Too often in EU cou ntries, pension funds are not free to diversify. In some cases they cannot even choose their service providers. The result has been unnecessary costs and inefficiency in serving members’ interests.
The marketplace is increasingly global. Competitive advantage and participants’ security can be enhanced by exploiting global market opportunities, cross-border synergies and economies of scale.
Monsanto is a US-based multinational sponsor looking after $6.5bn of pension assets. Five years ago, we decided not to wait for the rules to change to design and implement a comprehensive pension fund strategy. The task was to integrate pension funds in several countries into a global network. The project is almost complete.
Monsanto’s management decided it was not economic to run pension plans through largely decentralised, unconnected organisations. Decentralisation not only meant higher administrative costs and funding inefficiencies but also lower yields because global markets were not fully exploited.
Given the fiercely independent local culture prevailing in many operations outside the US and the fiduciary obligations of local trustee boards, streamlining the pension fund structures around the globe proved to be complex and time-consuming.
The initiative came from the top. The corporate pension director set the agenda:
q first, integrate multiple funds and plans within individual countries;
q second, simplify, coordinate or, if possible, integrate plans in different countries; and
q third, determine and put in place the best staff alignment.
Pension staff at world area headquarters were given the job of selling” the concept to local managements. Once the timetable was agreed, local human resources, finance and legal representatives took over the implementation with access, as required, to corporate resources and outside advisers.
Integration of plans in the US, UK, Canada and Australia is almost complete. Work has started in South Africa. As much progress as possible has been made on cross-country integration.
The first step was to pool the assets of our three UK pension funds to establish one well-managed fund of about £20m. A common investment fund (CIF) was set up, organised as a unit trust. This allows each plan to know the value of its own share of the assets while providing centralised investment, custody and record-keeping.
Representatives of each participating company and the parent company’s director of pension assets management serve as trustees. The CIF has seven investment managers with expertise in various assets classes.
One critical step towards a successful asset pooling scheme is to gain a strong “buy-in” from local management and trustee boards. Trustees are asked to give up some independence with respect to choice of managers, custodians and asset allocation. This must be clearly offset by the prospect of better returns and lower costs.
Having established a world-class investment fund in the UK, the next logical step was to open it to non-UK plans - in our case, our Belgian-based plan. Technically this is feasible.
Unfortunately, cross-border pooling schemes in Europe are still limited by tax and local investment restrictions. In Belgium, for example, pension funds are not allowed to invest more than 5% of their assets in unit trusts that are not publicly quoted and traded in Belgium.
Despite the obstacles to pooling global funds, our experience is that many of the desired benefits of pooling assets in different countries can be achieved by using common providers of services. Asset/liability studies undertaken for our Belgian and UK funds show that international investments, as separate asset classes, would bring diversification benefits.
We then faced a choice between expanding the mandate of local managers or hiring common multinational managers to manage global equities and bonds for each plan. We decided on the latter, for the following reasons:
q hiring the best manager from a global universe can be expected to provide betterperformance;
q costs can be reduced when assets are aggregated for fee calculations;
q although tracking must be conducted from each fund’s perspective, oversight is reduced;
q leverage on the manager is enhanced; and
q use of common managers will facilitate cross-country consolidation when the laws eventually permit it.
Cultural barriers need to be overcome. Diversification away from local securities and managers is often resisted by local trustees, especially when performance has been adequate. Training on the merits of international diversification and understanding of local sensitivities may be time-consuming, but they are essential. Use of outside investment consultants may help educate trustees.
We do not suggest that global investments should replace domestic ones. Some countries require pension funds to invest a percentage of their assets in domestic securities. There are sound management reasons for a pension fund to invest much of its assets locally. Local equity, bond or real estate managers are generally best qualified for these assignments.
Like many sponsors, we use the same auditors and actuaries around the world. Use of a common custodian would offer similar advantages but our experience is that custodians are more advanced in some countries than others. It can thus be expensive and cumbersome to implement global custody schemes.
Merging pension plans goes beyond organising an asset-pooling vehicle. It involves merging the assets and liabilities of separate plans under one trust deed. The advantages are compelling, leading Monsanto to merge plans in every country were there were separate plans. Nevertheless, the process is complex. A merged plan saves on actuarial costs through combined valuation and fee aggregation. It also leads to consistent valuation of liabilities and coherent funding practices. This is in the interests of both sponsor and members.
Potentially, plan merger can also reduce contributions if funding levels differ. If, for example, liabilities are 150% funded in one plan and 100% in another, future contributions may be needed for the latter. Merging the plans may alleviate that need.
An additional advantage is to streamline practices on benefit improvements. Decentralised plans tend to use surpluses to improve benefits. The corporate approach may instead be to use surpluses to manage contribution rates, leaving the benefit aspects to be determined by competitive practice. Merging plans is likely to help enforce the corporate approach. Plan merger does not imply that the benefits of the former separate plan members need to be harmonised.
Legitimate fiduciary and management questions need to be addressed in consolidating plans:
q Should trustees of an over-funded plan approve a merger with an under-funded one?
q Do benefit improvements or benefit programmes need to be harmonised for new entrants?
q The new trustee board must be representative but also manageable and efficient. How will it be composed?
q Who will decide on service providers?
q How is communication with members to be handled, especially when unions are involved?
q How will management trustees resolve the potential conflict of representing both sponsor and members?
There is no single answer to all these questions. Surplus dilution is probably the most sensitive issue. The sponsors may have to provide members of better-funded plans with an undertaking that their benefits will continue to be fully funded.
The appointment of outside counsel to the trustees (as distinct from sponsor counsel) may be required to help trustees discharge their responsibilities in total independence.