Saker Nusseibeh, head of investment at Hermes Fund Managers, sees something wrong in the current system of pension fund management, which he believes prioritises product proliferation and a mentality of ‘buyer beware’ over trusted advice.
“I passionately believe that we have blamed investment banks and the regulator for 2008,” he says. “I think we should blame the CIO community. It is not as if they did not know that a lot of these instruments and strategies were wrong. They did and they did not speak out loudly enough because they put the commercial interests of their firm ahead of the interests of their clients.”
So Hermes, the £25.6bn (€29.9bn) investment management company owned by the BT Pension Scheme, is putting its money where its mouth is in a bid to rethink the client/manager relationship, and is in the final stages of development of an investment office function that will work will work for all clients, regardless of how much or how little money they give Hermes to manage.
Nusseibeh sees the new function, which is currently being rolled out to clients, as a pioneering step in pension fund management, bridging the gap, as he claims, between the client and the fund manager, and working on behalf of the client.
Where the large Dutch pension funds have spun out their investment operations as all-in solutions providers for defined benefit pension schemes, Hermes has created a multi-boutique structure - a process that began in earnest when it sold its £30bn passive management business to Legal & General Investment Management in 2007.
The firm now has 12 boutique strategies across equities, fixed income and alternatives, as well as Hermes Equity Ownership Services, which specialises in shareholder engagement. In 2009, it acquired a majority stake in Sourcecap, which is now its European equities specialist. As part of its move to become a multi-specialist asset manager, the firm also outsourced middle-office investment operations, custody and fund administration to Northern Trust in the summer of 2008.
For Hermes, which traces its existence back to the privatisation of British Telecom in 1983, this process has meant downsizing from an organisation with over €100bn in AUM and 221 institutional clients at the end of 2006 to €47bn and 191 clients by the end of 2007, according to information the firm provided to the IPE Top 400 Asset Managers report. The firm also appointed its current CEO, Rupert Clark, over this period and managed just shy of €30bn for 193 clients at the end of 2010.
But the firm recognised that this recalibration of the business into autonomous boutique units still required central co-ordination at a risk management level, if decidedly not central control under a chief investment officer with a single-house view.
So how will the investment office work? Of course, the function was designed with the BT Pension Scheme, Hermes’ owner, in mind. But the decision to open the investment office to other clients is a pioneering one, Nusseibeh asserts, and one which is closely associated with a vision of responsible investment. For him, this concerns fiduciary responsibility and how this is divided between asset owner and asset manager.
“For us, the foundation of what we do is responsible asset management, which is different from responsible investment, although part of it,” says Nusseibeh. “Put simply, it means being stewards for clients in the ownership of assets. Responsible asset management is about the relationship between the asset manager and the client and that is where we think fiduciary responsibility with a small ‘f’ comes in.”
Succinctly, Nusseibeh describes the function in these terms: “It’s trying look after the interests of pensioners and to learn from the modern techniques of the 2000s where you have the analytics, the firepower, and very advanced long/short techniques but you combine that with a long-term house looking after the interests of the clients.”
This is not a soft commitment. For Hermes, this has not just involved implementing the products of Barra, Barclays Capital Point and Northfield. It has also developed its own internal proprietary multi-factor econometrics model called multiFRAME. The firm has also allocated dedicated risk management specialists, attribution specialists and fund managers to the investment office function.
“We are not running money, so we are, in some senses, an expensive resource,” asserts Nusseibeh. “It’s to do with expense on hardware and people, but it is also an attitude. We are owned ultimately by a pension scheme that happens to be our largest client and there is no way we can treat other clients any differently from the fiduciary care that we show to our main clients.”
Nusseibeh compares Hermes’ investment office with the kind of central risk office that large long/short funds have: “The difference here is that the risk function is embedded in the CIO office itself and the CIO becomes part of it, so the alignment is entirely with the clients. Second, we are proactive, not reactive. We are trying to look at the client’s own money as if it were our own book. For us the book is not the firm; the client is the book.”
An important part of what Hermes is trying to do in the investment office is to create an early warning system that picks up, not only on deviation in term of performance, but also in skill, in terms of the information ratio you would expect the manager to provide. “This means we can pick up on early warning signs even when the ultimate performance is not showing this. This is important because we can pick up on deviations both positive and negative, which allows us to talk to that boutique and if there is an issue to identify it and to identify the solution with the manager. We do not run the portfolios and do not have a house view but we know each manager very well and if the early warning system highlights an issue, we have a better chance of fixing it with the manager before it becomes an problem.”
So what does the client see? Nusseibeh believes the reports have a high level of transparency in terms of risk, the teams and the positioning. In other words, clients will see the same as the trustees of the BT Pension Scheme. In addition to quarterly reports, Hermes is also prepared to offer clients copies of relevant parts of committee minutes concerning teams and their strategies. “That is a level of openness that other people do not have,” he says.
The investment office also produces market analytics and shares this with clients. “We are not a consultant to the client and are not the asset manager,” says Nusseibeh. “But we are an internal consultant that can give the client, which may also be the consultant, additional input to help them make decisions to help them make sure they have, in the long run, sustainable and repeatable alpha.
What kind of person is suited to a position in a central investment office, in particular now that the multi-asset specialists who used to run balanced mandates have either retired, become specialists, or gone to global macro hedge funds? Nusseibeh also notes that chief investment officer function has shifted since the 1980s and early 1990s and has moved “from being a strategist to being a man manager and grand salesman”.
He sees a need for a variety of skills in the new function: “The new breed of investment office and CIO is a risk manager for the client. You need, therefore, a variety of skills - asset allocation skills, fund management skills, people who know how to run money at a senior level.” This involves examining data qualitatively as well as quantitatively, Nusseibeh says, with risk specialists “of the calibre of a hedge fund or the structuring unit of a bank” and attribution specialists who can work in the context of particular instruments of market conditions.
Now that the investment office is ready to go live, is there a danger that the model will be copied by others? “Although we will start losing our first-mover advantage, I still welcome [wider adoption] and it is right that people should do it. I still think the kind of structure we have put in place is to do with the way we think about the world. You also have to structure it so it is financially completely independent. It’s not a service that you sell and you are not linking the profitability to any bit of the business, you are doing it because you need to.
Ultimately, aside from the BT Pension Scheme Trustees’ satisfaction with the model, the external test will also involve solving problems before they happen. “The fact that few people will talk to us: if we solve problems there will be no problems,” as Nusseibeh puts it.
He concludes: “In the asset management business people tend to think of their heroes as the people who deliver performance - fund managers, strategists, alpha producers. We think there is a space for the people who look after the client quietly, day-in and day-out, who, almost behind the scenes, make sure nothing comes off the track, and who seek nothing more than the satisfaction that their client is looked after.
This is a lofty goal for a modern commercial organisation but it is one that Nusseibeh is evidently passionate about.