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IPE special report May 2018

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Complexity of pension fund strategies increases legal risk – consultants

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The increasing complexity of pension fund strategies and the merging of advisory and implementation roles is introducing greater risk of disputes with clients and even legal liability, according to some of Europe’s leading pension consultants.

At the same time, the need for more bespoke, scheme-specific solutions is improving the competitive landscape for consulting, especially in the UK, where the market is both highly important to the pensions industry and highly concentrated in the ‘big three’ of Mercer, Towers Watson and Aon Hewitt.

The opinions come from the latest annual survey of consultants conducted for the regular special report that appears in the March 2015 issue of IPE.

The report looks into these questions in greater depth, and contains further comment from the survey on regulation of the industry across Europe.

Not all consultants perceive there to have been an increase in disputes and misunderstandings as a result of the growing complexity of pension fund management, but even those who do not see a problem, such as Lukas Riesen, a partner at PPCmetrics, Martijn Euverman, a partner at Sprenkels & Verschuren, and Stephen McCourt, managing principal at Meketa Investment Group, recognise the importance of a “clear understanding of expectations, obligations, guidelines, goals and visions” to maintaining a “cohesive relationship”.

As Euverman put it: “It is our philosophy to reduce complexity, keep it simple and be to-the-point. This also helps us in preventing misunderstandings.”

Others strike a much more cautious note.

“The risk of misunderstanding increases with complexity and tight timelines for decisions,” said Tim Giles, partner at Aon Hewitt.

Alex Koriath, head of UK pensions practice at Cambridge Associates, agreed that “risks have increased” as pension funds have adopted more complex strategies such as LDI or investing in private markets.

“Successful outcomes from these strategies require closer and clearly defined working relationships between investment consultants, lawyers, other advisers and the scheme’s trustees,” he said.

“Without a clear implementation plan that is fully understood by all parties, complex strategies that look good on paper can become a nightmare in terms of additional costs and implementation errors.”

Great complexity of solutions has often led to the recommendation of more delegated governance approaches such as implemented consulting and fiduciary management, and some respondents pointed to this as a potential source of dispute risk.

“I do think the risks have increased, in that lots of consultants are also managing clients’ money,” said Patrick McCoy, a partner at KPMG.

“This is a completely different task, and, if clients go down this route, they should be very careful how the contract is negotiated.”

Pascal Duval, chief executive of EMEA at Russell Investments, said that, as the lines between advice and execution had “blurred”, investors’ expectations for how responsive their advisers could be to changeable markets increased unrealistically, not least because the change in governance approach had often been adopted precisely to cut back decision-making time.

“It’s been a frustration for many that advice has not been rapidly executed, and that advisers have not taken full accountability for that,” he said.

“In fact, the dominant driver of poor returns, poor outcomes and increased pension deficits has become ‘implementation leakage’. It starts from inadequate governance at investors’ level first, and goes down the food chain from advisers to managers.”

The trend for fiduciary management and other delegated governance structures also came up when consultants operating in the UK were asked to comment on the state of competition in their market.

Trustees should re-evaluate their current investment consultant on a regular basis and consider third-party overseers, said McCourt at Meketa, especially in the light of the “shift in focus by some large UK pension consultants to act as asset managers and develop investment products”. 

McCourt added that “specialisation” in advisory services would help to stimulate competition from smaller consultants – and these themes of the positive impact on competition of increasing scrutiny under fiduciary management arrangements, and the growing demand for bespoke solutions, was echoed by other respondents.

“From what we see, the level of competition is healthy and growing,” said Patrick O’Sullivan, director in investment consulting at Redington.

“As pension funds have moved from a generic ‘asset-only’ to a specific asset-liability context over the last decade, we have seen a greater demand for an approach that is more customised to the client’s individual situation – it’s funding objectives, its covenant, its capacity for risk. 

“This has led to clients seeking a consultant that is the best fit for them, rather than just one of the largest firms, leading to a level ground from a competitive perspective. The other factor is the innovation in technology, both ALM processing and the software and tools offered to clients that a number of consultancies now offer.”

Nonetheless some, such as McCoy at KPMG, still think pension fund trustees “tolerate poor service and quality of advice for too long before undertaking a review”, and even some who see improvement in market competition, such as Koriath at Cambridge Associates, report trustees saying that “it is hard to get a good overview of the adviser market and the strengths and weaknesses of the different competitors”.

More views from the survey, as well as in-depth analysis of both these contentious issues, can be found in the latest edition of IPE

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