Dealing with external advisers
IPE asked three pension services - in Germany, the UK and Poland - the same question: ‘How do you make use of consultants?' Here are their answers:
Richard Barlow, chief executive at the Electricity Supply Pension Scheme, which has AUM of £23bn (€30.7bn)
We have a two-tier scheme consisting of a central administrator and 21 separate groups, and each group has its own actuarial and investment consultants. They are appointed under separate contracts and may be from different firms. We also have an investment consultant at scheme-wide level because in addition to the investments that are managed by the individual groups we have £1bn of assets which are supervised centrally.
UK law requires trustees to appoint an actuarial consultant for your scheme. And the burden of UK regulation has increased the pressure on trustees to be compliant and thorough, which has in turn led to a rise in the use of consultants.
Trustees have wide powers with regard to investment strategies but unless they are regulated - which most of them are not - they do not have powers of day-to-day investment decision making, for example in the selection of particular securities for the portfolio. Although they are now legally required to have sufficient experience and knowledge, trustees are not investment experts per se.
It would be inconceivable in my view to act as trustees in investment matters without having the benefit of expert advice and background from an investment consultant. It helps trustees evaluate strategies, tactics, appointments and reviews, and to carry them out effectively. However, it does not mean that trustees must always follow this advice.
For us the use of investment consultants has been advantageous and necessary. They add value, probably more than fund managers on a penny-for-penny basis.
The scheme and its groups often have the same investment consultants for long periods, as appointments do not tend to be changed frequently. Nevertheless, both the scheme-wide and group levels, have regular plans for reviewing the appointments of consultants, and some of the groups are working with very recently appointed advisers.
Some UK schemes and investment strategies may benefit from the expertise and resources of a very large consultancy while others may find the slightly more boutique approach of a smaller consultancy tailored to their particular requirements is more useful.
But the quality and relationship with your appointed consultant is as, or even more, important than the nature of the consultancy firm as a whole.
At the moment there are discussions in the UK industry on how best to evaluate the performance of consultants. The National Association of Pension Funds is undertaking research in this area which should be available shortly.
Marek Sakowski, chief operating officer at Pekao Pioneer PTE, which manages a Polish mandatory fund that has AUM of PLN2.1bn (€582m)
In general, consultants play a very minor role in the open-ended pension fund market in Poland because the law favours the use of in-house specialists regardless of pension fund or consultancy size.
Because we are based on the Chilean social model and started our pension system in 1997 - seven years before Poland joined the EU - we differ from most other east European countries. The principle of Polish second pillar open pension funds is that the money has to be transferred to another entity when an employee reaches retirement age. Consequently, it does not make sense for us as a pension fund to use actuarial consultants.
We also do not make use of the services of external investment consultants as the law restricts us to managing the pension fund by ourselves. We cannot distribute parts of our assets to other asset management companies, for example.
But like all pension asset management companies (PTEs) managing Poland's mandatory open pension funds (OFEs), we have to have our own internal investment advisers - who are responsible for our investment policy and management.
The major advantage of external consultants is that they can introduce different opinions to augment those of the internal advisers. However, it is very difficult to find an individual, external investment consultant in Poland because all these activities are concentrated within banks and brokerage houses. Since we started in 1999 we have only been given a truly independent opinion on investment two or three times.
But because we believe it is always good to hear different points of view we often invite leading economists from a wide range of investment banks or brokerage houses to our company to exchange opinions, a service for which we pay.
The recent appointment of a new pensions minister could lead to changes in our pensions law, such as a relaxation of the 5% ceiling on investments outside Poland. This may eventually lead to more demand for external consultants and more of them setting up offices in Poland. But as most open pension funds are part of big international groups, they will generally already have in-house advisers on these topics.
Dirk Lepelmeier, head of investments at Nordrheinische Ärzteversorgung (NAEV), which insures 55,000 physicians and other healthcare providers and has an AUM €8.6bn
We use consultants in three different areas: first in financial services on asset-liability management (ALM) studies, value-at-risk calculations and stress tests, second for manager selection and third in the actuarial area.
We need to use consultants because our manpower is limited and consequently, we cannot provide sufficient in-house expertise in these sectors.
A primary advantage to bringing in external know-how for special subjects is that you can change consultants if you are unhappy with their service. However, we have long-term contracts with Feri and Heubeck, which advise on the financial services and actuarial sides respectively. In these areas it is important to know your consultant well, and such information advantages mean the barrier to change a consultant is very high.
But we use several consultants in the manager selection area, depending on the project. We choose those with a good track record and experience in specific areas, for example commodity or hedge fund of funds.
Generally the size of a consultancy does not make a difference to us. But the type of project can often determine the type of consultancy. Depending on the task we might sometimes look for a big, global network and at other times for a niche provider.
For us, employing consultants is an essential part of our strategy. Admittedly, consultants are only human and sometimes they can do badly or provide only average performance. But our overall experience has been good and they have definitely added value to our investments.
A lot of traditional smaller investors in Germany think that money spent on consultants is wasted because they believe they have the expertise themselves.
However, consultants have become increasingly popular and new branches of large consultancies such as Watson Wyatt have come onto the German market over the past five years. But the increased market penetration may now have peaked as those investors that were in need of consultants have now started using them.
There is a tendency for larger investors to use consultants because they are more internationally orientated and more likely to benefit from them. Smaller institutional investors may not want or be able to afford them.
But there will be additional requirements in the risk management area as part of the Solvency II framework. And because many small investors cannot meet these conditions the engagement of consultants could be boosted further.
In general, all regulations that require the structurally documented backing of investments make investors choose between their own manpower and outsourcing. Very large investors, such as the insurer Allianz, tend to have their own in-house experts but that does not make much sense when it comes to pension funds. An alternative to the use of external consultants is that similar sized pension funds work together in terms of expertise, but that is not always welcome.
As one of the larger pension funds NAEV, for example, offers its risk management services to smaller players in Germany, but so far we only have two contracts because as a larger organisation you are always viewed with some degree of suspicion.
That is why I expect the demand for expert advice as a result of Solvency II to be satisfied primarily by independent, external sources rather than by the pension funds' own systems or co-operation with other insurers.