Pension Fund Governance: A market in maturity
Continuous and rapid change in financial markets, the increasing complexity of financial products, and a soaring regulatory burden. This three-pronged challenge requires efficient task-sharing and monitoring of asset managers, according to Anton van Nunen, who developed the fiduciary management concept last decade.
His arguments, culminating in his 2007 book Fiduciary Management: Blueprint for Pension Fund Excellence, state that fiduciary managers should assist pension funds in optimising the diversification of their portfolios, tightly monitoring asset managers and reporting back to boards in the required way. Fiduciary managers, therefore, needed to be capable, in particular in accounting for, but also in following and anticipating developments on financial markets.
Van Nunen emphasised that pension fund boards need sufficient expertise to assess their fiduciary managers’ activities – and they must ultimately be in control. It is up to the board to establish a neutral risk budget, and to assess whether the fiduciary manager has filled it in accordingly. Decisions on the strategic portfolio, active risk and benchmark specifications should not be delegated by the board either, he argued.
The fiduciary concept took off.
By 2006, KPMG’s annual survey suggested that 50% of Dutch pension funds, including the larger ones, were considering engaging fiduciary managers. The main reasons they cited were the increasing administrative and management burden, as well as a lack of expertise. However, 40 of the 100 schemes surveyed indicated that they had doubts about their control over fiduciary management.
In 2006, Pensioenfonds Vervoer, the Netherlands’ fund for private-sector road transport employees, went as far as contracting out its entire assets of €5.4bn – including the entire management of its investment strategy – in what was the largest fiduciary mandate in the Netherlands. Goldman Sachs Asset Management (GSAM) became the manager of the investment managers, responsible for hiring and firing them.
At a glance
• Fiduciary management took off in the Netherlands during the mid-2000s, but almost immediately pension funds experienced implementation difficulties.
• ‘Pick-and-mix’ came into fashion but underperformance during the financial crisis confirmed that fiduciary management was no panacea.
• The industry responded with a re-statement of best practice, and the regulator questioned the extent of outsourcing.
• Criticism of PME’s arrangements led to a significant roll-back and stiffer demands that much of the industry is unable or unwilling to meet.
• But the ensuing shake-out has led to consolidation of mandates and left almost 85% of Dutch assets in fiduciary management, broadly-defined.
A year later, Walter Brand, Vervoer’s CEO, concluded that the arrangements were working well. He told IPE that communication problems were solved and, during the transition to GSAM, funds had been successfully transferred to tax-transparent funds.
However, KPMG had already started to find that schemes had become somewhat more ambivalent about the concept in its 2007 survey. They were not certain whether managers could deliver the flexibility promised by the model. Of the 80% of pension funds that had fully contracted out their asset management, only a third had done so with a fiduciary manager, and the subject was only high on the agenda of 20% of the schemes surveyed.
While 2007, saw Stichting Pensioenfonds TNO award a €2bn fiduciary mandate to BlackRock, giving it the key roles of lead overlay risk manager and strategic adviser, the scheme kept the management of and manager selection for its equity and alternatives allocations in-house.
This ‘pick-and-mix’ approach was seen as the second wave of fiduciary management – having been established in 2006 when SBZ, the industry-wide pension fund for healthcare insurers, chose ABN AMRO Asset Management as fiduciary lead overlay risk manager, and Russell as manager of managers, in a €2.2bn mandate.
Meanwhile, managers were flocking to the increasingly rich pickings. Fidelity International, Credit Suisse Asset Management and F&C Asset Management were among many entering, or preparing to enter, the fiduciary market. By the end of 2007, Dutch assets under fiduciary management totalled approximately €100bn.
In 2008, the combination of ING and its newly-acquired pension investment management subsidiary AZL, claimed €17.3bn of assets under fiduciary management, and was considering a proposal abroad. MN – the asset management provider for the metal-sector funds PME and PMT – adopted the fiduciary concept for all of its €30bn of assets, and similarly aimed to expand into the UK. The peak of the fiduciary management wave was perhaps the establishment of APG and PGGM as fiduciary managers in 2008, after they were spun-out from the civil service scheme ABP and the healthcare fund PFZW, respectively.
The financial crisis was already underway prior to the meltdown caused by the Lehman Brothers bankruptcy. It had become clear that concerns were deepening and the integrated fiduciary model was coming under pressure. Many fiduciary managers were also performing below expectations. Extensive outsourcing turned out not to be a guarantee against a funding shortfall, and pension funds felt that they were losing grip, and a view of, their assets.
Experts suggested that the disappointment might have been triggered by high expectations, too much responsibility being given away, or insufficient expertise within pension funds for them to act as a properly countervailing power. They stressed – as Van Nunen had before – that fiduciary management is supposed to be a partnership, with two-way traffic.
To clarify the definition of fiduciary management, the Dutch Fund and Asset Management Association (DUFAS) launched a good practice checklist. The set of principles was meant to draw the distinction between asset management, multi-management and fiduciary management, and to provide rules on transparency and costs.
In November 2009, the Association of Industry-wide Pension Funds (VB) urged pension funds to evaluate their fiduciary mandates for transparency, to ensure their board would be in control during a crisis. Additional checks and balances, as well as an upgraded role for risk management, were the most important lessons from the credit crunch, it argued.
Soon afterwards the Netherlands’ pensions regulator, the Dutch National Bank (DNB), which had encouraged outsourcing and the spinning-out of asset management divisions from pension schemes, expressed concern that pension funds had become too reliant on external providers. It noted that many schemes had placed multiple tasks that are best kept separate – such as asset management, risk management, strategic advice and advice on implementation – with a single fiduciary manager. The DNB called on pension funds to bolster their governance, set up independent risk managers, rein-in freewheeling mandates and provide sufficient countervailing power to regulate external providers.
