“If I was a large pension fund, I would see no reason to invest in a pooled fund. They are more expensive and less flexible.” When this is the opinion of a global investment consultant, it is little wonder that the pooled fund market continues to be the domain of small pension schemes Europe-wide.
This negativity has not deterred the fund management industry though, which comes as some relief. The past year has seen an influx of European and US fund managers setting up institutional funds and introducing institutional classes of shares to existing funds in a bid to attract more pension fund interest in pooled fund structures – and they are not just going for the small schemes either.
According to Irish lawyers Dillon Eustace, around 50% of funds established in Dublin are now aimed at the institutional market. Luxembourg funds are enjoying a steady inflow of institutional money, increasing levels of which are being sourced from the Belgian pension fund market, which has been given a new lease of life since limitations on mutual fund investing were overruled. Previously Belgian investors had been limited in their choice of funds, namely BEVEKs, the Belgian equivalent of French SICAVs, largely down to the fact that the custody assets had to be domiciled in Belgium. Since that rule no longer exists, schemes have been busy examining the alternatives.
And in Switzerland, the eight-strong KGAST set of investment funds now account for 10% of the Sfr40bn (E25bn) Swiss pension fund market. According to Watson Wyatt figures, KGAST funds had a 20% average growth last year, though in many consultants’ opinions they are not the sort of funds which should be used by larger pension schemes. And this is a philosophy common across Europe – segregated belongs to the big players, small funds should stick with pooled.
“It’s a typical product which should be destined for small funds,” says Gio Puglia at Watson Wyatt in Zurich of the KGAST, though he admits: “They are good for tactical asset allocation, for easier asset switching.”
Much of KGAST growth has been down to an influx of smaller schemes carving off the investment side of their fund but keeping on their insurance companies for the risk coverage. On a parallel with this movement, the investment foundations have res-ponded and are now differentiating themselves by altering their risk profiles to attract more business. “Pension funds can now choose one which suits their asset allocation,” he say.
Fund managers such as JP Morgan, Barings, MFS, Schroders to name but a few have introduced institutional classes of share, and will invariably reduce the fees as the mandate size increases to make the costs more attractive to all sizes of pension funds. A common view is that pooled funds would actually attract greater market share of the institutional marketplace if they were more flexible on their fees, as many believe this is a key deterrent for the larger funds.
Many fund managers, however will refuse to negotiate their fee levels if the performance is good enough to keep attracting smaller investors. “Fees are the only stickler on the pooled funds side,” admits Ryan Pollock at Investeq Guinness Flight in London. Investeq which has had substantial success in South Africa is now readying itself for a strong institutional marketing push into Europe, and is an example of a manager who will not negotiate on fees. “We have outstripped the competition in South_Africa by 8% over the past year,” reasons Pollock. It is not yet clear whether this philosophy will be rolled out into the European market, but as Roland Franz at Vontobel in Zurich concurs, at the end of the day, the push for a more attractive fee structure needs to come from the investors themselves. “If institutions put on more pressure then prices will come down,” he says.
But Watson’s Puglia is not alone in his scepticism of the extent to which a different pricing structure is going to attract the upper end of the market. “You have to see if they are competitive with segregated mandates,” he points out. “And more often than not they aren’t.”
However, with so many asset manager’s returning disappointing results of late, particularly in the UK market, one could say that the competitive advantage of segregated accounts is somewhat less than it used to be. The emergence of multi manager fund structures has been largely down to the downfall of balanced management in the UK and the needs of pension funds to get more out of their investments (See pages 53). And their success not only in the UK market but on the continent puts pay to any claims of total superiority on the part of segregated management – multi manager fund providers have proved that pooled funds can take on separate accounts – and win.
Aside from the fee issue, there is a concern amongst pension funds over the actual investment process of pooled fund managers and whether it matches that offered by a segregated account team. In some investment management houses, the results can differ dramatically for this very reason. Pollock at Investeq believes on performance grounds neither approach should be better than the other if you implement the same asset management style across the board, leaving the cost issue really the only core factor for pension funds opting for separate accounts over pooled funds. “Your performance shouldn’t be different at all,” he says.
Arno Kitts, CEO of JP Morgan Life Assurance in London which has been set up to tap the UK pensions market, supports this. “What we do is put the stock selection piece of the investment management process in the fund, because that’s the same - whatever we do across all accounts, we would be buying the same equity. So what you are doing is reducing our costs essentially by having them all managed in one fund.” JP Morgan does actually offer discounts to its pension fund clients as do a number of other pooled pension fund managers. “This reflects a mitigation in cost that we get.”
Even so, while the benefits of pooling - diversification, less risk, econ-omies of scale - have been well argued out by fund managers, those funds which have simply added on an institutionally-attractive share class have another very real issue on their hands. In such ‘hybrid’ funds the comings and goings of the retail element can drag the overall performance down.
“If you are going into the same fund as small retail investors, and you have not got a proper allocation of the costs of them buying and selling to those investors then you are going to have a long term dilution on the value of your holding,” warns JP Morgan’s Kitts.
He adds: “I am certainly not suggesting for a minute that fund managers are not addressing these issues, but, they are issues.” Indeed, the common complaint of ‘lack of transparency’ in the funds’ structures is an issue which need to be combatted by the fund industry in the tools they make available for investors to assess the real suitability of a fund (See box).
It is not only the retail investors that are of concern either - it is the other pension fund investors in the vehicle. While the economies of scale argument, of course, is undeniable for smaller pension funds, when ‘segregated’ levels of assets are being in-vested, the pension fund needs to feel that it is not ‘carrying’ the investment fund as the majority stakeholder. Because if that is the case - why not just get a separate account with the added flexibility that goes with it? This has in fact been a very real problem faced by fund managers marketing to the upper end of the market, says In-vesteq’s Pollock. Investeq found in the US, that while larger plans fully appreciated the funds’ performance and levels of service, they were not willing to dedicate any of their assets. “They wouldn’t give us the assets because we don’t have enough in the pooled funds,” explains Pollock. “Because if another large shareholder of the fund wants to disinvest, it can be a problem.”
In light of that, pooled funds are undoubtedly simpler to exit should problems arise. “We are priced and valued and accept cash on a daily basis,” says Frank Satterthwaite at Vanguard in Brussels. “If you want to invest today that’s fine. If you want to withdraw tomorrow that’s fine. In a segregated account you are limited to when you can invest and when you can redeem.”
Many might sniff at pooled funds dismissing them as the poor man’s investment tool, but fund manager’s should not lose heart as many believe that pooled funds hold the future key to Europe’s pension markets. When the much vaunted defined contribution revolution finally arrives, should it take any notice of the US 401k experience then pooled funds will be the joyous benefactors. Fund groups across Europe are already preparing themselves for that very occasion (See page 54).
And, while the fund industry may be becoming slightly disillusioned with the frustratingly slow developments on the pan-European pension fund side, the pooled fund has been at the forefront of discussions (See page 50). A number of multinationals are known to be looking at pooled funds as the very vehicle which will allow them to consolidate their pension fund assets worldwide. One of them is the £3bn Diageo pension scheme in the UK which is just beginning to tackle the issue and is in the process of examing what fund providers have to offer. “It is very much on the agenda at the moment,” says Steve Mingle, group pensions and benefits director, at Diageo in London. “And is something we really want to get our teeth into, particularly with the smaller funds because the relative cost of administering the assets is high, and if we can find a way of bringing these together we will.”
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