Taking a long and hard look
Despite a tough year marked by investment underperformance, it wasn’t all bad news in the development of the Irish pensions industry during 2001. First there was the announcement of the tendering process for the C7bn National Pensions Reserve Fund (NPRF) and, a few weeks later the publication of the Pensions Bill.
These events have brought new opportunities for asset managers, both domestic and foreign, who are looking forward to picking new mandates after having gone through a pretty quiet period.
The outsourcing of the asset management of the NPRF has attracted interest across Europe and wider afield. Although the final managers line-up has not yet been announced, there are many fighting to get a piece of the cake. The National Treasury Management Agency (NTMA) – that teamed up with online manager search tool IPE-Quest to conduct the tendering process – hopes to be able to make a decision before the end of this quarter and the expectation is growing.
It is still early days to talk about the impact that the selection of managers and the investment strategy developed by the NPRF will have on the Irish institutional management as a whole,but it will be fascinaiting to see to what extent this case sets a standard for the industry.
“It will be very interesting to see whether what they do is going to be seen as a model to follow by other pension funds in Ireland or not,” said Paul O’Faherty, managing director at consultants Mercer in Dublin. “So far, they have been taking all the right steps. It has been a huge challenge for them to move from having everything invested in cash and lacking investment strategy, to actually deciding to outsource around E6bn to external managers, with an asset allocation of 80% in equity.”
The outsourcing of the assets of the NPRF is, without a doubt, a remarkable exercise, for both the volume of assets and the number of people involved. But, due to the typical small and medium size of the vast majority of Irish pension funds, it doesn’t seem likely that it will result in similar processes being undertaken by other institutional investors in the country. “The NTMA has the scale to employ specialist managers for each asset class”, says Kevin Gallacher, head of business development at Montgomery Oppenheim in Dublin that manages E850m for institutional clients in Ireland. “Most pension funds here are much smaller and would only appoint one or two managers that would manage across different asset classes.”
The list for mandates for the reserve fund includes equity briefs covering Europe, the US, Japan and Pacific Basin ex-Japan, and one Euro-zone long bond active mandate. The fund will not have exposure to Irish goverment bonds. The specialist nature of the mandates and the limited exposure to Irish invesments could clearly benefit some of the international managers participating in the tendering and some expect the final manager line-up will be dissapointing for the domestic players.
Gallacher, whose company is tendering for one of the mandates, is in favour of increased specialisation. “Specialists are likely to outperform generalist in any field and investment is no exception,” he says. “I think we will see more pension funds moving away from balanced management, setting scheme specific benchmarks and employing managers with proven expertise in each asset class.”
The reduction of Irish equities within pension fund portfolios has certainly be a trend during the last few years.According to figures from Mercer, the average equity distribution among Irish pension managed funds at the end of 2001 was 18.2% in Irish equities, 16% in the Euro-zone ex Ireland and 37.5% in global equities.
“Irish managers have been reducing their exposure to Irish equities and this will continue over the next months,” says Michael Phelan, investment manager at Aberdeen Asset Management in Dublin who manages E2.8bn for Irish institutional clients. “There is much more focus on overseas equities and specialist managers who can demonstrate that they can outperform in this area will have the greatest opportunities.”
At Irish Life Investments in Dublin, director of investment development, Gerry Keenan, notes: “The biggest change that we have seen in the Irish pension fund industry started a few years ago and it is now accelerating. The pension fund industry in this country has undergone a huge educational journey that has had different stages.For most of the past 20 years the industry has managed pension funds on a balanced active managed fund basis and this has given disappointing results to many trustees, causing a review of strategic options in many funds.” He adds: “The second stagefor trustees is to choose an option that allows them to achieve more consistent and reliable results for their fund and this is what is happening at present.”
Instead of jumping from manager to manager, pension funds are taking a step back to analyse their fund’s structure, focusing more on the liability side and planning the right investment structure for the future.
In general, the level of sophistication among Irish trustees is higher than a few years ago.
“The reaction from clients after the recent market falls has been good,” says Tony Gargan, head of pension marketing at AIB Investment Managers in Dublin.“In the last few years they have seen different downturns in the market and they know how to react. They do recognise that over the long term their strategy is the right one and although they are concerned, they are not panicking.” AIB manages assets of E12.7bn,of whichE10.3bn are Irish institutional assets.
At the Bank of Ireland Asset Management (BIAM) in Dublin, head of institutional business Pat Lardner comments: “While 2001 was a year of negative returns for Irish pension funds, the first since 1994, the picture is still very strong over the long term.
“As always we continue to spend a lot time talking to our clients and have found that despite the initial negative impact following September 11, investors have retained a long-term perspective.”The message for investors from BIAM,that manages E13.7bn assets for Irish institutional clients, is that they shouldn’t make dramatic changes to their strategy other than those on fundamental investment decisions. “What’s important for our clients is that we continue to concentrate on fundamentals,”Lardner says. “We continue to seek out the best companies to invest in throughout the world and by best we mean those that represent good value in a global context.”
