Trustees now have various opportunities to delegate some investment decision-making. Gill Wadsworth asks whether fiduciary management is a better bet than implemented consulting
From time to time fund managers and investment consultants are united in a shared doctrine about the way in which pension funds should be run. The latest mantra from both parties stems from their common belief that running a pension fund is all too much for the layman these days, and the complexities and intricacies of modern investment strategy dictate that only an expert is capable of carrying out such important work.
In many cases they have a point; a greater emphasis on improving governance coupled with demands for diversified portfolios that reflect a scheme’s unique liability profile, are a distant cry from the straightforward domestic equity/bond split that characterised pension funds until the turn of the century. And the financial chaos of the past couple of years, which caused the UK’s defined benefit funding ratios drop to an average 79.5% when markets were at their lowest ebb, has highlighted the limitations of traditional pensions management.
Trustees are undoubtedly weighed down by countless demands on their limited time and resources, and the opportunity to pass some of this burden on to a third-party offers significant relief. Consequently fiduciary management, which has long been a favourite in the Netherlands, is enjoying a surge of popularity among institutional investors in the UK, Ireland and, to a lesser extent, the Nordic regions and the US.
Michael Marks, chief operating officer for BlackRock’s fiduciary mandates team, says: “The volume of potential clients we are talking to, and the ones we have won already, leads us to the conviction there will be a very fast take-up [of fiduciary management] - much faster than we might have expected 18 months ago.”
Hewitt’s global risk survey 2009 found 21% of pension funds were considering a move to fiduciary management, an increase from just 2% in the previous year’s survey (figure 1). As such obvious revenue-generating opportunities are created, organisations across the industry have been falling over themselves to join the fray.
Where once the boundaries between consultants and fund managers were clear and each played a distinct role in the process, now they jostle for position, desperate to differentiate their fiduciary offering from that of their nearest rival. As a result there has been an explosion of labels and descriptions of services that mostly fall under the fiduciary umbrella - solvency management, implemented consulting, delegated, to name a few - but essentially these all amount to the same thing: taking a more proactive role in pension management.
“There are all sorts of terms vying for attention, but what is important for any trustee considering this approach is to understand the differences between what the firms are offering, and to fully understand what it is they are looking for,” says Sion Cole, investment consultant at Hewitt.
Given that the role of fiduciary manager is a departure from the traditional fund manager or consultant models, investors have to ask themselves which party is best able to equip themselves with the requisite skills. For the fund management contingent, the advent of liability-driven investment (LDI) in recent years has led them to broaden their capabilities, encompassing a better appreciation of asset and liability matching - a core tenet of fiduciary management.
Robert Ross, senior consultant at Russell, says: “Whilst fiduciary management has expanded significantly in recent years, much of the assets allocated to this approach have been awarded to investment managers who have developed the consulting skills required to extend their products.” Ross adds that providers with consulting backgrounds have been less successful in developing credible products. This is attributable to a lack of track record in providing fund management services either as a standalone business or as part of a broader product.
While fund managers may be able to demonstrate a host of necessary talents to boost their fiduciary credentials, a key consideration has to be their ability to provide investors with access to all the appropriate asset classes that their unique situation needs. Even the strongest multi-asset house cannot claim to be expert across all asset classes. As such, the real test of a fund manager’s fiduciary offering is in the area of open architecture.
“Fund managers will always be torn between their in-house products and outside ones,” says Patrick Disney, managing director of SEI’s institutional business for EMEA. “We know that the very big firms have very big products, but it’s a difficult position to be in when you are choosing between your own products and one of your competitors.”
Chris Trebilcock, head of product development and client management at Investment Solutions, says it is a necessity for a fiduciary manager to be able to access a diverse range of growth and protection assets to enable a scheme’s liability risk to be managed effectively. However, he adds: “There are not many players out there that can offer all this without the help of a specialist investment provider.”
BlackRock is one such fund manager building a presence in the fiduciary arena, having secured its most recent publicised mandate with the £410m (€162.3m) PA Consulting pension fund in October last year. The firm claims it is possible to be completely impartial when selecting external managers. Leen Meijaard, BlackRock’s head of institutional business in continental Europe, says performance-related fees help align the provider’s interests with that of the clients, leading them away from a home bias.
