Just the DC ticket
The evidence suggests that in a mass market, individual investors do not make refined choices. In Sweden’s PPM, for example, where there is a choice of 660 funds with no penalties for switching, only four of the largest funds by assets are run by foreign providers.
Conversely, only three of the bottom 100 by assets under management are Swedish.
It may be that ordinary Swedes know something we don’t, but it is more likely that they have opted for local and familiar brands rather than performance potential.
Given such evidence, it seems that more care is needed when offering defined contribution choice to individuals – and this covers almost all short-term savings vehicles, long-term savings vehicles and occupational defined contribution pension plans in Europe.
“Everyone thinks choice is a good idea but choice is a dangerous thing if people are not informed how to choose,” says Tony Earnshaw, managing director, Northern Trust Global Investments, Europe. “Individuals bear the risk in a defined contribution scheme but they do not have the resources required to make informed decisions.”
Like other multi-manager providers, NTGI believes that passing over choice to professionals who monitor investment managers for a living will yield better results for individuals than leaving them to make selections.
Stephen Appleton, client executive of institutional investment services at Russell, agrees: “We think we are better at structuring and selecting portfolios than ordinary scheme members.” Using a benchmark based on average returns from a mix of commonly-held assets, Russell calculates that an ordinary member’s retirement pot can be increased by more than 25% if that benchmark is beaten by 1% annualised over the member’s working life.
Of course 1% is the Holy Grail for active managers and Appleton admits that it would not be a neat 1% every year: some years are worse than others. But the improvement in spending power for a retiree is profound. Instead of a pot worth 47% of final salary from mere indexed investments, the 1% annualised outperformance (which Russell’s hypothetical example puts at 7.4%) pushes it up to 59% of final salary.
Such considerations have to be made by those responsible for all types of collective savings arrangements. Every pension fund official would like the investments under their control to outperform. But what makes the job of many defined contribution scheme fiduciaries more tricky is the element of individualism.
This model, known as self-select or the cafeteria system, is an import from the US that has not spread much beyond the UK and Ireland. Typically individual scheme members can choose from upwards of three funds in which to invest. The basic trio comprises a cautious fund, a balanced fund and a growth fund. The first invests mostly in bonds; the last mostly in equities while the middle fund is a truer mix of the two.
There is no legal reason why this trio could not multiply into 25 or 30 funds. There is a view that members ought to be in a position to refine their investments, not merely opt between the fundamental asset classes contained in the basic trio.
This form of empowerment would not leave members entirely isolated in their decision-making. To assist selections, they are typically offered access to independent financial advice. In the UK, it is illegal for unqualified individuals to offer financial advice and so the fiduciaries themselves cannot direct members at this juncture.
Multi-managers are marketing themselves as an additional layer of responsibility between the individuals and the underlying funds. Arguably, they offer an alternative to an independent financial adviser.
Fiduciaries might want to consider this layer as a kind of insurance against future claims of negligence. Outsourcing to multi-manager experts avoids potential legal wrangles regarding the boundaries where trustees’ responsibilities end and members’ own decisions begin. Self-select or cafeteria schemes might face legal action from disgruntled members who have unsatisfactory amounts of retirement money. Their case would be that the scheme left too much onus on them to manage their savings for pension via fund choices.
Such a case has not yet materialised in the UK and there is no certainty that it ever will. However, there are a number of examples of litigation in the US whose subject is the role of fiduciaries of defined contribution cafeteria schemes. For example, in the late 1990s information technology provider Unisys found that one of the funds on offer to members in its scheme could not deliver the guarantees promised. A succession of cases followed to determine on whose shoulders responsibility fell for the failure of that fund provider. One of the legal arguments rested on how much scheme members might reasonably be expected to know from the public domain rather than scheme literature.
Given the terrible prospect of answering these kinds of arguments, the multi-manager model appeals.
Adrian Swales, managing director of Aon Asset Management, expands on those ill-defined areas whence conflicts could arise: “In a traditional scheme, if there is an active manager whose performance does not pick up, the trustee removes it. In a cafeteria-style scheme, an individual member thinks they want to remove an underperforming manager: what happens?”
Swales feels that not only
can multi-manager leave responsibility in the hands of competent practitioners, but it offers exposure to a greater variety of providers. This is an argument about economies of scale. The multi-managers are popular with all types of provider because they save themselves marketing costs. “Multi-manager gives access to specialist managers at commercially sensible rates,” says Swales.
His view is shared by Debbie Clarke, senior investment
consultant at Watson Wyatt. “We think multi-manager is quite a good fit because it can give access to some highly skilled managers which might not offer defined contribution solutions,” she says. Clarke also agrees that trustees find appealing the outsourcing of the tricky job of dealing with poorly performing managers.
But Watson Wyatt has expressed concern about the construction of global equity funds by multi-managers. The consultancy generally views multi-managers as most attractive for the higher-returning asset class of equities rather than bonds. It believes, however, that many global equity offerings have merely been the composites of multi-managers’ regional funds instead of a genuine mix of global equity specialists. A similar criticism is that for the UK market, global equity funds have had an artificially high weighting to UK equities.
New products which have
quietened these criticisms are
two genuinely global equity offerings from Russell and NTGI.
On fees for equity funds from multi-managers, Watson Wyatt considers 60-80 bps as reasonable. Anything greater than 100 bps it feels would be hard to justify over and above the benchmark.
So where lies the future of multi-managers in defined contribution? Fairly remunerated, perhaps, but some patience is required. The ethos of individualism has not spread far in European occupational savings: many might consider it a contradiction in terms and some national legislation is prohibitive. Italy’s new industry-wide and regional schemes have been struggling since birth seven years ago to reform laws which put all members in the same compartment regardless of life expectancy or risk appetite.
PP, the fund for the Swedish media, last month introduced individual choice for additional savings but it has no plan to
give members such responsibility for the fortunes of their main
In Switzerland, UBS offers a multi-manager programme, including names such as Alliance Bernstein, Capital International, PIMCO and Schroders alongside the domestic talents of Vontobel, Independence, Pictet and ZKB. But it is not clear how many DC schemes have chosen UBS for this programme.
In the UK, Clarke confirms that most of Watson Wyatt’s DC scheme clients have some element of self-selection by members. Not only the larger consultancies but medium-sized players like Lane Clark & Peacock have built investment software programmes to aid members of client DC schemes make sensible choices.
But among the providers, even Russell, the biggest multi-manager, has no more than 20 such clients. Patrick Disney, head of institutional business, Europe, at SEI, admits that its prime target is the defined benefit sector because it contains the overwhelming majority of assets.
Given the short-term pressures of the asset management business, multi-managers are more likely to strike up agreements with larger organisations such as insurers than win a lot of new business from defined contribution clients direct.