Let’s be clear on solutions
There is a bewildering array of tools available to UK DB pension schemes to help them achieve their objectives. These vary from the obvious, such as closing a scheme to new members, to the fashionable, such as contingent asset guarantees, to the technical, such as commutation exercises. They include popular tools such as introducing glide paths with derisking triggers and unpopular ones such as changing the scheme to a cash balance plan. This area offers a wonderful opportunity for acronym peddlers to bamboozle us with their jargon. Tools include ETVs, SPVs, ABCs, PIEs and ERPIEs.
We calculate over 40 of these ‘tools’. We call them tools because they are actions which, when sensibly put together, make up an overall strategy. They are not ‘solutions’. The term ‘solution’ should be reserved for an initiative that is more far-reaching than any single tool. This article aims to define this term better.
The word solution has been used for years in investment circles, to the annoyance of pensions professionals. One trustee told us in 2011: “Solution is just a buzzy phrase that is over-used and out-of-date.” Another said: “Saying you have a solution makes it seem as if you think there is one neat answer for everything, which is ridiculous.” Another was even more cynical: “Solution means high fees for low-quality advice”.
Times have changed. Solutions offerings are being used by pension schemes. By our measure, over 30% of UK DB assets are now serviced by seven solution-based offerings, and this will only grow.
Despite its poor press and worrying connotations in the early years of solutions development, the word is now used with more intensity by investment firms and consultants. We have counted 66 firms operating within the UK who present themselves as solutions providers. As was made clear in a recent IPE survey on solutions carried out with our help, many firms use the term solution formally as part of a divisional badge of honour.
So it really is time to clarify what solution means. There are, in our view, five criteria which an offering might meet to qualify as a solution.
• Its focus must be outcome-orientated. The most common outcome targeted by schemes is to achieve a specified funding level over a defined period, at a defined level of risk. A solution is an offering that takes responsibility to help the scheme achieve such a goal and a solution provider’s interests should be aligned with these objectives. Targeting investment performance against an external benchmark is not a solution.
• The provider of a solution should be an influencer of its client’s strategic decisions. Solutions usually involve providers having a seat at the strategic planning table. To achieve most outcomes, solutions providers need to see and offer influence over the whole – if not much – of the liabilities. Where the provider has no dialogue or influence over investment strategy, then it is not offering a solution.
• Providers of solutions offer help on several dimensions. They tend to aim to address different risks (not just one) by accessing several asset classes. In order to help schemes achieve an outcome, such as a funding level target, the solution will tend to be addressing either several risks, or managing several classes of assets, or both. Single-risk or single-asset offerings have roles to play, but they are components rather than solutions.
• A provider of a genuine solution will tend to have wide scope, by which we mean the provider will add value to a client’s assets, liabilities, or both. Typically, more than 30% of the assets should come under the scope of a solution for it to be defined in this way. Offerings that act on a small proportion of a client’s assets can add real value, but they are not solutions.
• A solution is provided by a third party. Some schemes are building in-house teams capable of delivering many, if not all, the benefits of third-party-provided solutions. These are the exceptions. A team can only call itself a solutions provider if it is capable of providing services to several clients. When looking for sophisticated financial expertise required for solutions provision, the majority of schemes rely on third parties.
You could say that, to qualify as a solution, you need to meet all five of these criteria. If you take this line, there are only two services which can be defined as a solution: liability-driven investment (LDI) delivered through segregated mandates; and fiduciary management covering all, or most, of a client’s portfolio. We have heard arguments that these are the only solutions, indeed some fiduciary managers would even exclude LDI. “Only those who sit beside the client and have oversight of the whole balance sheet can claim to offer a genuine solution,” one fiduciary manager told us.
But limiting the definition in this way is excessively purist. We reckon that a solution is something which meets four, or more, of these criteria. In which case, there are five other offerings which qualify. Pooled LDI is one, as is partial mandate fiduciary management. So also are diversified growth funds (DGFs). Even longevity insurance and buyouts/ins are solutions by this definition, although we recognise that they are not investment solutions.
Some will say this definition is excessively tight. There are asset managers with solutions teams who are not providing any of these offerings, but who maintain that what they can offer should count as solutions. These are offerings which meet two or three criteria. These are semi-solutions.
The list of semi-solutions is far from comprehensive but numbers 43. There is not space to list them, but they include investment strategy solutions such as asset-liability modelling, and integrated asset-liability studies. They also include many risk management solutions, a range of multi-asset and multi-manager investment solutions, an array of single-asset-class investment solutions and a selection of investment-execution support solutions.
There is and will be an increasingly wide list of solutions available to the DB market. The need for a definition will grow, so we hope this contributes.
Magnus Spence is a director at Spence Johnson