A recent report on fiduciary management in the UK published by XPS Investment claims that fiduciary managers are “largely untested” when it comes to de-risking strategies and helping clients achieve their long-term objectives.
XPS Investment, a subsidiary of advisory firm XPS Pensions Group, noted that fiduciary managers often have a reputation for providing solutions for clients during the growth stage of a scheme’s funding journey, where assets are typically required to deliver high levels of return to reduce a funding deficit.
Often portfolios are constructed with a degree of complexity, the report said, and may use illiquidity to target high levels of return, often at a higher cost.
However, as The Pensions Regulator (TPR) places more emphasis on the importance of long-term funding targets, the report revealed that the approach taken by fiduciary managers to de-risking varies greatly and is impacted by size of scheme, flexibilities in fiduciary managers’ approaches and opportunity set.
“Given the importance for trustees to set long-term targets, it is imperative that fiduciary managers understand these objectives as soon as possible and are measured and monitored against them,” André Kerr, head of fiduciary management oversight at XPS Investment and co-author of the report, said in the report.
When appointing or reviewing a fiduciary manager, trustees should consider their approach to de-risking and consider how they plan to achieve their scheme’s long-term funding objective, Sophie Tennison, head of investment and co-author of the report, added.
“This is important to consider when appointing a fiduciary manager – even if not an immediate concern – due to high barriers and costs of exit”, the report added.
The report identified three main approaches used by fiduciary managers as part of a de-risking toolkit for end-game investing:
- barbell approach – under this approach, whilst the asset allocation typically moves from growth to matching assets, the asset allocation within the growth portfolio remains broadly the same;
- lower risk growth portfolio – under this approach, as the target return of a portfolio is reduced, the growth assets are typically invested in lower returning, lower risk assets, such as credit or high-quality secure income assets. The strategy may still hold growth assets, but they will be a smaller proportion and reducing over time. This type of portfolio is appropriate for schemes targeting self-sufficiency or buyout;
- cashflow driven investment (CDI) – the primary benefit of CDI is to invest in contractual income generating assets to lock in returns for the longer term. However, there are a range of interpretations and some managers may also seek to match near term cashflows to pay benefits. Therefore, the approach taken by a fiduciary manager varies considerably depending on how they define CDI.
Preparing for buyout
For schemes ultimately targeting buyout, the report noted, the approaches used by a fiduciary manager within the de-risking phase will be important – particularly when buyout remains a few years away – but consideration should also be given to other ways in which the fiduciary manager will support schemes in their transition to ultimately transacting with an insurer.
One example of this is where fiduciary managers use live tracking for buyout pricing to take advantage of favourable market buyout pricing, according to the report.
This approach contrasts with those fiduciary managers that set their own proxy buyout bases, where there can be a spread of up to 0.5% p.a. between the most optimistic and most prudent discount rate assumptions and hence a potential mismatch relative to the price at which the scheme can transact.
Fiduciary managers that originated as traditional consultancies tend to have established, in-house processes and use the tools within the wider business to support schemes in those areas, it added.
For other fiduciary managers, such as certain asset managers and specialist firms, end-game investing is relatively new. However, to be able to support clients, some have linked up with various third-party firms to ensure fiduciary managers can provide clients with a credible end-to-end solution.
In many cases, these third-party agents will be solely focused on insurer dealings and are very experienced in this field. However, whilst trustees should be exploring fiduciary managers’s capabilities in supporting a move to buyout where that is their end-game, it is also important to understand the level of experience fiduciary managers have in using these tools.
Schemes’ journey plans
“No matter where schemes are on their journey plans, trustees using or considering a fiduciary manager arrangement should be seeking to understand how [such manager] can provide support throughout all phases of those plans, rather than focusing solely on the strategy that has relevance today,” the authors said.
This is true even for schemes with a reasonable time horizon remaining. It may be valuable for trustees to seek independent advice for the most suitable solution and how that will evolve over time, they said.
“Whether it be low dependency, long-term targets or those aiming for ultimate buyout, many fiduciary managers have been somewhat untested so far when it comes to getting a meaningful amount of clients to their end goals,” they said.
Trustees should therefore look at several factors when considering how a fiduciary manager will assist them in the latter stages of their schemes’ journey plans. These include de-risking tools available, additional expertise in transitioning to buyout and ultimate experience in taking schemes through to the different types of end-game targets.