More focused on the liability side of the schemes, trustees are moving away from peer group benchmarks. “This is something we have witnessed for some time. There has been an increase in the number of pension funds adopting specific benchmarks more and more for the different portions of the portfolio and we fully support this approach,” he adds.
As pension schemes move away from peer benchmarks, they are also looking for managers that can do things differently and offer choice and consistent investment processes. Fund managers are adapting
themselves to this new environment and foreigners are finding their place in the industry.
“Fund managers from abroad find in Ireland a very attractive market to enter,” says Joe Byrne, deputy managing director at consultancy firm Coyle Hamilton in Dublin “The National Pension Reserve Fund has increased this interest from foreign providers in the Irish pension fund market, and investors are more and more keen to hire an international name, as long as they can deliver what their fund needs.
“Institutional investors in Ireland are very open to those who can provide added value. Being an island, Ireland has always been open to things coming from the US, the UK or the rest of Europe, and the same is true about the fund management industry.”
The concern about active balanced current performance is also driving Irish pension funds to look at indexing as alternative to control risk and diversify portfolios. The concept of passive management through consensus funds has been attracting Irish pension assets during the last few years, but when it comes to more orthodox forms of indexation - as those used in the US or the UK - and the application of a core-satellite approach the figures are not very high, but they are growing.
“There is definitively a reduction of balanced and active and an increase of specialist and passive,” says Irish Life’s Keenan. “Some funds are dissatisfied with the traditional approach and are making changes in the direction of core/satellite and this will eventually come to all funds.”
BIAM’s Lardner comments: “The level of interest in passive management in Ireland has increased in recent times, in line with international trends, and we have developed our own passive offering for the domestic market. What we are saying to clients is that wheter you want active or passive management we can meet your needs.”
Regarding alternative investments, it seems that investors in Ireland still think that anything alternative is also risky.
“Certainly there is interest in this market about the role that alternative investments can play, but at this stage it’s unclear how big the appetite is. I think the reason for this is that it is still a relatively new area and people are feeling their way,” Lardner says. “Typically, the size of Irish pension funds is quite small and diversification into alternatives comes mainly from the very large schemes.”
Coyle Hamilton’s Byrne says: “It will take some time before you see a real demand for these products in the market. After some good returns from venture capital investments and forestry, pension fund trustees have become more interested in including alternatives in their portfolios.”
The next thing should be hedge funds, although it seems that Irish trustees are not very keen on this investment approach.
“I haven’t seen much interest in hedge funds so far but trustees may want to consider these to provide some downside protection given current market underperformance,” says Philip Shier partner at consultants Delany, Bacon & Woodrow in Dublin. “There is certainly a need for better education about alternative investment strategies, not only for trustees but also by scheme members that under the new defined contribution (DC) schemes will have investment choice and therefore need investment knowledge.”
The DC market is considered to have the largest potential of growth and managers are getting ready for it. In this area of the market, choice and extensive programs focused on members’s education will be crucial. “Assets in the DC market are not particularly large, but there is a very healthy cash flow,” Gallacher says. “To gain new business, managers need to be able to explain clearly their investment process not only to trustees, but to members that may not have the financial knowledge required to understand complex investment issues. Historically, investment managers have concentrated on the trustees of DB schemes,” he adds. “Going forward, we expect to see an increasing demand for presentations to scheme members and employee focused literature and reporting material.”
Regarding this, consultants are also playing a major role in the market, bringing together trustees, members and investment managers, at a moment of important changes in the market. “Consultants have access to trustees and to members and the role they are playing in terms of education and organising training courses is significant,” says AIB’s Gargan. “From time to time we are asked by clients, especially the large DB schemes, to do presentations on topical issues encouraged by the consultants, and this is good for the development of the market.”
The consultancy market share is clearly dominated by Mercer, which in some cases can facilitate things for managers on the preferred list and makes things very difficult for those trying to break into the market.
“One thing that is benefiting us increasingly, is that when we talk to global consultants very often they have come across us in other countries, if not here, so they already know how we work,” says Lardner of BIAM, which manages most of its assets for non Irish clients.
However, even for those with more possibility of gaining new business, competition is tough. “Competition has been always intense but its nature is changing,” he says. “Ireland’s fund management industry is made up of 15 fund managers, some managing assets from here and other from overseas. Ours is a global business and increasingly we find that customers, no matter where they are based, want access to the best global expertise.” The ever increasing sophistication of the Irisk market suggests that Ireland is not exception, ‘and as a global manager, based in Dublin that is good news for us.”
But, as larger size and more sophistication would translate in the use of more specialist mandates, there is also plenty of room for medium-sized managers. At KBC Asset Management in Dublin, CEO Gavin Caldwell comments: “We have seen changes in market shares during the last few years. The asset management business in Ireland is very variable and as the pension fund market becomes more sizeable, more international players are trying to break in.” KBC currrently has E6.8bn under management for Irish institutions.
“We hope this year will be busier than 2001. We will see a continued growth of the market, with more DC schemes that will be looking at a wider range of product choice where managers would be required to gear up on this demand.”