How we moved our money
Last year, the Dutch pension fund PME mandated Mn Services with the fiduciary management of its assets, and took a stake in the company, in what was the largest ever European portfolio transition. Iain Morse discusses the transition aspects of the deal with Roland van den Brink of Mn Services
Last year saw Europe’s biggest ever fiduciary transition, as the Dutch pension fund PME moved the management of its assets to Mn Services, simultaneously taking a stake in the company, which was previously wholly owned by its sister metal industry pension fund, BPMT. With a value of €21bn, this still counts as Europe’s largest single transition measured by asset value, and big transitions of this kind are a rapidly emerging trend in Europe and the UK as more and more pension funds choose to sub-contract the management of their asset portfolios to fiduciary managers. Mn Services, like some of its rivals, may be owned by pension funds, but it operates as a transparent, for-profit service provider.
A rapidly growing number of fiduciary managers - now more than 20 - are competing for new business by offering Dutch pension boards and sponsoring employers a new paradigm for managing their assets. This leaves responsibility for strategic goal setting with pension boards, but moves responsibility for most or all implementation to the fiduciary manager. “When we talk about transition, the focus tends to be on tactical transition,” notes Roland van den Brink, previously head of investments at PME, now on the executive board at Mn Services, “but now the focus deserves to move to these larger, fiduciary transitions.”
Tactical transition cost analysis has been developed as an exact science by consultants like Mercer and Watson Wyatt in relation to the transitions between managers and in the physical assets they manage. A typical transition might involve terminating, say, a European small cap equity manager, appointing a global bond manager and switching the underlying equity portfolio accordingly. The new manager will only want its performance measured from the point when it takes over management of the model portfolio. The cost of the transition will also impact overall fund returns. Market timing, efficient execution, minute analysis of hard and soft costs have been endlessly rehearsed. A whole industry has grown up around managing transitions of this kind with custodians and investment banks competing to manage these portfolio adjustments.
“This kind of transition typically only applies to part of the pension fund’s overall portfolio,” says Van den Brink, “and it takes place within a pre-existing strategy and implementation that may remain with the board.” By contrast, fiduciary transitions encompass a fund’s entire portfolio, which is transferred from the fund’s in-house management to an external provider. In some cases, there may be few if any changes made to the underlying asset portfolios. This trend has become so pronounced that a book has been written on the subject, ‘Fiduciary Management’, by Anton van Nunen, a Dutch academic and pensions consultant.
This book is likely to be influential in shaping attitudes to fiduciary management and it deserves consideration, especially outside the Netherlands. Van Nunen’s argument is that too many service providers, ranging from pension consultants to asset managers, and custodians to transition managers, have become involved in pension fund management with the result that no single provider accepts full responsibility for the overall outcome. We lose sight of the wood for the trees. This is an argument for re-centralising management rather than devolving it, and centralising via a fiduciary model. Van Nunen also introduces subsidiary arguments about the need to manage scheme specific risk budgets and implement portfolio theory, all towards the same conclusion.
This line of thought speaks for comprehensive outsourcing of a scheme’s whole back and mid-office functions, and Van den Brink says the fiduciary manager will also take over matters such as fund administration and scheme accounting. This can be complex. For instance, accurate scheme record keeping, particularly in defined benefit schemes, often depends on in-house staff with knowledge that cannot easily be transferred. “If you say you only want the money but not the people, then you risk throwing away that knowledge,” warns Van den Brink, adding that Mn Services places a strong emphasis on retaining this knowledge. “Of course, you need to look at the cost of doing so, but the cost of not doing so can be long term,” he adds. The message here is simple: up-front cost cutting is potentially expensive in the long run.
In a transition like this, the role of a fiduciary manager like Mn Services is that of a network company. “For instance, we only manage limited portfolios in-house,” continues Van den Brink, “part of our job is to find appoint third party managers and other service providers within the terms of agreement reached with the pensions board or the trustees.” This entails that the agreement must be comprehensive. If implementation is fully sub-contracted to the fiduciary manager then the pension fund board will no longer be actively engaged in day-to-day implementation issues. “What we need from them is a clear set of guidelines on issues such as our risk budget and the future liabilities of the scheme,” adds Van den Brink. The fiduciary must in turn display a robust methodology for the selection of subsidiary service providers.
In the case of selecting tactical transition managers to transition assets between managers and asset classes, Mn Services developed an exhaustive selection process. The RFP, sent to selected providers, included questions about their organisation, transition management process, operational management and compliance, although Mn Services thinks that transition managers can add most value in illiquid asset classes. The RFP also asked in-depth questions on this subject. The firm thinks that there is no single, optimal business model for all types of transition; as a result it asked one broker/dealer, one fiduciary, and one asset manager to join the shortlist. In its view, broker/dealers tend to focus on cost control, fiduciary managers on risk control and asset managers a blend of both. For very complex transitions, Mn Services think that a fiduciary will tend to be the best solution, whereas more liquid assets would tend to favour broker dealers or asset managers.
This new fiduciary paradigm can also have major consequences for the efficiency with which scheme assets are managed. Under the old paradigm, quarterly or half yearly meetings by a scheme investment committee deal with a wide range if issues, from manager selection to the setting of investment strategy. The timing of meetings can affect the speed of response to changing market conditions. In a tightening regulatory regime it can also test the competence of committee members.
Extraneous issues can also play a role in this decision taking; for instance, in many European countries, trade union representation is mandatory. “A lot of factors can get in the way of rapid, effective decision making,” adds Van den Brink, “but when we take this over these factors are reduced to an absolute minimum.’ This approach is likely to appeal to sponsors increasingly concerned over the cost of pension provision, not to mention boards and trustees worried about their legal liabilities for the decisions they take on behalf of scheme members.
But any relationship between pension scheme board or trustees and a fiduciary manager will require constant monitoring. “We are under an obligation to keep checking Mn Services’ performance,” says Hans van der Windt, chief executive officer at PME. “We have the management resources to do this partly because we appointed them and freed up our management team as a result.”
PME sees a wider range of less obvious benefits in the appointment of Mn Services. The fiduciary manager should be able to achieve significant economies of scale in back office areas like administration, but also in areas of growing importance such as risk management competence. While assets remain hypothecated to pension schemes, there are also potentially large savings to result from asset pooling. Asset pooling is already a significant trend in Europe, but until now has mainly been achieved through cross border pooling by otherwise related pension funds, typically those owned within a common corporate entity. Fiduciary management offers the prospect of pooling to unrelated schemes which invest via the same fiduciary manager.
According to Van den Brink, these cost savings can yield some significant cost reductions for pension funds choosing a fiduciary manager. “Once you invest €200m or more with one manager you can ask for a fee reduction,” he thinks. But this is not just about saving money: improved risk control and better selection processes for active managers should also contribute to more stable long term investment performance. “If we can give a pension fund average returns of, say, 7.5% per year over ten years and save 10 basis points on costs, then for many this would be a very attractive prospect,” he adds. The trend to fiduciary management clearly still has a long way to run. Yet larger transitions are in the pipeline.