Doing business with the family
When looking to outsource, pension funds are increasingly being given a new opportunity to have their asset management provided by another pension fund which has taken the step of providing these services on a third party commercial basis. This trend has advanced in the Netherlands in particular, where a growing number of funds are offering or preparing to offer their facilities to their peers. Are these services something that outsourcing pension funds should examine seriously?
At a recent seminar in Amsterdam, organised by the Association of Investment Management Sales Executives (AIMSE), representing those active in the sales and marketing of asset management services, the topic of pension funds becoming investment managers was addressed by a high level panel of Dutch experts, under the heading ‘Friends of foe?’.
It was an asset manager Chris Brandsma of Robeco, who set the scene, by acknowledging “this is a tricky issue”. “We all have heard the arguments: ‘Pension funds speak the same language; they are part of the same world; they want to share their experience; they can be trusted and so on.’ That all sounds very good.” But he did not regard it as a sound basis for a good business model.
Why do pension funds want to go into asset management, he asked and summarised their reasons as revenues, costs, people and performance. On the revenue side, there was certainly a big market in the Netherlands, with E400bn in pension fund assets, but the top 10 external pension funds controlled 75% of this. “It is highly unlikely they will outsource that business to colleagues in another pension fund. When they do outsource, it is specialist mandates only,” he noted.
The remaining E100bn is controlled by around 10 external asset managers again to the extent of 75%, which makes it very difficult for others to penetrate the market. “Strong foreign competitors find it very hard to get a share of that market.” Also, the Dutch DB market is not growing, he pointed out. “It is only a replacement market. So to win a place in that market, you need very strong sales power and client servicing.” Brandsma warned that the fees that are paid in the Netherlands are the lowest in the world, making it a low margin business. The only way to survive was to have critical mass. Funds had to decide how they were going to pitch their fee levels.
On the issue of costs, he felt pension funds would certainly have a cost advantage. “But to be competitive in the business and service your customer base, your costs will be higher than you might expect, with personnel and systems.” Will the existing pension fund business subsidise these higher costs?
The motive that seems most compelling is that of needing to attract and retain the right people, he said. “But you also need more and different kinds of people to do the sales and client servicing.” The real challenge he perceived is how to manage the completely different culture the fund is now in. “You are moving from an internally focused organisation, to a client servicing one. How do you manage that challenge as it certainly is not without risk?”
Can a pension fund produce better performance than a traditional asset manager – Brandsma did not think that was a real argument. “Pension funds will only have a few clients and a few products, you are very vulnerable to performance – and not just investment performance.”
From the plan sponsor’s viewpoint, what kind of signal is being given, if clients start to leave the pension manager? “There is a risk that your sponsor will become less loyal to you.” They may end up seeing advantages in diversifying with different managers, Brandsma added.
If the pension funds participating were daunted by this splash of cold water, it did not show. With Hans Rademaker, chief investment officer of Mn Services, pointing out that in the past five years or so, there has been a shift where pensions boards had become clients of their own asset management, which is now regarded as a tool in the delivery of pensions services to members.
“We believe that there is a need for an agent, which we call a ‘fiduciary manager’, in between the asset manager and the pension fund. In our business model we have positioned ourselves in between the board and the asset managers.”
He did not see them taking away business as competitors from traditional asset managers. “The only thing we try to do is to deliver best of breed to the pension fund.” In his view, there are ‘easy investment processes’ and ‘difficult investment processes’, with some specialist services that cannot ever be replicated in the pension fund. “But there are other investment products that a pension fund manager can easily manufacture themselves, which can provide alpha, if you have sufficient size, the systems, research capacity and the right people.”
At the end of the day, the asset management arm had to deliver the whole investment process to the board of trustees, but that did not mean going into the marketplace as broad-based asset managers. “Only investment processes that can be replicated easily will be insourced. But that will probably only be a relatively small part of the business. Nor is the fee aspect the most interesting element.”
In the past 10 years, probably too much has been paid for easy investment processes, compared with the specialist mandates, argued Rademaker. “We notice a gap between investment management at the bottom of the pyramid and the final solution provided to the trustee board, there is a lot to be done in between. In some areas, there is a need for products that are not created yet, for example, the issue of Dutch inflation compared with euro inflation, needs attention as it poses a problem for asset liability management because of a mismatch between the two inflation rates. We are aware of this and are directly responding to that. There are many benefits for a pension fund of having a fiduciary manager, who takes care of that. Pension funds need an independent agency between the asset management industry and the fund. And they like having someone act on their behalf and financially aligned with the pension fund’s interests.”
How the Philips group’s Schootse Poort Investment Management became established was outlined by Dick Snijders, CEO of this operation that now has a range of external clients. “We started with the idea of providing a pension fund management organisation – not an asset manager and not an intermediary, but a full pension fund manager – at a time of structural change at Philips,” he explained.
