Bob Crew finds pension managers going to independent custodians for peace of mind
There are many compelling reasons why pension fund managers and their trustees appoint an independent custodian.
Some decide to make the change to achieve better reporting control, monitoring and more professionalism, not to mention valued-added services such as securities lending, specialised tax reclamation, proxy voting, assistance and attention to detail when it comes to the tedious and time-consuming administration associated with holding securities in emerging markets.
Others simply want to get shot of the core services - safe custody, clearance and settlement, income collection and the detailing and relaying of corporate actions.
Then there are those who want in-creased security - post Maxwell - so that they can sleep better at night !
John Flitton, Ciba's UK pensions fund manager, says that he appoint-ed an independent custodian for one reason only - greater security.
He says: I guess Maxwell drove us to it. Our trustees wanted to be confident that there was no chance of our employees being left without a pension. There was no dissatisfaction with our investment managers or the way custody was being handled in-house,which was perfectly satisfactory. We just wanted our share certificates to be held in our name independently and safely - rather than in a fund manager's name - and to be able to see them whenever one of our auditors or trustee directors felt like it."
Of course, it's not as easy as falling off a log, tracking and inspecting share certificates held in a fund manager's name, for the simple reason that the fund manager may have them tied up with other moneys also registered in his name - say, £50m in his name, of which £5m belongs to you. It can be done, inspecting certificates in someone else's name, but it's more difficult and time-consuming. With an independent custodian, however, it's very simple and not in the least inconvenient.
Flitton says: "Our internal auditors and trustee directors have been to our independent custodian and seen our share certificates. I do not believe, three or four years down the road, that the assets of our £730m ($1.1bn) fund in the UK were in any danger before, but it's just reassuring to be able to gain access and see for ourselves whenever we wish. It's more comfortable and don't forget that we are an ultra-conservative Swiss company."
But Flitton does not go to an independent Swiss custodian, for the simple reason that British custodians were cheaper. He explains: "We se-lected Midland Security Services who were 50 and 100% cheaper than Swiss Bank Corporation and UBS."
And he decided against stock lending, he says, because it was perceived as too risky: "We thought it not worth the potential risk. What happens if a company goes belly-up during the gap between the lending and return of your stock? Okay, perhaps it's never happened, but what if it does?"
Flitton - whose investment managers were Mercury and Schroders before the switch to Midland - says that he doesn't believe that "Midland has brought anything else to the party, other than security. It's no criticism of them. We're getting an excellent service, but it's in no way better than what we already had, and we are having to pay more than previously for our custody."
But, if Ciba hasn't yet experienced a greater level of professionalism from its independent custodian, the UK's Lucas pension fund certainly has. Says William McDougall, one of its managers: "We used to do our custody in-house, but felt that it would be more professional and secure to appoint an independent. And it was. Also, we wanted to do stock lending, and we couldn't do that in house because it's too complicated and risky. We got better reporting, control and monitoring and greater security. Look at Maxwell and see what can happen to internal custody. We do our own official records, still, and enter all our trades on our in-house computer system whilst our independent custodian - which is State Street - checks our accounts and holds our assets."
As far as charges are concerned, it is true to say that when an investment management house handles a client's custody, as part of a package, it is usually a mystery how much is being charged for the custody function because it is included in the overall management fee, which is far from transparent. As one independent custodian puts it: "You simply don't know the cost of your custody when it's placed with an investment manager because it's wrapped up in the fee".
It is argued that an independent sole custodian is more efficient and cost-effective, and saves the client valuable man-hours, because he handles all the assets - instead of having them scattered around in, say, three or four different investment management houses sending in separate reports to be reconciled and consolidate by a beleaguered pensions manager. This puts him in a position to bolt all this together in one simplified process.
This should mean better control, reporting and cashflow than a fund management house, which is after all contracted for a service that is 98% investment management and only 2% custody. As a result of knowing the net position of funds and being assured that they are coming in by a certain date - that settlement and income is under control - in-house pension fund managers ought to be getting improved cashflow from an independent sole custodian. IPE"