The watchdog also ordered the large metals-sector scheme PME to improve its control of investments and outsourced risks. It found that PME – which had outsourced its asset management to MN two years earlier – lacked an adequate management framework, and that its funding was in a “worrying state”. Nearly half of the scheme’s board resigned, and it re-established an internal and independent asset management department.
At the same time, Van Nunen, noticing that consultants were joining the ranks, leading to conflicting and confusing interpretations of the model, re-stated that it must involve the integral combination of advice, portfolio construction, manager selection, monitoring and reporting – and that the education of pension funds’ boards should also be part of the concept.
While insisting that fiduciary management had delivered better risk management, monitoring and reporting results, and improved portfolio diversification and the use of the risk budget, he conceded that active investment policies had not brought positive results, at least not during the first years of the crisis.
Meanwhile, high-profile news of fiduciary management gone wrong continued to break. Co-operation between Vervoer and GSAM broke down after the fund felt that GSAM had delivered disappointing investment performance before and during the financial crisis. Vervoer took its mandate to Robeco, instead, and has recently settled out of court having sought €250m in damages following claims of an “inappropriate” €349m investment in a portable alpha structure, as well as “negligence” in the implementation of its worldwide high-yield bond strategy.
13 years of Dutch fiduciary management
• Goldman Sachs Asset Management is appointed to manage €1bn of assets for Stichting Pensioenfonds Campina Melkunie. The first fiduciary management mandate.
• May – Pensioenfonds Vervoer appoint Goldman Sachs Asset Management.
• October – KPMG conducts the first of a series of fiduciary management surveys.
• Anton van Nunen publishes Fiduciary Management: A Blueprint for Pension Fund Excellence (Wiley).
• Stichting Pensioenfonds TNO awards a €2bn mandate to BlackRock, but maintains internal control of its other assets, one of the first major ‘in-part’ fiduciary management mandates.
• December – Fiduciary management assets under management in the Netherlands reach €100bn.
• March – APG Asset Management established as an entity independent of ABP.
• March – PGGM established as an entity independent of PFZW.
• May – MN Services announces plans to expand its fiduciary management business into the UK.
• November – Dutch Fund and Asset Management Association issues a checklist for good practice in fiduciary management.
• November – Association of Industry-wide Pension Funds issues guidelines on fiduciary management for pension funds.
• January – PME, whose fiduciary manager is MN, restructures its board, apparently in response to DNB criticism of its oversight of scheme assets.
• March – DNB publishes a letter detailing its concerns about fiduciary management.
• July – Pensioenfonds Vervoer files suit against Goldman Sachs Asset Management before London’s High Court.
• December – Fiduciary management assets under management in the Netherlands reach €700bn.
• June – Pensioenfonds Vervoer settles its dispute with Goldman Sachs Asset Management.
Against this background, pension funds have begun moving away from overall outsourcing, focusing on regaining control through in-house expertise; even providers of fiduciary management themselves have started airing doubts as to whether an all-in-one proposition is desirable from a governance point of view.
Van Nunen, now director of strategic pension management at Syntrus Achmea, thinks that while a competent fiduciary manager should be allowed to manage assets, that should not happen as part of an all-in-one solution.
“As a pension fund wants to have its interest-rate risk managed in detail, the management of the matching portfolio should be carried out as close to the client as possible if the matching portfolio is a complex mix of bonds and derivatives,” he reasons. “In-house management by the fiduciary is the best solution. However, because of the fiduciary manager’s expertise in financial markets, his advisory role in the portfolio construction and his role in risk management, he shouldn’t play a dominant role as an asset manager in many [other] parts of the portfolio [either].”
Raising the ante
Pension funds have also increased their fiduciary demands, in particular for risk management and monitoring, but also for reporting, advice and board support. A few fiduciary managers now find themselves insufficiently equipped for more complicated and expensive tailor-made services, or are simply not prepared to provide them. The result has been a shake-out.
A 2011 survey by our sister publication IPNederland confirmed that pension funds’ interest in fiduciary management was still increasing, but that potential clients were seeking in-part solutions. A majority of the participating schemes indicated that they were in control, through in-house or hired expertise, and in particular through their own – often newly established – pension competence bureaux. At the time, 75% of Dutch pension assets was estimated to be managed on a fiduciary basis. Full service was declining, while pension funds had gained in confidence about their grip on things, according to the annual survey.
Meanwhile, the remaining larger fiduciary managers have erected firewalls between asset management, risk monitoring and advisory functions. They have expanded their trustee support services to better educate and inform their clients. Pension funds have invested in trustee education, doubled the frequency of board meetings and appointed professionals on their boards. New governance legislation even allows entirely professional boards.
Van Nunen does not see any potential for another giant leap in fiduciary management theory or practice.
“It is about accents now,” he says, adding that providers like Syntrus Achmea can distinguish themselves through the advisory task, assisting with the definition of targets, objectives and investment beliefs as the start of a sound fiduciary process. “What follows is mainly a technical process, in which the parties are at a par.”
Reflecting these developments, the IPNederland survey in 2013 suggested that more than €706bn – approximately 83.5% of Dutch pension assets – is now under fiduciary management at the ten largest providers. Funds were still seeking fiduciary solutions – but now for no more than 0.5% of all assets.
The Dutch fiduciary market seems to have matured; some might say it has become saturated.