Fiduciary/Delegation: Your faithful friend?
Liam Kennedy assesses the European market for fiduciary management. Where the earliest fiduciary contracts outsourced almost the entire value chain of pension management, more recent agreements centre on different levels of delegation, and managers are having to learn new tricks
Fiduciary management has evolved in the eight years since the first agreement, between the insurer VGZ and Goldman Sachs Asset Management. More and more providers have added fiduciary management to their institutional offering and the concept has been successfully transplanted to the UK and Germany. The scope of the fiduciary service has been codified, in the Netherlands at least, in the Dufas principles of fiduciary management. New asset managers have added nuances in their interpretation of the service, while new and existing clients, sometimes in new markets, have added new specifications and requirements.
As IPE's 2010 survey of fiduciary management providers confirms, there are three main types of fiduciary manager: asset managers such as GSAM and BlackRock, of which some have a manager of managers heritage, like SEI and Russell; Dutch pension managers like APG and Mn Services; and consultants of various types. This category includes the likes of Mercer, which has enhanced its multi manager offering to create an integrated service offering, and Towers Watson, which has the ambition to expand the number of clients delegating responsibilities on various levels, but which currently lacks a platform to settle and collateralise derivatives, for example.
Patrick McCoy, partner and head of investment advisory at KPMG, sees 12-13 parties willing to respond to requests for proposals (RFPs) but just six that have a credible offering.
Providers have taken different routes in the development of their fiduciary management offering: in some cases through organic development of existing operations; in others through acquisition of other entities, such as Dutch pension managers or multi manager boutiques.
Where Goldman Sachs developed its offering in 2002 by deploying its private banking platform in New York alongside its extensive risk management capabilities in-house, BlackRock, in its previous guise as Merrill Lynch Investment Management, launched itself as a fiduciary manager in April 2005 through its purchase of the Philips Pension Competence Center, previously Schootse Poort. It took on the then €12bn assets of the Philips pension fund in a seven-year deal that expires in 2012.
Managers of managers have beefed up their multi manager fund operations to include risk management capabilities, and the Dutch pension managers have essentially opened up the strategies they already ran for their in-house pension funds to external clients. There has been some cross-border activity among this provider group, such as the deal between APG and PensPlan in Italy, while Mn Services has a UK office.
Another group of managers, which includes ING Investment Management and F&C, have had a background in (Dutch) balanced management for pension funds and a large number of often smaller pension fund clients. This group has added the necessary risk management and other capabilities in recent years in order to qualify as fully fledged fiduciary managers. In ING's case this also included the acquisition of Altis, the Swiss-based manager selection boutique and AZL, the Heerlen-based pensions administration specialist.
"There is a gradual shift from asset-only to an integrated balance sheet approach. If you look from where our clients are coming from, it is clear that asset-only was not the way forward," observes Martin Nijkamp, head of business strategy at ING Investment Management.
This diverse group of managers has coined a confusing range of terminology to describe offerings and services that fall under the umbrella of fiduciary management. These include integrated balance sheet management, advanced investment services, dynamic de-risking solutions, outsourced CIO, and strategic partnership, among others. Such is the popularity of the term fiduciary management, however, that some in-house pension investment managers call themselves ‘internal fiduciary managers'. Are managers splitting hairs with marketing terminology, or do they represent important differences in service offerings that trustees should be aware of?
It is easy to make a case that terminology is important, especially if full-service fiduciary management remains a minority activity, as most providers acknowledge it will, due to regulatory stipulations in the Netherlands, for example, and many trustees' unwillingness to take such a bold step especially in the UK: "I don't expect the influence of fiduciary management in the UK ever to reach the proportions that it has in the Netherlands," as Paul Trickett, European head of investment consulting at Towers Watson, puts it.
The large figures quoted for fiduciary management in the Netherlands conceal the fact that the ABP and PFZW pension funds have externalised their previously self-managed pension operations to entities that they either own outright (in the case of PFZW and PGGM) or in which they have a majority stake (in the case of ABP following the merger of APG and Cordares).
However, the base case for some form of decision-making delegation to a fiduciary provider is intact. Reasons commonly cited are increased regulation and emphasis by pension supervisors on pension fund governance, coupled with the complex mechanics of running an effective derivatives hedge over time, increasing short-term dislocations in financial markets, and the complexity of many advantageous investment classes and structures.
There are now also many variations along the fiduciary theme, and a large number of mandates involve something other than full-service fiduciary delegation - the pension fund may retain more control over manager selection, for example, or may retain full control over a portion of the assets, which the fiduciary manager will integrate into its overall risk management system.
"No two clients buy exactly the same service across our client base," says Michael Marks, COO of the fiduciary mandates team at BlackRock. "They are quite varied in terms of their expectations, their requirements and the level of power that they are comfortable to delegate. Some clients want to delegate and others want to take decisions and be actively involved."
An interesting example of a fiduciary mandate ‘plus' is the decision of the €2bn Dutch pension fund for the baking industry in April this year to outsource 75% of its assets to Lombard Odier, with the stipulation that four staff from the Beon entity - formerly owned by the pension fund but latterly acquired by Robeco - will move to Lombard Odier. Robeco will continue to manage the remaining 25% of the assets for the fund.
