course, it is implicit," he says. "There is, however, a duty to seek as stable employer contribution rates as possible."
Stability inevitably begins with asset-liability modelling. Greenwood was not going to take the well-trodden path. He does not believe that traditional actuarial providers necessarily have the knowledge to model alternative asset classes and he didn't want the fund to put 5% in alternatives merely because "that's what everyone else does". His own actuary concurred and a team from Morgan Stanley got the brief.
Backed by what Greenwood describes as a "solid ALM", the tendering process began in the summer of 2008. That securities trading all but froze that September was not pleasant but did not radically affect the scheme's timeplan. Greenwood viewed the crash phlegmatically. As a former ex-stockbroker he knew what loss of liquidity meant and was astounded as anyone else by the speed at which the collapse of Lehmans hurt global markets. But for a long-term investor, which was not transitioning assets at the time, Berkshire's plans were not derailed.
The first new investment mandates appeared in April. Having now introduced a raft of new ideas, structures and managers, it is interesting to see how Berkshire is modifying and looking to improve itself.
On the manager level, for example, Greenwood altered a bond mandate with Fidelity last March to investment-grade only in expectation of extra returns as credit spreads narrowed. He says he looks two to three years on, as any short-term focus is a sure way to going nowhere.
Generally, Berkshire has two managers per asset class. On the strategy level, the fund appointed three active currency managers but Greenwood ponders whether this whole practice is becoming too crowded to persist long term.
On the governance level, two external advisers have been appointed to the investment working group to strengthen its inputs when making dynamic asset allocation decisions. As an aside, Greenwood notes that except for its limited partnerships in private equity and infrastructure, the scheme can divest within a month from all commitments, including hedge funds. It may have been a blessing that the initial tender process took the best part of a year, thereby mitigating the rupture of the 2008-09 crash, but from hereon in, Berkshire is a big fan of pooled investments.
The investment working group needs to be able to implement decisions fast and operating via the traditional channels of EU-wide tendering takes months not days. For a similar reason, hedge fund exposure is achieved by means of a managed account run by Lyxor Asset Management. It is not permissible for underlying hedge funds to obscure their positions. Lyxor is a pioneer of such transparency; it is interesting to note that the larger hedge funds of funds have followed or are following suit.
Finally, another US investment bank has been modelling non-normal returns for the scheme. This tackles the dark waters where black swans glide. Now that Berkshire has its asset return assumptions, Greenwood is keen to get a sense of what happens if things go really wrong: those unexpected events that we all now know plague financial markets more than other walks of life.
The local authority scheme is not fully funded. Greenwood wants to know how much is at risk on the path back. Rest assured the findings of the investment bank scientists will be put into plain English before they reach the panel members.
The views expressed in this article are those of Nick Greenwood in a personal capacity and not those of the Royal Borough of Windsor and Maidenhead