Specialist overseers have a crucial role to play for pension funds using fiduciary managers. But the trustees themselves must watch the watcher, writes Brendan Maton

Fiduciary mandates worth more than €11bn are due to be awarded this autumn in the Netherlands alone. Two industry-wide pension funds, for hairdressers and butchers, will decide their preferred provider, while the fund for transport workers, Vervoer, awarded a €10bn mandate to Robeco in mid-September.

No one is under any illusion that fiduciary is some kind of final decision for a board of trustees. Pensioenfonds Vervoer headed by Walter Brand and Patrick Groenendijk, is actually one of the first pension funds to review a new-wave fiduciary, Goldman Sachs Asset Management, which it appointed in May 2006 for what was then a €5.4bn brief.

So the question in a fast-growing market is: who watches the watcher? If the boards of pension funds are to put so much responsibility into the hands of a single organisation, they need to do a lot of due diligence ahead of such a momentous move and a lot of monitoring afterwards. But several advisers question the level of preparation made by some schemes.

"If a pension fund appointed an equity manager without taking advice, everyone would be up in arms," says Patrick McCoy, head of KPMG Investment Advisory. "They would say it is inappropriate and imprudent. Yet pension funds are passing into the fiduciary services of their consultants without any independent advice."

McCoy has a point. The number of clients now taking some kind of implemented or fiduciary service from the likes of Aon Hewitt and Mercer far exceeds the number of RFPs issued for such mandates. The head of new business at one asset manager fiduciary told IPE he saw only about a dozen such ‘open' RFPs in 2010.

The standard reply from the consultancies is that any such change is merely an extension of their existing service.

McCoy is not convinced. As a pension fund adviser with no fiduciary offering but an established service monitoring fiduciaries, his complaint is not that KPMG doesn't get a big enough slice of the pie, but that much of the pie is out of reach of open tender.

"My real frustration is that the fundamental problem is often dissatisfaction with the current adviser," he says. "It doesn't matter whether the board go down the fiduciary route, or even whether they stick with the same adviser. But to have some kind of independent evaluation of the services they are being offered is really helpful."

In the UK KPMG is widely seen as the market leader in fiduciary manager evaluation and monitoring, although Hymans Robertson scooped a prize mandate earlier this year when the Merchant Navy Officers' Pension Fund chose the Scottish firm over incumbent KPMG (even overseers can lose business).

In the Netherlands, the major consultancies have far fewer potential conflicts of interest because they are far less likely to be appointed fiduciary manager. But the Netherlands also has Ortec Finance, the ALM and risk management specialist, which does not have a UK peer.

One of Ortec's unusual features is that it does not perform manager selection. This means that for its 10 clients with fiduciary managers, Ortec concentrates on locating where risk lies relative to the original asset-liability modelling and strategic asset allocation (another dozen clients just buy the software and do the analysis themselves). This is significant, as Dutch boards typically maintain control over these matters but leave all else including tactical asset allocation to the fiduciary manager.

Does Ortec struggle to win new business? Loranne van Lieshout, head of investment consulting, replies that some fiduciary managers resist its appointment because they claim to provide all these risk-monitoring services themselves. However, one of Ortec's regular discoveries is that much time is devoted to secondary matters such as manager selection, rather than the primary issues affecting funds' solvency. This in itself perhaps explains the occasional resistance to Ortec's appointment.

However, trustees and sponsors increasingly understand that you have to set a strategy first before you can start looking for a solution provider that best fits objectives and constraints. This is as true of fiduciary as any other approach.

The discoveries emerge because Ortec seeks to attribute risk management to each party: the board and the manager. Attribution refers back to their agreed responsibilities, although van Lieshout explains that there is more than one reference point: the original strategic asset allocation and funding ratio risk allocation, which is dependent on market-sensitive valuations.

Van Lieshout is sceptical about the term fiduciary manager. "Several fiduciaries were born out of internal pension fund management teams. As such there was not always a clear definition of the fiduciary manager's duty. We find that some young portfolio managers in the fiduciary push illiquid, risky products because they are the most interesting to research. These managers have a profit to make and I think that sits at odds with being a fiduciary sometimes."

Of course, many overseers make the point that while fiduciary is a growing trend, it is often not the correct remedy for a pension fund's problems.

This is demonstrated by the following example supplied by Muse Advisory, which specialises in pension scheme governance. One well-established UK fund with about £200m came to Muse convinced it needed to move to fiduciary management. When Muse ran a workshop for the trustees, it emerged that, in fact, the problem was their relationship with the current investment adviser. The trustees did not feel the consultant was generating enough ideas and presenting them with answers to their problems.