“Our fee is dependent on the performance of both the internal and external managers so there is a strong incentive to select the best managers,” he says.
Further, BlackRock says it is not swayed by a certain house view on asset classes or investment strategies, and that every portfolio constructed by the fiduciary team is unique. However, Marks adds: “When we are building portfolios it is tailored to each individual client’s needs. If there is commonality in the mix of assets and managers we like, and they are appropriate for more than one client, then it is likely we would build that commonality across those mandates.”
Schroders is another firm showing an interest in the fiduciary area, building on its LDI and diversified growth fund capabilities to get a foothold in the market. Neil Walton, head of strategic solutions and a former Mercer employee, says that it is straightforward to set
up legal agreements dictating how the portfolio will be split between internal and external managers. What matters is whether an investment manager has the contacts to establish a platform boasting the best providers with the strongest srategies.
“There needs to be an investigation of capability, resource and skill to see how that can be brought to bear in the right solution for a client. Some trustees do this already, looking through the business model to test whether a provider is managing any potential conflicts that arise,” he says.
For investment consultants marching into the fiduciary space, access to fund managers is unlikely to prove a sticking point. Their extensive manager research built up over decades of advisory work means they are well placed to ascertain who is best placed to deliver the best performance and risk. However, making the transition from gatekeeper to provider requires a whole new skill-set, and traditional advisory firms will need to demonstrate that they have an implementation ability equal to that of their fund management counterparts.
“There are many other skills required to actually manage an investment product,” says Russell’s Ross. “Assembling the component parts of custody, reporting, analytics, and portfolio management systems is a challenge but perhaps one of the hardest skills to acquire is practical, hands-on experience of managing such a venture through time.”
Mercer has spent the past three years developing the fund management arm of its business in order to operate effectively in the fiduciary - or implemented consulting - market, and now has £3bn of assets under its care. Dan Melley, head of business development for Mercer’s implemented investment consulting business, says: “The things we talk to a fiduciary client about are no different to what we have been talking to clients about for 30 or 40 years. All we have done is just package it altogether, so if you are buying our advisory capability then why not consider us for implementation?”
And it appears pension funds do consider consultants to be viable fiduciary managers. Mercer’s implemented consulting business has amassed 46 clients in the UK and a further 89 across Europe. Similarly, Hewitt has witnessed a major uptick in its delegated consulting offering, while PSolve, the asset management arm of consultancy firm Punter Southall, boasts around £1.4bn in assets under management under its ‘total investment governance solution’.
The consultants’ success could, in part, be attributed to their established relationships with trustees. Since they are already acting as adviser or gatekeeper, they are one step closer to the end client than their fund management counterparts. However, Schroders’ Walton says he has seen limited hostility towards consultants’ encroaching into what was traditionally a fund management space.
“We need to be grown up about it. The market it evolving and there will be times when organisations are competing one day, collaborating the next,” he says. “A fund manager might refuse a search visit on a product because of what [a consultant] is doing in this space, but the next day they have the same consultancy research in a different part of the business.” He adds: “While the market is evolving it is unsettling for all parties concerned because the rules of the game are adjusting, but if we are mature about it we will be fine.”
Given the size of the DB pension market in the UK and Netherlands, not to mention possibilities in the Nordic countries and elsewhere, there should be plenty of fiduciary spoils to go round. However, as with any pioneering market, some players will fall by the wayside. Melley believes the market will split between clients looking for providers with more of an advisory heritage and those looking for a fund management background. This suggests that organisations that falls between these two stools might be lost to the market.
“The two types of offering are different enough that if the client is considering what they want from fiduciary management they will gravitate one way or the other,” he says.
The role of fiduciary management - whatever its label or form - is an important development in a world obsessed with improving governance and raising pension funds out of funding crises.
It is still too early to judge whether providers, be they consultants or fund managers, can deliver on their promises, or whether, in fact, we end up moving from a world of specialists to one populated by jacks of all trades who are masters of none.