Europe is going specialist
With global financial markets continuing their struggle, many European pension funds are taking a closer look at their portfolios, and an increasing number are switching their assets into specialist mandates. A recent study by Mercer Human Resource Consulting revealed a 64% increase in specialist mandates in Europe over the last five years - a trend, say many pension fund industry participants, that is set to continue. If the prophecies are correct, then balanced managers could well have come to the end of the line.
It is in countries where defined benefit schemes dominate, or those that have been traditionally funded, that the move to specialist managers has been most visible. Says Julia Hobart, head of manager advisory at Mercer: “the Netherlands, Switzerland, Ireland, and Belgium have all experienced the gradual shift from a balanced approach to a multi-asset approach and on to the specialist management approach. The underlying trend towards specialist management is at different stages in different countries, but as the bigger pension plans move in that direction, the bulk of the smaller pension plans will follow. “
In the UK, the turn to speciality managers has also been dramatic. According to a study by Greenwich Associates, use of specialist managers has more than doubled in the UK over the last five years, from 41% in 1998 to 89% in 2002. The share of total assets managed by specialist managers has also grown – from 27% just three years ago to a hefty 74%.
Hobart believes the phenomenon to be driven by liabilities, explaining the greater interest demonstrated by defined benefit schemes. Says Hobart: “it may sound blindingly obvious, but assets need to meet liabilities – and this has received recognition. The balanced approach, which has been relied on for many years just does not recognise liabilities, as it is determined by returns.” As markets have struggled, so returns have come under scrutiny, and the emergence of more sophisticated performance techniques has exposed weaknesses among balanced managers.
But are specialist mandates really so special? In terms of what they can add to pension funds, the question deserves a one word answer. Yes. And it all boils down to alpha says Hobart - although alpha should not be regarded as just performance, but consistent outperformance, value for money and risk adjusted return all rolled into one package. As it is very unusual for fund managers to be able to produce alpha in all asset classes, it, therefore, makes sense to dissect a portfolio and distribute to those with the right expertise.
By concentrating on specific assets, managers would also be more aware of the profitability of each asset class. One need only compare asset allocation of balanced pension schemes, and those where there as been an asset-liability study to be aware of the tendency to use a specialised approach in the latter. Funds having conducted strategic asset allocation tend to have a lower holding of equities, a higher proportion of index-linked assets, and a much lower allocation to overseas bonds.
Specialist managers are indeed benefiting from the increasing popularity of ALM studies among pension schemes. Says Hobart: “ALM studies have led to funds looking at strategic asset allocation in order to meet liabilities. When applying strategic asset allocation, it is then easier to divide up schemes into specialist, core-satellite structures.” Whether asset-liability studies are as useful as many perceive is another argument, but their use is clearly generating business for specialist managers.
But is the use of specialised managers for everyone? Traditionally, it is the large pension schemes that tend to be associated with specialist managers. Small pension funds often do not have the resources or time required in the vast selection process. The increased management cost together with the cost of more complicated internal administrative arrangements just do not make specialist management worthwhile for smaller pension funds, believes one consultant.
Mark Duke, principal at consultant, Towers Perrin, disagrees. “Whether you have £1 in your bank or £100m, you still want to access people who are the best at what they do.” Some pension schemes may be too small to divide their assets between a selection of managers, but multi-managers were designed specifically to address this issue, believes Duke.
By using a multi-manager, smaller pension funds are enabled access to specialist fund managers which they would ordinarily not be able to afford, or to whom they would not normally have access. Multi-managers benefit from economies of scale in this regard. In the UK alone, the Association for Institutional Multi-Manager Investing (AIMMI) expects multi-managers to be managing between 16% and 30% of the pension fund market in five years’ time.
Multi-management, whereby funds are handed over to a multi-manager which then distribute the assets among other fund managers, has its own drawbacks, however – the frequent criticism being that it is too expensive. Stephen Delo, managing director of Escher Teams and founder member of AIMMI, disagrees. “Multi-management is being imprecisely compared. Small to medium pension funds ordinarily use pooled fund solutions – which are indeed less expensive. But these funds are probably balanced, or have a low outperformance potential. This cannot be compared with multi-manager funds, which have high outperformance targets, and invest in specialist funds.”
In Europe, multi-management is slowly finding its feet. UK-based multi-manager Investment Manager Selection (IMS) has won three European mandates this year, and research director Paul Kim believes Europe, in particular northern Europe and Switzerland, will see continued growth in the multi-management market. “With markets as they are now, funds want to employ managers that will make the most of this situation. They want the choice, and this is becoming increasingly accepted.”
So what future do balanced managers have? Duke believes balanced managers to be “dying on their feet”. “It is very uncommon for funds to appoint balanced managers. Those that are managing funds were employed five or ten years ago. It is very unlikely that having reviewed the fund, trustees would employ a balanced manager.”
Specialist management of funds, aided by the increasing popularity of ALM studies and multi-managers, looks set to take the place of the balanced methodology that has so long dominated European pension funds. Duke offers a word of warning though to pension funds thinking about switching to specialist mandates: “Yes, you want the best of breed, but don’t underestimate the task you have set yourself. Dividing your fund into four to six mandates, each with several managers all doing their own thing is going to mean a lot of monitoring!
“Plus, don’t forget that the risk is there. By picking single managers specialising in one field, you are more at risk. Performance of single managers over time is not durable, but they will be good for a period.”