In answer to this dilemma, Muse ran a twin-track search for a replacement consultant or a fiduciary manager so that the trustees could compare both kinds of option - they ended up choosing Hymans Robertson on an advisory basis.

Such an appointment makes sense but is not necessary for all schemes, according to John Heskett, senior adviser at investment consultancy, Allenbridge Epic, who has several pension fund clients. One employs Towers Watson as fiduciary but made the appointment and monitors it without third-party advice because the sponsor is a large international bank and the pension fund trustees are comfortable with financial technicalities.

Like many others offering such oversight, AllenbridgeEpic relies much on personal reputation to win business. Led by Karen Shackleton, formerly of Barclays Global Investors, most staff have long experience in pensions or investment management. This is true of Muse and the likes of Avida International and First Pensions in the Netherlands. At the latter, Jelles van As spends one day a week in his role as chief investment officer of the Hoogovens Pension Fund.

All point to their independence from other commercial providers as significant in the avoidance of conflicts of interest.

This point extends to emerging fiduciary markets. Ronan Smith, co-founder of Verus Advisory, a new oversight service in the Irish market - where Mercer has huge market share in investment consultancy as well as quasi-fiduciary offerings - says that trustees need an independent point of view. He doubts most boards have the expertise to investigate prospective fiduciaries alone.

Smith is at pains to avoid any insinuation that Mercer's dominance has prompted the creation of Verus. Whichever provider is considered, he believes boards will need help in understanding the offering.

Smith and two of his co-founders are former portfolio managers; the fourth is an actuary. Like so many other overseers then, they have credibility but what about the kind of quantitative endorsement by which fiduciary managers are partly judged? McCoy gives an example of the fiduciary manager seeking clarification on whether its performance bonus would be based on gilts or swaps. "This is really complicated stuff but we saved the schemes hundreds of thousands of pounds by guiding them to the right decision," he says.

Frank ten Brink, chief of The View Consultancy in the Netherlands says that he has advocated revision of bond-based benchmarks where the most indebted states occupy a greater share of the index than self-financing peers. But Smith reckons that consultants' efforts can never be judged quantitatively. "Our job is to help boards specify their objectives clearly," he says. "As for choosing between consultants in this space, what we do is done in front of the board, unlike the asset management. They can see for themselves and decide which firm they like."

Some trustees, however, really don't prioritise their adviser's competency. Not because it is irrelevant but because it shifts responsibility wrongly from the board itself. Kees van Rees, former head of Shell pension fund in the Netherlands and a man who has both hired and fired fiduciary managers as chairman of the pension scheme for organisational consultancy, GITP: "It all comes back to the trustees. The legal framework states that the board needs to be in control. Fiduciary managers and advisers are no substitute for the competence of a board, whether the scheme is large or small."

In other words, if a board is so weak that they can't understand a fiduciary manager, they should reform themselves rather than ask a consultant to do the thinking for them.
Van Rees joined the GITP fund as chairman precisely to effect such a turnaround. He negotiated the ending of Achmea's contract and the appointment of Robeco and Corestone as the new fiduciaries within eight months. In the process Paul Boerboom assisted GITP. "I knew Paul as a high-flyer at the Shell fund," van Rees recalls. "He really helped us but I have to emphasise again that it was the board which took the decisions."

Fiduciary managers support this view. Toine van der Stee is chief executive officer of Blue Sky Group, fiduciary manager to more than ten pension schemes including those of KLM, the national airline. While its clients have different set-ups, van der Stee believes that it is the quality of the people on the board which counts. "It does not really matter what system of oversight you have in place; it's the quality of the people on the board," he says.

As an example, he relays the ethos of the KLM pilots' pension scheme, which is that its levels of risks are to be decided only by members of the scheme because only they face the consequences. "That is quite typical of Dutch people," says van der Stee. "It is also what the Opf recommendations say."

So even though the three KLM funds have an investment advisory committee, and Blue Sky decides asset classes and external managers without recourse to the board, the main issue of having sufficient capital to meet liabilities rests with the board.

"Some folk in pensions say that you don't have to worry about the short term because only the long term matters," van der Stee recalls. "Pilots have a much more black and white view. You either make the journey or you crash."

So who should watch the watchers? The answer seems to be ultimately the real fiduciaries: trustees themselves.

The coda is that the Netherlands looks set to allow experts to sit on pension boards rather than merely advise. Whether representative board members are replaced by these experts or simply move along the table, in the Netherlands fiduciary overseers could find themselves one big step closer to making decisions on workers' retirement wealth.