Anton van Nunen, godfather of fiduciary management, responds to questions on his philosophy from André de Vos
Ten years ago, Anton van Nunen wrote his Fiduciary Management handbook. Now a revised version has been published. “As the one who devised the concept, I found that the handbook needed to be updated”, he says. “The greater part of Dutch pension capital is invested using fiduciary management. The volume of assets is involved is so large that you have to keep your finger on the pulse, certainly after a financial crisis caused an enormous shock. I wanted to investigate how the fiduciary concept has behaved under that pressure.” Here, Van Nunen responds to seven questions about fiduciary management.
1. Fiduciary managers have not been able to prevent the level of coverage of pension funds declining sharply owing to falling interest rates. How do you respond?
“I am impressed by the performance of fiduciary managers. They identified interest-rate risk at a very early stage, by far the greatest risk for institutional investors. With all the funds with which I am directly or indirectly involved, it has been made clear to the board that it must face this and that it was necessary to hedge against it. I do not know a single fiduciary manager who has not declared management of that risk to be the number one article of faith.
“Fiduciary management has brought the risk management of pension funds to a higher level. Certainly where interest risk is concerned, making decisions has improved. Interest rate expectations have been uncoupled from the question of whether an interest hedge should be deployed. Strangely enough, no research has been done into the matter in the Netherlands, but I dare to stake my reputation on it that pension funds with a fiduciary manager generally have a much higher interest cover than average.”
2. Does the desire to invest more simply point to a lack of trust in fiduciary managers?
“The trend towards less complex investments is disastrous. Simplification is not an answer to an increasingly complex world. The wish to invest more simply arises from the demands of the regulatory authorities, but it sometimes goes too far in that direction. Managers have to explain, for example, how credit default swaps work and what effect they will have on the portfolio, even if they are only 0.1% of the investments.
“Every investment portfolio has become less simple through the deployment of a fiduciary manager. This is a good development. Use is made of the expertise and experience of dyed-in-the-wool financial players. Management of interest-rate risk plays a pivotal part and is not simple. Diversification is also important. There is volatility, the level of which is unpredictable. It is about diversifying assets and, within assets, managers in such a way that the volatility in the portfolio as a whole is reduced. Fiduciary management introduces complexity, but for a very good reason.”
3. Is passive investment a death blow for fiduciary management?
“The increase in passive investment has to do with the costs of more active investing and the attitude to risk of investors and the regulator. The past 10 years have made clear that risk management is the essence of investment and balance sheet control. One part of this, although not the most important part, is the management of equity volatility. If the results of this are not certain, it is a small step to reduce this volatility through indexed investment. But it is questionable whether this will succeed. Active policy, provided it is well executed – in other words truly diversified – has been found not to affect the volatility of the portfolio as a whole.
“Another reason for less active management is interest rates. This was dramatic, with consequences for coverage ratios, reducing the excess returns of active management to an insignificant few basis points. So why take the extra trouble?
“With current and anticipated low returns, it is questionable whether active policy should not be pursued. If there are less efficient markets and a fiduciary has good selection capabilities, a fund should ask itself whether even a modest extra return is not important enough in times of low returns.
“Incidentally, the question is what is understood by passive. What about a European fixed-interest benchmark that does not use market capitalisation? Avoiding southern European securities as far as possible is a much used policy and active in principle. Many parties say that they invest passively, but very few do. And that is all to the good.”
4. Is the fact that pension funds are more active in asset management a good trend?
“I agree with that, provided that they are capable. I have my doubts about that. Let us be clear: there are a lot of financial products and nearly as many managers who all have fine stories as to why you must use them for good investment service. How can a board that does not consist solely of people with a financial background make a good choice? And is the help of a consultant who bills by the hour sufficient?
“With an expanded board, supplemented by an investment committee and possibly a consultant, doing more in-house can be a good option. But, a warning is in order: after the decision to do something in-house, a lot of time must be available for analysis, research and monitoring. Lastly, there must be a guarantee that troops will be available for a possible intervention in the event of a disaster. Thus, there are a lot of constraints on doing it yourself. What you are seeing now is administrative offices are being created to do the work of the fiduciary again. This is disastrous.”
5. Does a fiduciary manager always pay for itself?
“There is another cost layer; in other words, that of the fiduciary itself. But this can be recovered: through purchasing power and lower charges from asset managers and, more importantly, through a better, more diversified and more alert policy, so that returns are higher. That effect is more important than the costs, since it is a matter of net returns.”
6. Is the current pension system in urgent need of change?
“The industry must find an answer to low absolute returns. These will adversely affect funds’ right of existence. If the anticipated returns are structurally lower than the growth of our national income, a pay-as-you-go system would be better than capital coverage, which means our present system will be in danger.
“Legislation has forced funds to adopt a one-sided investment policy with a strong emphasis on interest-rate hedging. An increase in interest rates may be a long time coming, but it will certainly come and will have disastrous consequences for the left-hand side of the balance sheet. And that side indicates what pension funds can mean in the long term for the contributors.
“We must protect our pension system against the threat to its survival. That will happen if low rates continue. With the low returns being imputed, not only will indexation be impossible, but cuts will be almost certain in the longer term.
“A different framework must be developed. A great good – such as a pension system that has historically worked well and that enjoys a high reputation – deserves rethinking. We must reject killing off real ambition by means of a strictly nominal framework, within which a big interest hedge is unavoidable. Ideas to this end have been developed that must be given a chance.”
7. Must fiduciary management be drastically different?
“I do not think so. The concept has maintained itself well. I see a new development, such as engaging different fiduciaries for different aspects; the supermarket model. That may offer advantages, but who is responsible for ultimate oversight? One important new insight has been added in that fiduciary managers have the duty to share their knowledge with pension fund managers. They must bring them to a higher knowledge level, precisely because the world is increasingly complex, and without the fear of making themselves superfluous.”
Anton van Nunen’s standard work, Fiduciair management. Blauwdruk voor een goed bestuur van institutionele beleggers, has been reissued in a second edition in the Dutch language. This article first appeared in Pensioen Pro
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