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Impact Investing

IPE special report May 2018

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How tight a hold on the reins?

Last month, Paternoster, a company created by former Prudential UK head Mark Wood, announced that it has secured £500m (e722m) of equity financing. The firm has been set up to transfer the defined benefit pension fund liabilities off a corporation’s balance sheet and into an FSA regulated insurance company. Amongst its backers are Deutsche Bank and Eton Park International, the hedge fund.
It is easy to see the logic. Wood believes that his firm can generate economies of scale by aggregating mid-sized pension funds, and putting schemes together to build efficiencies in administration and asset management. In a world where trustees are continuously under pressure, where legislation is requiring them to take greater responsibility, and where sponsoring companies are concerned about longevity and investment risk, there is room for a different breed of service provider. The fact that hedge funds and in fact private equity companies are seeing the potential for growth is indicative of just how lucrative such businesses can be.
Of course, removing defined benefit (DB) scheme liabilities entirely may not be what many trustees had in mind. Increasing though, there are greater options for the outsourcing of both administration and investment management, and service providers are banking on the fact that outsourcing will make good business sense for many funds.
Kevin Carter, European investment consulting head at Watson Wyatt, believes that one reason outsourcing is increasing is because trustees have realised that they have their hands full. “Trustees have recognised the complexity of their job is very hard to execute when they meet infrequently. In many cases they have to be honest that their competencies are being challenged by the number of tasks that now have to be done,” he says.
Costs are also a big factor. “When pension funds have an aging platform, older technology, or a costly base in administration, it is a trigger to outsource. The driver is not just to get lower costs, but to also avoid future technology spend,” explains Stewart Copland, associate director at Etheios, the implementation service provider.
Research from Watson Wyatt has shown that small pension schemes costs more than four times as much to run as the largest. In a study of the running costs of 250 occupational schemes, schemes with more than £5bn (e7.2bn) under management cost as little as 20 basis points to run, while those between £250m and £1bn cost 43 basis points to run and those under £50m incurred costs of 87 basis points.
It explains why larger schemes are so much less likely to outsource administration than smaller ones. In the UK, 84% of schemes with between 1,000 to 3,000 members outsource, 52% of schemes with 10,000 to 30,000 members outsource, while only 32% of schemes over 50,000 members outsource, according to Allan Course, head of administration consulting at Watson Wyatt.
Many observers believe that outsourcing will change the landscape of the pension fund industry very quickly. “In five or 10 years, we will go from 800 funds to perhaps 100 in the_Netherlands,” argues Alfred Kool, managing partner of Kool Corporate Communication in Amsterdam. He believes that a number of larger administrators, who also have the capability to handle investments for pension funds, will grow to take responsibility for every aspect of running a pension fund. “You have players like Achmea, Blue Sky Group, AZL. They all have numerous pension funds as clients, and the execution and administration of funds will continue to be outsourced,” he argues. Kool believes that so-called ‘one stop shops’, those that can offer a pension fund the execution of the entire scheme, will become commonplace.
It is an assessment that service providers agree with. Large fund management houses, such as Fidelity and Merrill Lynch, are offering defined contribution services that cover the full rostra. “There is an unquestionable trend from in-house to outsourcing, and from unbundled to bundled, which is why we are focusing all our efforts in that direction as well,” explains Colin Williams, head of Fidelity’s UK defined contribution business. The firm provides administration, investment, and communications and education. The latter is the one area that often slips through the priority list, but an area that no pension fund can afford to ignore, argues Williams. Fidelity’s UK business stands at around $5bn, and Williams says the firm is looking to extend its operation into a number of European countries.
Still, not everybody is convinced that fund managers should be offering full outsourcing solutions. “You often see investment managers moving into the administration market. They literally package the administration with the fund management. I think there are some potential synergies there, but there is also a downside. If you bundle these services together, they become harder to split at some future point,” argues Tim Giles, head of the pension administration business in the UK at Hewitt Associates.
Last year, Hewitt purchased the Dutch pension administration activities of Philips, the electronics group. It provides pensions management and administration services for 165,000 scheme members, including 137,000 scheme members from the Philips Pension Fund (PPF). In March, it also opened a human resources outsourcing centre in Krakow to provide services to European based clients. In the long term, suggests Giles, there will probably be too many administration players in the market, and consolidation will occur.
For his part, Fidelity’s Williams dismisses arguments about the operational risk of having all your eggs in one basket. “All of the bundled providers have been setting up open architecture models for their DC platforms. A properly run platform manages out market risk,” he insists. He also believes that unbundled administrators will have to seriously review their business models. “We’re noticing that for a lot of blue chip companies, the vendor sourcing decision is coming from the purchase department, and they are looking at the best possible deal for the company. They do want the one stop shop.”
It is something that Robert Plumb, a principal at Mercer Investment Consulting, believes will occur more frequently. Lager, multi-national employers in many European countries, like the Netherlands, Switzerland, and Germany, are looking for cross border administration options. Often, he suggests, the best approach is to outsource.
The one stop shop argument has not deterred a new breed of service providers from entering into the market. IT providers, custodians, and even multi-managers, all think they have something to offer. “This may not be as profitable as specialist consultancy, but it’s repeat business with a predictable income,” explains Plumb. “Many of the providers are coming into the market with specialist knowledge in different areas. But each has their unique selling point,” he points out. One such provider is Dallas-based Affiliated Computer Services (ACS), which bought out the human resource consulting and outsourcing business of Mellon Financial Corporation last year. “If you look back prior to the acquisition, you would have found that ACS was a very solid human resources administration and technology provider, but with two gaps that needed to be filled in benefit administration and on the consulting side,” explains Arthur Mazor, managing director of the human capital management solutions organisation within ACS.
ACS filled up its consultancy gap with the purchase of Buck Consultants, and says it’s now a full service provider. When the company was founded eight years ago, it was a business providing data services to banks. It still provides IT services to companies like McDonalds and Disney, and so it is easy to see ACS as a pure technology provider. But Mazor insists that in the outsourcing world, it is a level playing field. “In the human capital space, the brands are all very new in many cases. It’s a very young industry, and the players that are playing today are very different from the ones even five years ago. Five years ago, you would not have thought that some of the current competitors, ACS, Accenture, and IBM, would be in this space. We are finding that the mix of technology, process and expertise is very relevant.”
Still, one technology consultant believes it may be hard for technology providers to be competitive in this space. “This is not really an IT issue; it is a whole business process. They will have to have expertise which is not easy to build. You can buy the skill and build on it, but you also buy legacy systems and a legacy process. There is a risk in buying an existing company and you have to be pretty acute about what you are going to buy,” he says.

