Pension funds still wary
On the surface of things, investment banks, particularly those with dedicated pension fund advisory groups, are making strong gains into the pension fund market. A report by Greenwich Associates, the US research consultancy, revealed that one third of UK pension funds are considering liability driven investments in their funding policies. Some 4% of respondents have implemented policies, while another 5% are planning to do so in the future. And 39% of funds with more than £2bn (e2.9bn) in assets were in discussions with investment banks on issues such as reducing equity exposure, risk, liability matching and long-term tactical asset allocation.
Still, pension funds and some consultants say that investment banks will have to work long and hard to make their case to UK and continental European schemes. Many are not sold on the merits of investment banking products at all.
“Investment banking is not common to the world of pension funds, and they only provide service for a short period of time,” says Roland Van den Brink, managing director of investments at the E14bn Dutch PME scheme. He says the firm has used Goldman Sachs in the past to help execute orders and transitions, but not for any long term mandates.
Other large Dutch giants, such as the PGGM, the health care fund, and ABP, the civil service scheme, also claim to have little or no interaction with investment banks. ABP says it does not use investment banks at all, while PGGM says that the relationship is “so modest it is not even worth talking about”.
In the UK, pension funds who are using investment banks are reluctant to even comment on the relationship, largely, suggests one consultant, because they are testing the waters. Others are not so charitable. “There’s no doubt at all that investment banks have products that pension funds need, but banks really have to improve their image with respect to pension funds. Pension funds have a negative image of the compensation systems within investment banking, and they are seen to be greedy merchants. The stereotype is vastly different from reality – banks have a strong culture of controls and their system is hugely meritocratic, but this stereotype does exist,” says Amin Rajan, chief executive officer of Create, the research consultancy group. Others believe that because the relationship begins on the corporate side, it takes a long time for trustees to become comfortable with it.
For their part, corporates have become ever more involved in the plight of their schemes. Last year’s failed £940m takeover bid for WH Smith by Permira, the private equity group, illustrated just how important pension funds have become to the health of their sponsoring companies. The bid failed because of a disagreement with pension fund trustees about what to do to plug the funding deficit at the group. Last year also saw the landmark hiring of Credit Suisse First Boston by the pension fund trustees at Marks and Spencer, during Philip Green’s bid. It was the first time that trustees mandated an investment bank independently of its corporate parent.
“Pensions have moved right up the corporate agenda,” says Gareth Derbyshire, managing director of the Insurance and Pensions Solutions Group at Merrill Lynch. Because of their relationships with corporates, investment banks initially talk to treasurers and finance directors, until that relationship is broadened to include trustees. “If you think about investment bank strengths historically, we have been advisers to companies on a whole range of issues, and the pension fund is just one more of these. Given that pensions risk is now often the single biggest source of risk to a company, it’s very logical that we should be involved in this area.”
Still, other investment banks say it has not always been easy to convince trustees, asset managers, and consultants about their merits. “We spend a lot of time with consultants to make sure they understand we are not trying to take their role away from them. A year, or a year and a half ago, there was some real concern,” says one. And asset managers have also expressed concerns. Barclays Global Investors, for example, issued a warning that banks could use data gained from pitches that were unsuccessful to their own advantage.
Consultants may have reluctantly embraced investment banks, but some observers feel it will take along time to cement the relationship. “Many investment banks have set themselves up to give investment advice over the last two to three years. This reflects the shortcomings of traditional actuarial consultants. Investment banks are trying to step into their shoes,” says John Ralfe, an independent pensions consultant. Another observer believes that consultants are jealously guarding their own turf, making it difficult for investment banks to get access. “The whole governance of pension funds to me is problematic. It is aimed at an investment world that no longer exists.”
For his part, Ralfe believes that investment banks may be very good at structuring products, but these products may not engage with the fundamental issues that pension scheme trustees and companies are trying to grapple with.
Other consultants also argue that the long term viability of investment bank solutions are in question. “Our concern is that they are almost by definition short to medium term solutions. If you closed your pension fund to new joiners, and everybody has retired, than you could probably solve all problems with structured products and derivatives. But this is not usually the case,” says Andy Maguire, head of the asset management practise at the Boston Consulting Group.
David Hewitson, pensions finance manager at UK group Rexam, which has no formal relationship with investment banks, points out that not all pension funds who could benefit from liability driven approaches or other investment banking solutions are even in a position to do so because of resources available, or because the products aren’t consistent with the overall strategy. “If we thought an investment bank could help us, we would use one. But it doesn’t fit into our own particular asset strategy,” he argues.
Not surprisingly, it is an argument that investment banks dismiss. “There are some long term swap overlays which will remain in place for 30-40 years without needing to be amended materially. However, other clients are more interested in obtaining tactical protection against an equity market crash, so ongoing management is the nature of the product being used,” says Rupert Brindley, who is responsible for the Life and Pensions Solutions Group at UBS.
Whether it is the suitability of products, or a negative cultural perception, it is clear that investment banks still have a long way to go. Nick Horsfall, a senior investment consultant at Watson Wyatt, points out that the firm has been involved in 20 executions with banks for a total of 12 clients worth £9bn over 12 months. “We’re pretty sure that our clients have been more active than other people’s clients,” he says, arguing that at this particular moment, the market for investment banks is remains small.