There are some clear long-term trends in pension asset management in Europe. Collective is giving way to individual provision. Defined benefit (DB) schemes are closing, crystalising liabilities and deficits, and implementing LDI programmes. This, together with accounting and capital adequacy standards and the decumulation phase of an ageing demographic, is pushing funds into fixed income. Where growth assets are still required, investors look beyond domestic markets because growth is expected to come from emerging economies.
Now think about how Schroders looked a decade ago. It had a great business focused on institutional DB clients (rather than intermediaries or insurance companies), the majority of which were UK-based, with their assets mostly invested in UK equity or traditional balanced mandates. By contrast, last year 72% of Schroders’ revenues came from outside the UK and equities accounted for just 45% of AUM. Multi-asset and alternative mandates have taken the lion’s share of the growth, while fixed income increasingly determines its European DB client relationships, which are themselves decreasing relative to insurance companies and intermediaries.
“A strategy paper for our board identified pre and post-retirement as the largest part of our growth potential over the next two decades, led by global savings ratios and demographic trends,” says executive vice-chairman Massimo Tosato. “That’s why our intermediary business has grown so much, and why we feel that insurance companies will become major distribution partners.”
Insurance companies have always dominated the post-retirement market, of course. But Tosato notes that, particularly outside the well-defined ‘long-term savings’ DC markets of the US, Switzerland and Australia, decades of effective lobbying has also carved out a strong position in pre-retirement. “In continental Europe insurance companies always possessed this retirement space,” he observes. “Already 18% of our net new business comes from insurance companies, and about 24% of our assets.”
This involves Schroders providing components for products risk-managed by the insurance company distributor, but its role as a solutions provider in pre-retirement is, arguably, stretching beyond LDI-context mandates for DB clients. Why? Because retirement saving and drawdown has become a complex risk-management problem for individuals. As the population moves into decumulation it needs more of an emphasis on income. But improved longevity lengthens the decumulation phase, leaving most savers needing growth, which will either be modest (because of developed-world demographics), or volatile (if it comes from emerging economies).
“We see major, demographics-driven opportunity in the income space,” says Tosato. “Pre-retirement, the client’s time horizon is shortening and his main aim is to limit volatility and protect capital. But post-retirement, the horizon is now 20-30 years, over which it is very difficult to provide income without growth. You can’t do either with bonds alone anymore - you need a diversified growth component with downside risk management.”
One can see this evolution at Schroders in everything from its Income Maximiser strategy for the UK market (a portfolio of high-dividend equities with covered option overlay downside risk management), through absolute return (like the UCITS-compliant Gaia Platform of in-house and third-party hedge fund strategies), to multi-asset products for banks, IFAs and unit-linked policies. Schroders’ still-growing 60-strong multi-asset team manages over €32bn - including a 16-year-old brief to manage almost 100% of the assets of Levi Strauss OFP, winner of Best Belgian Pension Fund at the IPE Awards 2010.
These three areas of income, absolute return and diversified beta are referred to in-house as ‘outcome oriented’, and their mix of equities, bonds and alternatives with dynamic rebalancing or even derivative overlays often resemble DB portfolios in miniature. It is no surprise that Tosato speaks about them in the context of DC default funds, and of the importance of getting these solutions right for tomorrow’s retirees.
“We’ve learned a lot from working in markets like Australia, Chile, the US, and we are concerned that, in transferring risk-management from institutions to individuals, there is a superficial assumption that the education process will be easy,” he says. “I’ve seen many disasters arise from those assumptions. Education is important - but we cannot expect 80% of the population to become sophisticated investors.”
Tosato believes that the safest way to square this circle begins with an element of compulsion and contribution levels rising to 20% of income. The education process should be limited to helping investors with the basic decision about their personal risk appetite - and pre-retirement provision should then be biased towards professionally-managed default risk-return solutions.
“I think that a range of risk-return options should be available,” he says. “Some prefer lifecycle or target-date products, and there have been different experiences in different countries. But one thing is for sure - offering a hundred strategies from US Treasuries to Korean equities doesn’t help anyone. Not many countries are going down this route. The issue of compulsion is clearly a source of heated debate but if you really understand how difficult it is to take the decision to save for tomorrow, especially for those on low to middle incomes, I think it’s the beginning and the end of the story. At EFAMA [where Tosato is a board member] we are working on this proposition, and pensions is one of the hot topics of regulation at the European Commission.”
This touches on another important way in which Schroders’ business is adapting to these big trends. Pensions have always been a political issue, developing along national lines.
“The more you move towards individual responsibility, the more pensions take on a national character, and the more you have to adapt to those national environments,” he says. “Pension mechanisms and tax regimes, which influence portfolio construction, tend to be national in character, so over 10 years we have built a network of specialist local presence across Europe to establish good understanding of the client base. And to take insurance as an example of a type of client, the accounting and regulatory framework is so fragmented that you really need specialists with detailed knowledge of how they manage their balance sheets and reserves if you want to offer product to them.”
This gets to the dual layer of Schroders global frontline marketing structure. The firm deploys more than 120 marketing and institutional sales staff from 35 offices, split into local teams with region and country-specific expertise and a mix of central and local teams with client-type expertise (focused on financial institutions and intermediaries, insurance companies, or consultants). These teams concentrate on understanding and communicating client requirements (Tosato speaks of thousands of conferences, roadshows and webcasts across 40 countries for more than 100,000 professional clients). They are backed up by 20 product specialists who help match those needs to Schroders’ 200 or so strategies; and a product management team that monitors client guidelines and develops new strategies.
Needs are becoming more localised and strategies more tailored and numerous. “Schroders is now a very large machine that has changed the way it works as a consequence of this move to DC and the growth of the intermediary markets,” says Tosato. It has moved into new areas in terms of geography (internationalising), product range (fixed income and multi-asset, with a focus on high-alpha in equities) and distribution channels (intermediaries and insurance companies).
Getting ahead of this curve was vitally important, because while relationships in the intermediary market currently tend to last 1-4 years (as opposed to 5-7 years with institutions), this money could become very sticky, indeed, as it moves further into retirement provision - Tosato expects relationships to be maintained out to perhaps the 10-12 year range. Miss out now, and you may miss out for good.