Still, it isn’t just the technology providers that have gotten into the game. Custodians say that outsourcing for pension funds is a natural space for them, too. State Street was the custodian for the Philips pension fund, and the fund outsourced some of its fund accounting to the company. “This is our first fund accounting mandate for a pension fund, but this is a logical extension from being the custodian,” explains Rod Ringrow, senior vice president in the Netherlands. He says that State Street will be very active in looking for mandates in this area. The firm has a joint venture company called CitiStreet, which is active in the US and Australian markets, an offers benefits administration.
Even multi-managers are getting in on the game, and not just for smaller pension funds. In the US, two very large pension funds have outsourced the entirety of their investment management to SEI, claims Greg Rodgers, director of institutional sales for continental Europe. And in Europe, the firm is talking to pension funds in excess of up to e16bn about a total outsource of investment management. “The need for investment innovation, use of derivatives for a pension liability matching strategy, use of absolute return strategies, essentially a lot of what is now required to effectively manage a pension fund is getting beyond the reach of even sophisticated plan,” says Rodgers.
He dismisses concerns about the concentration of operational risk from having outsourced to one multi-manager only. “What is required for the relationship to work is a high degree of transparency and communication. The pension fund is outsourcing the execution strategy, and we are executing on the strategic direction they have set. We believe that the most important decision they have to make is the strategic allocation,” he says.
Rodgers believes that SEI will also enter the investment administration outsourcing business through strategic partnership. “The administration side would be where we would need to build out but we are looking at our ability to do that, to partner and to build that out. We think that’s the right direction to go,” he says. And if SEI does chose to partner with an administration provider, it can opt to white label the service.
The UK’s Capita Hartshead already works with two fund managers, offering white labelled administration capabilities. Stuart Heatley, marketing director, declines to comment on who the two providers are.
“The idea of the one stop shop is not a new one. Life insurance companies have been offering fund management bundled with administration bundled with actuarial services and everything else. I think there’s been a sizeable shift within DC, and there much more of a tie up between fund management and administration. But I think there will still be a need for a choice of different fund manager than an administration platform can give you,” he says.
With increasing numbers of providers, it would be easy for companies to outsource everything and try to wash their hands of the whole business. Watson Wyatt’s Carter believes that this won’t happen. “In the UK, the pensions act is very clear about what trustees’ responsibility is. There is a separation of managing activities and governing activities. But the governing activities, they cannot simply avoid.”

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