Investment Solutions: Remedy, not a cure
Alex Koriath and Calum Brunton Smith outline trends in the £50bn UK fiduciary management market
Fiduciary management (FM) is a relatively new approach to the management of pension scheme assets in the UK, involving the delegation of investment decision-making responsibilities from trustees to a fiduciary manager.
The rationale behind FM is to allow trustees to better use their time, whilst helping investment decisions to be taken and implemented rapidly and with clear accountability.
The concept was first adopted in the Netherlands and has recently spread to the UK, albeit under a slightly different structure.
In the UK, a provider can assume responsibility for a range of tasks including both investment consulting and asset management services. This can encompass: journey plan design; strategic and tactical asset allocation; growth and matching portfolio structuring; investment manager selection; and administration. Unfortunately, there is ongoing confusion around which services constitute fiduciary management.
At KPMG, we define ‘full delegation’ fiduciary management as a service where the trustees set the strategic asset allocation, risk and return targets based on advice from the provider, but delegate asset allocation decisions as well as manager selections across the full scheme assets to a fiduciary manager. This means full delegation fiduciary management is a crossover service requiring investment consulting and asset management skills. We then define ‘partial delegation fiduciary management’ as any FM mandate where the provider does not have complete responsibility or manage the full scheme assets.
Over the past five years, the UK FM market has grown steadily from a small base, both in terms of number of mandates and assets under management and also across both full and partial delegation appointments.
As of June 2012, the size of the market was in excess of £50bn (€59bn) with around 300 UK pension scheme mandates. The full delegation portion comprised around £23bn of total AUM. This figure is the sum of 174 full delegation mandates and equates to about 2.5% of the total UK defined benefit pension industry by AUM.
The UK market remains a small part of the wider fiduciary management market. Having been established for less than 10 years, this market remains in its infancy and represents a significantly smaller part of the wider pensions market than more established markets such as the Netherlands, where FM represents 70% of the market.
Fiduciary management is not a rigid investment management service. It is a flexible investment approach, where mandates are constructed to meet trustees’ investment objectives within agreed tolerances and permissions. As such, fiduciary providers will tailor their services to meet their clients’ requirements.
As noted above, there are a number of elements within a fiduciary management service, such as journey planning, allocation, structuring, selection, and so on. To offer clients full flexibility, fiduciary providers commonly also offer services on a modular basis. Typically these modular services are based on the heritage of the provider – with consultants, for example, offering journey planning and de-risking frameworks on a standalone basis and investment managers offering asset management and execution based mandates. These mandates would be classified as partial delegation.
However, as the UK FM market has developed, the proportion of full delegation mandates has increased. This is likely to be down to a combination of trustees becoming more familiar with the full delegation model and implemented consultancies marketing their full delegation solution to clients – these appointments represent the significant majority of UK FM mandates.
In terms of mandate size, one would expect FM to be a highly bespoke service that lends itself best to larger schemes. However, the majority of UK full delegation FM mandates are relatively small in size. The KPMG 2012 FM survey revealed that about 88% of all UK full delegation FM mandates have AUM of less than £250m. There were only three full delegation mandates with assets greater than £1bn as of 30 June, 2012. We believe the reasons for this are cost and a trend in larger schemes to hire more specialist managers and advisers instead of relying on one provider to be able to provide best-in-class services across the board. Given the current position of the market, and our experience to date, we do not expect this trend to change over the short to medium term.
There are various types of provider offering FM solutions in the UK market. KPMG divides them into three sub-sectors:
•Implemented consultants – legacy consulting firms who have built out fiduciary management as an additional service for clients;
•Specialist FM providers – businesses for whom fiduciary management is the primary business function; and
•Investment managers – legacy investment management firms that have developed their advisory services to deliver full services investment service for clients.
When we started to look at the FM market five years ago, we expected the investment
managers to win a material market share because it appeared easier for an investment management organisation to add on consulting capabilities compared with legacy consulting firms building asset allocation, risk management and operations capabilities.
However, the UK FM market today is dominated by implemented consultancies, with over 70% of FM mandates run by these providers. This demonstrates the importance of the trust-based relationships that investment consulting firms have built up over years as a good number of FM mandates have been won by switching existing advisory relationships to a fiduciary relationship, many without going through a full market review.
Given the broad spectrum of services provided by fiduciary managers, the flexibility within the solutions and the different heritage of each provider, there are significant differences between the approaches of each provider, even within the sub-sectors above. As part of our research and client work, we have seen significant evolution in the resource, infrastructure and solutions offered by the providers in the UK market.
This has meant asset managers building out their consulting, journey planning capabilities whereas consultants have been expanding asset allocation and LDI capabilities. This has been aimed at closing perceived weaknesses due to the legacy business models and has meant more of a convergence of implemented consultant and asset managers’ offerings.
We have also seen a greater focus on performance measurement, as potential clients are asking for verifiable track records and are no longer satisfied with reference to the bespoke nature of fiduciary management mandates. We expect these trends to continue as the UK market develops.
In terms of full versus a more modular approach to fiduciary solutions, we expect providers to continue to develop the flexibility within their fiduciary solution to appeal to the widest spectrum of clients – hence, as solutions develop, we expect that providers will make available each element of their holistic solution.
In our experience, many trustees consider fiduciary management, initially, in respect of a few specific services. However, in the process of carrying out proper due diligence, many opt for a full delegation approach on the basis that engaging a partial solution would serve to restrict the ability of the provider to add value as they would not be in control of all elements in unison.
There have been a number of new entrants in the market and we are seeing continued interest from asset managers with a number of firms appearing to be sitting on the sidelines ready to jump in if the market develops into a too big threat or too big opportunity to miss. These organisations have the majority of the tools required to develop a fiduciary solution, but they are conscious of the barriers to entry that other providers have encountered in the early years of the UK FM market.
Looking ahead, we expect the FM market to continue to grow. FM is not the silver bullet to solve pension investment problems that some market participants believe it is. However, we believe it is a solution that can be useful for some schemes and trustees.
The market has come to realise the heterogeneity and lack of standardisation in FM and the need of independent advice when assessing suitability of FM for their scheme and also structuring appointments to ensure appropriate terms and protections are built into the agreement. In that respect, we expect a more open competition for mandates going forward and also a range of the early FM mandates, which have not been put out for competitive tender, to come out for re-tender after they now have been in place for 3-5 years.
In response to increased market growth, we expect the solutions of the existing providers to evolve, new providers to enter the market and mandate trends to change as clearer market practice materialises.
Alex Koriath is director and head of research, investment advisory; Calum Brunton Smith is executive consultant and head of fiduciary research, investment advisory, both at KPMG