On the Record: Fees take a backseat in manager selection
What approach do you take when selecting managers?
Head of manager selection
• Invested assets: €13.5bn
• Mandatory pension fund for France’s 4.6m civil servants
• Hybrid of DB and DC
• Date established: January 2005
• Funding level: 110% (Aug 2012)
Four-fifths of our portfolio is invested in bonds, mainly European sovereign debt but also some European credit, while another fifth is allocated to equities and a first investment in direct real estate.
As a public entity, we follow a two-stage public tender process.
In the first stage, we select the candidates, while phase two is about confirming the selection. In stage one of the selection process we look at the experience of managers and resources allowed in similar mandates as well as the financial stability of the company.
We usually select five managers that make it to the second stage. Here we delve further into their investment process and team. We also assess their risk management, operational organisation and fees.
Socially responsible investment (SRI) is at the core of our pension fund and translated into our investment criteria.
Therefore we also look at the SRI capabilities of potential managers. At the first stage we screen them to see whether they have existing SRI resources, while in the second phase we analyse how they would apply our own SRI charter to the asset class they are tendering for.
Before we appoint the successful candidate we conduct on-site due diligence.
While fees are important to us, it is not our only criteria hence we do not always invest with the cheapest manager and rather look for the manager offering the best value for money.
One change the pension fund has undergone with regard to manager selection concerns the role of consultants. Until the summer of 2011, the fund manager selection was done with the help of consultants. Since then, ERAFP has been undertaking the manager selection on its own although the process has remained the same.
With growing assets and the pension fund increasingly diversifying its portfolio, tenders will be issued more frequently. This year we have issued three, which is why it makes sense to have an in-house associate who does it. Depending on the complexity of the asset class, the use of the consultant might be considered.
The managers’ performance is reported on a weekly basis but as a long-term investor we try not to focus on such a short timeframe. Mandates are generally three to four years long and can be extended to allow managers to make investment decisions based on their conviction, while maintaining a competitive environment.
Deputy CEO/head of investments
• Invested assets: €30bn
• Around 900,000 active members within 36,000 companies
• Date established: 1961
• Solvency ratio: 23%
Our current asset allocation consists of 40% equities, 44% fixed income, 11% real estate, 2% hedge funds, with the rest made up of other alternative investments such as commodities.
We tend to use external asset managers mainly for our investments in equity or fixed income mutual funds, although we also employ them for allocations to private equity and hedge funds. In general, we do not let external managers manage our portfolios. But for the selection of those fund management companies we have a special due diligence process in place.
Their past performance is one of the most important criteria we look at. Other factors we analyse in our selection process are risk management, corporate governance and reporting mechanisms in place.
Ilmarinen has been a responsible investor for more than 10 years and is used to implementing environmental, social and governance (ESG) factors into its internal investment process. Therefore, we pay a lot of attention to corporate governance and other responsibility credentials in the fund managers we select.
In terms of corporate governance, we specifically look at their ownership and type of fiduciary policies.
With regard to risk management, we are benchmarking any potential fund management companies using systems that are close to best practice.
All the fund management companies’ processes, from risk management, to corporate governance, have to be at an acceptable level for us. If we find something that is not acceptable, we will not hire them.
Based on this initial selection criteria, we make a shortlist of candidates from which we will then appoint the fund manager.
The timeframe according to which we evaluate managers and the way we judge them differs from case to case. It depends on the asset class, the amount invested and other individual characteristics.
But we regularly review their performance. If we have, for example, three mutual funds with specific targets, we are observing them the whole time.
If one of the managers is underperforming against this group or against the market we change them. We have had this process in place for many years and have seen no reason to change it.
• Invested assets: €1.2bn
• Members: 12,000 of which only 658 were active at the end of 2011
• Collective defined contribution
• Date established: 1971
• Solvency ratio: 105% (Sept 2012)
We have changed our equity mandates over the last three years. We used a consultant to invite almost all the managers in the investment universe to apply for a mandate. The consultant analysed the applicants’ performance and risk figures over different time periods, including upward and downward capture. In addition, they helped us with the suitability analysis.
For emerging markets, for example, we had a universe of about 170 managers, 60 of whom made an offer. Of these 60 managers, 18 were suitable.
With this revaluation of managers at the end of last year, we changed our selection process as well as the strategic allocation of our total equity portfolio. We divided our equity exposure into three portfolios only, namely Europe, US and global emerging markets.
Even more crucial than the performance are the qualitative aspects we look at during our manager selection. Most important to us are the transparency of the investment process, a coherent investment philosophy and the long-term bottom-up focus of the manager.
In the on-site due diligence, besides compliance and risk management, the investment team and the culture and stability of the organisation are significant. In the early stages of the manager selection process, we are not fee-driven. Of course, we negotiate the fees as low as possible at the end of the process but we might pay a higher fee for one manager than for another, simply because we think that it is a good manager to have in the portfolio and one that can deliver alpha.
We do not include sustainable or environmental, social and governance (ESG) criteria in our selection process. As we invest mainly through funds our direct influence on security selection is limited. However, we use an ESG overlay on the holdings of the managers and our ESG overlay provider undertakes the proxy voting where possible as well as the engagement for our portfolio.
In principle, we look at least at the monthly performance of the managers we have selected. Unless there is a good reason to review their performance earlier, we evaluate them every three to five years. If the teams, processes or philosophy of the portfolio managers change with time we are likely to evaluate them earlier.
For our US equity portfolio, for example, we use several large and mid-cap managers with various value and growth styles. If one of them deviated from its previous style, it would disturb our overall portfolio in that region.