“It was uncertain how the restructuring would turn out and the board of the trustees of the Philips fund felt it would be a good idea if former members of the Philips group be offered the same services in relation to pension funds after being divested.
“The venture started in 1991, and since then had received a considerable number of requests from ‘real third parties’ to provide the same services to them on a commercial basis,” he said. “We could never contemplate anything that would end up being a cost to the existing pension fund members.” The fund then decided to respond to this demand.
“We received these requests, because pension funds are not satisfied with services of the professionals. If they were satisfied, they would not be asking us. These funds were interested in all aspects on the crossroads between asset management and other pension affairs, which explains why they approach us.”
Schoote Poort, with 200 professionals dealing with all aspects of the pension business limits what it provides, for example, it does not feel it could offer hedge fund services or private equity. “But we do have a number of core competencies and because many of those managers servicing the pensions funds are not delivering properly, this makes openings for us, particularly in the current climate.”
With 200,000 people now being looked after indirectly by the organisation, which runs assets of E17bn, the decision was taken to change the governance. “We are no longer the Philips pension fund, since services are better provided through a company structure.”
Snijders believes it is essential that trustee boards do not carry all the responsibilities, including of execution, within the pension fund, but separate them. “It is too heavy a load for a board of trustees based on the current fund structure. The democratic process may be good for running a country, but it is not for running a company.”
The issue now facing Schootse Poort is to grow in a “solid and gradual way”, he said. “We could have more and more clients, but we are very careful that we do not grow too quickly.”
Erik van Ballegooijen, who runs the TNO Pension Fund, said their approach to pension fund asset management is definitely on the other side of the fence to the others. His fund was not contemplating any such move in the third party direction, but would continue to be an active outsourcer. “My question as a client is what could a pension fund manager provide for us rather than a traditional manager?”
Pension funds were disappointed about what they received from traditional providers. “The trustee boards are disappointed about the degree of professionalism.” Van Ballegooijen said they were concerned as to what value was being added by these managers generally – an issue that was unrelated to current market conditions. “This is why many pension funds are looking to shift from traditional managers. More are changing to indexing and that is not necessarily a good thing.”
But what additional features could be expected from a pension fund manager? Choosing such a manager is not purely a business arrangement, it has also to do with the relationships. But he noted a problem area summed up by the Dutch saying: “You should not buy a second-hand car from a friend”. There was always the difficulty of making complaints if things are not working properly. “With a traditional manager you have a strict business relationship, but with a pension fund manager, it can be just like buying the car from a friend.”
While traditional managers were not in any danger from the moves of pension fund managers, there was definitely a role for pension funds to provide services that the other managers cannot provide and add value. “It is for these specific services and not in the real, positional management, like managing a mainstream portfolio, that this will happen,” he argued.
“It is still a big decision to go with a pension fund manager because of the ‘emotional’ aspects involved.” But his fund was prepared to buy products from other pension funds and had plans to do so.
Philip Menco of Fortunis Investment Consultancy, decided there was not a case to go to the pension investment managers on the grounds of performance. “My reckoning from the figures we have seen is that pension funds do not do much better than the poor performance of most asset managers.” For a product like a balanced mandate, there does not seem to be much by way of added value. “When it comes to specialist products, funds should look for expert asset managers. Few pension managers can offer better products than leading specialist managers.”
He felt it was better to seek out the best specialists, rather than going the pension route where connections and relationships could limit the choice and the outcome a sub-optimal solution.
“Where I do see a lot of added value comes from the fact that a pension fund knows much better than an asset manager the complete business you are in. It is not just a matter of assets, it is also one of liabilities and this is where pension funds should have an edge.”
But are these new pension fund managers sufficiently focused on the demands of external clients, Menco wondered. “Marketing is not an easy game, nor is real client servicing.” It is only the larger asset managers that have big teams that are well trained.
Menco believed that on the cost side, there were significant advantages for pension fund managers to pool their assets, which should produce much lower costs. “There has been a lot of money made in the asset management industry, but without that much by way of added value.” Pension funds are all about providing pensions and costs reduce the flow of future income to pensioners. “The lower the costs, the better for them,” he emphasised. “For smaller pension funds in particular, pooling their assets can save costs, since they end up paying significantly more for having their money managed than larger funds do.”
If money is being managed for both the original sponsor of the investment management and a number of smaller outside clients, Menco thought there could be a conflict of interests.
As the different contributor’ positions disclose, there appears to be a demand for pension services and not just those limited to asset management to be provided by pension funds to other pension funds. Where pure asset management products are involved, these need to be specialist and cuting edge to differentiate them from what traditional managers in the market provide. The full servicing that these managers provide is not something that cannot be replicated easily. The suggestion that more assets be managed on a pooled basis could be a way of outsourcing and reducing costs.