Dancing to the benchmark tune
Most pension fund managers, judging by IPE’s survey, match their performance against a benchmark, having abandoned the goal of achieving an absolute return as irrelevant in today’s markets. Approaches to benchmarking vary, as do attitudes to changing benchmarks
In this month’s Off The Record we asked you to bare all with regards to the ‘benchmark’: that hallowed reference point by which pension schemes and investment managers soar or suffer.
And by all accounts the relative ‘benchmark’ is well … today’s benchmark of choice for pension schemes, as opposed to measurement of a fund’s performance based on an absolute return basis.
All respondents say they now utilise a specific benchmark or index by which to compare the performance of their fund, with only around 20% noting use of an absolute return yardstick for investment figures. No scheme says it operates absolute return comparisons without the back-up of a relative standard and less than 1% say they have ever changed benchmark approach. An explanation for this comes in the response of one manager to their fund’s benchmark shift: “With the markets as funky as they have been, absolute return was an irrelevant measure of a managers performance.”
Only one respondent points to the setting of a minimum absolute return figure for their investments – a 6% real long-term rate on property returns.
The ‘funk’ of the markets may have led managers to dance to the same benchmark tunes, but only 44% of schemes are comparing their moves to peers in the market and benchmarking accordingly.
And less than 1% of schemes use the average performance of similar funds as a guide.
Other benchmark approaches mentioned by scheme managers include comparing the average performance of identical mandates awarded, simulations of efficient frontiers and also, in one case, comparison to a national portfolio.
In terms of changing benchmarks, around a third of funds say they can switch within periods of three months or less. Conversely, around half the responding managers comment that it is possible to alter benchmarks either annually or every three years.
One manager notes they have entire freedom, but adds: “It doesn’t make sense to change though.”
Another notes that there may be occasions to consider a shift: “I suppose that we could change whenever we liked. However, we consider it inappropriate to change benchmarks often and like to keep the same. We did change benchmark though for overseas equities towards the end of 1998 as we thought that the original benchmark was adversely affecting our performance.”
For performance measurement of internally managed funds, it appears the approach is relatively diverse, with in-house processes being complemented by advice from a mixture of consultants, custodians and specialist performance measurers – with little consensus revealed.
For external mandates, the performance measurement split is more marked. Preference is split 50/50 between asset managers and custodians, with consultants and performance measurement groups – those mentioned include WM, Frank Russell and CAPS – also garnering business from a third of scheme respondents.
And almost 100% of funds are using these figures to put their investment managers through the treadmill and assess whether they are meeting objectives.
Around half say their asset allocation policy is also rebalanced according to performance measurement statistics, with 56% reallocating funds between investment managers on the back of the figures.
Tactical asset allocation shifts as a result of the statistics are considered by a quarter of funds, and 44% comment that they are employed for calculating performance related fees. Only 12.5% of schemes say they use performance figures to pay bonuses to investment managers – although one fund says this is the sole benefit of their figures.
Certainly the onset of performance attribution analysis and reporting appears to have become the norm today by which scheme managers can see the workings of their investments.
Two thirds of respondents are using such information – for the most part accumulated on a quarterly basis (50% of respondents).
Around a quarter of funds ask their investment manager to perform the attribution dissection, 20% opt for their custodian and 12.5% for a consultant.
And the level of analysis performed is as varied as the pension funds responding. One fund says they require the “main facts only” others go for “very detailed” and one stipulates the desire for “currency, allocation, timing and stock level reporting.”
For the most part, funds are using these statistics for performance enhancement, although other reasons include risk management, manager evaluation, portfolio rebalancing and the practical function of “presenting board reports”.
For one respondent the use is straightforward: “We use this information as information.”
In general, the reports received are considered of ‘good’ quality, with only a couple of dissenters claiming figures to be merely “sufficient” or “average to good”.
The response seems slightly baffling in light of the fact that a third of schemes point out that the numbers they receive are inaccurate.
And a handful of managers estimate that the figures they receive could be as much as 25% wrong.
However, even more tellingly, 44% of schemes says they have discrepancies at least 5% of the time, indicating perhaps a default level at which attribution figures can not be 100% correct. Again, most funds (75%) check these figures on a quarterly basis, followed closely by 69% of schemes which verify monthly and just under half which also look on a half-yearly timeframe.
Of course there is always the chance that the accuracy of statistics can be measured against the amount of money changing hands for them. For 35% of plans the arrangement seems to be part of a package where a fee segment of between zero and 0.5 basis points is being charged for the information.
Other schemes are quite clearly seeking more specialised outside help and paying between five and 10 basis points for the privilege.
On the whole though, the revolution in the availability of such information and the greater levels of public dissemination of performance figures occurring in today’s European pensions arena is seen as a positive development.
For some fund managers the ‘competition’ element of releasing pension fund investment figures ensures best quality to prevail: “Public interest in our performance entails that the investment department has to perform well at all times,” notes one manager.
Another adds that benchmarking keeps pension schemes on their toes: “It is a good tool to challenge what you have done so far and take the necessary correction measures or keep to one’s strategy.”
One scheme notes the protection element against misdemeanours: “The more openness in the affairs of a pension fund the less chance of future scandals. The principles of good governance should apply to allow the fund’s members and all connected with it to have access to such information.
But one manager fervently disagrees with the above statements, arguing that public documentation could be detrimental to the pensions industry: “There are a lot of political issues in the several funds, especially concerning real estate and mortgages to members.
“The funds are not comparable. The other reason is that we are strategic long-term investors and because of this more successful than life insurers. We should keep this advantage.”
Like it or not though increased levels of analysis, accountability and disclosure are here to stay.
The variety of responses to this month’s Off The Record, however, suggests there is some way to go before like can truly be compared with like.