A future area of institutional growth might also be in ‘liability-aware' risk overlays, where the overlay manager has access not only to the full range of portfolio positions but also to the day-to-day swap hedge positions that the fund is running. Coupled with good reporting, some larger pension funds may see this type of solution as an alternative to fiduciary management.
But the problem with this diffusion of fiduciary-type services is that catch-all terms become less and less meaningful. "As you define this thing in different ways the range of players starts to expand but you very quickly get away from fiduciary management as it might be defined in the Netherlands," says Trickett of Towers Watson in London, which prefers the broader definition of implemented consulting to describe the range of levels and types of delegation that clients now prefer.
Cardano, for example, offers two broad business lines, which it defines as advisory and delegated. The delegated approach is analogous to fiduciary management, while the advisory work is consultative "but also very directive", says Richard Dowell UK head of clients at Cardano.
Some providers with a consulting heritage now see fiduciary management as part of a continuum of levels of investment and risk management delegation. These might include full-service fiduciary management on the one end, with variations of the level of delegation, all the way to diversified growth funds in the UK or bespoke diversified alternatives strategies at the other end.
RFPs rather than direct approaches are the norm nowadays for fiduciary mandates: Marks, COO of BlackRock observes that the UK market has moved quickly from direct approaches to RFPs, which he believes is a sign of a maturing market.
Most providers and users of fiduciary management recognise a need for a long-term relationship of at least 3-5 years, not least because the due diligence process involved with the selection is long and onerous, with between three to six months as a realistic timeframe from RFP to appointment, and sometimes even longer.
In the end, of course, it is the resulting legal agreement that determines the level of delegation, the services offered and the communication with the trustees, and the complexity of that service-level agreement requires much effort and time on the part of both parties.
From the pension fund's perspective, full fiduciary delegation must also mean a step change in the way it operates - moving from being an executive board to one that sets strategy and regularly monitors the implementation of that strategy. Given the range of services on offer, it is unsurprising that trustee boards might not start with a clear idea of what level of fiduciary delegation or outsourcing is appropriate for them - or, importantly, they will be comfortable with.
"A lot of times when we talk to clients, they are not sure what they want," says Tom Murphy, head of investment management at Mercer. "They know that what they have is not fit for purpose, they know what want to delegate to experts to have better real-time decision making but they are not sure what level to delegate at."
Mercer launched its dynamic de-risking solution in the UK last autumn, hiring Rupert Brindley from UBS as head strategist. It now has 12 clients for its full-service offering in the UK, with $1.5bn in assets. "Clients are happy to delegate but that does not involve providing them with a broad map of the world and asking us to take them to some exotic place. Instead they want to see a very specific and tailored roadmap," adds Murphy. "Our job is to take them there."
Thanks to the complexity of the agreement and the level of delegation, many pension funds therefore seek advice on research and selection. "Today in the Netherlands no selection is made without a very thorough due diligence and selection process and in most cases a third party is involved," observes ING Investment Management's Nijkamp.
In the Netherlands ‘traditional' consultants have not hitherto promoted their implemented consulting capabilities and some advise on search and selection. Smaller boutique providers are also present, such as Avida International, Goris & Partners or Bureau Bosch.
In the UK a variety of firms will advise, or have ambitions to advise, on the appointment of fiduciary managers. Names commonly cited are Muse Consulting, Capita Hartshead, Allenbridge- Epic, Pan Governance and PWC. However, it is worth noting that some providers retain a ‘house view' on the optimal constellation of services while others have retained managers.
KPMG already runs searches for clients in both the Netherlands and the UK. It is currently managing the selection process for Vervoer in the Netherlands after that fund announced the review of its relationship with GSAM. In the UK it is also managing the process for MNOPS, reviewing its existing relationship with Towers Watson.
McCoy says KPMG advises pension funds in search of a fiduciary manager to first assess their own governance structure. "Usually the first aspect is a governance review to understand what is not working, what the resources are internally and the frequency of meetings, in order to determine whether the trustees want to be more or less involved, and to assess their skills," McCoy says, noting that some selection processes will not result in the selection of a fiduciary manager.
Marks of BlackRock observes that around 80% of questions in RFPs are standard and only the remaining 20% is client specific. "We think that 20% could be 40% in an RFP," he says. "What we would expect to see as those firms become well established in terms of the capabilities of searching this area, is that there will be the generic RFP provided to the firm but nothing to do with the specific client - the basic due dilligence - and when it comes to the individual clients it will be individually tailored to individual requirements. There will already have been a pre-screening of who's capable." As Marks recognises, however, getting that balance is complex with such a client-specific service.
Fiduciary management has always been about client specifics, but if the first fiduciary management contracts were about a total outsourcing relationship, now the trend is towards much more flexible and customised demands along the institutional investment value chain. The recent demands of the Dutch regulator for greater pension fund board control of risk management and outsourcing relationships are a result of the fact that outsourcing itself can lead to unintended governance risks.
Both in and outside of the Netherlands, an increasing focus on pension fund governance structures will likely lead to enhanced client reporting for fiduciary managers, extra costs, and probably less emphasis of providers on the full-service fiduciary offering - not least because the competitive fee structure of all-in mandates makes the high level of reporting demands unrealistic and unprofitable for providers. These are not simple add-ons.
In short, if the original fiduciary offerings were about a rebundling of the value chain of pension fund management, the future emphasis of providers is likely to be on unbundling. Flexible execution and fiduciary partnership are terms we are likely to hear more of in future.