Consultants have a role to play
Although many smaller pension funds do not find it necessary to take on the services of a custodian, it becomes necessary at a certain level of complexity. In the UK, at least, if a fund only invests in pooled funds, there is no need for a custodian since the pooled fund manager has a link to a custodial services provider.
But when a fund is larger, or has some other specific requirements that mean segregated mandates are used, it then has to appoint a custodian, says Marek Siwicki, consultant at Aon Consulting in London.
“The advantage for a pension fund in having a global custodian is that all your assets are in one place,” he says, which allows all kinds of operations to be performed. Transitions, for example, are much easier to effect. “Moving portfolios to a new manager, from equities to bonds, for example, can be done quite efficiently.”
An important point about choosing a custodian, says Siwicki, is that the firm selected ought to be able to work well with the asset managers. After all, there is far more cooperation between custodians and asset managers than there is between pension fund and custodian.
When helping a client select a custodian, Aon would ask the fund manager used by the client which custodians they find they can work with. “It’s quite important to see that the relationship between the custodian and the fund manager is good,” he says.
Other factors are quality of systems, the ability to operate in different markets and added extras, says Siwicki. “But most of them (the providers) are pretty similar,” he says.
Frits Bosch, director of consultancy Bureau Bosch in the Netherlands agrees pension funds are now becoming more aware of the value of extra services that custodians offer. “I think many of them now realise they need a custodian not only for the regular custody activity,” he says. “They’re looking much more for the broader services that are provided.”
These include data warehousing and management, risk management, portfolio analysis, analysis of trades and the costs involved. “Custodians are no longer only doing custody, but are being able to give tailor-made services to pension funds.”
The larger pension funds in particular tend to choose the larger custodians, says Bosch. The bigger the asset base of the pension fund, the more likely it is to conduct asset management in house, and this can result in the need for a wide range of services from a custodian.
Securities lending is certainly one of the services often required, but there are reasons why many pension funds shy away from this. There is always a certain amount of risk involved in securities lending, says Bosch. “It depends if they want to run these risks,” he says, while on the other hand, many pension funds see that the advantages of lending out their securities outweigh the risks.
It is important for the business of custodians to be conducted completely separately from asset management, he says. “The analysis must be done objectively,” he says.
While some of the larger custodians such as State Street and Northern Trust successfully maintain a ‘Chinese wall’ between their investment and custody operations, this is not practicable for the smaller ones.
Although switching from one custodian to another inevitably causes some degree of upheaval for a pension fund, it is important that funds are willing to do this. They must keep a watchful eye on the value-for-money they get from any of their service providers.
“A lot has to be done about costs,” says Bosch. “Pension funds are very aware of the costs these days.” If the services are available from another custodian and it costs less, then pension funds are obliged to consider switching. Custodians are actively seeking business from some funds, making offers based on services and cost.