State Street investment chief calls for “real world” mandates

UK – The chief investment officer at State Street Global Advisors has called for “real world” mandates as part of a fundamental rethink of pension provision.

Alan Brown has come up with a three-point plan to ease the pensions crisis. A key element, he says, “is to align the fund manager’s interests for the first time with that of the fund”.

He says: “That means giving out real world mandates that directly address the need to maximise surplus or minimise shortfall risk, the real concerns of the trustees, sponsors and beneficiaries.”

“And the mandate needs to acknowledge that the risks the manager can take must be contingent on the current surplus position.”

He called for managers to have a liability benchmark, contingent risk budgets and necessarily multi-asset class mandates. “Funds are likely to have much more “balanced” allocations to asset classes, including equities, bonds, property and all sorts of alternatives.”

He said that, “you can’t afford not to have an asset allocation policy”.

“To do so is the financial equivalent of setting sail with all canvas up, and not trimming the sails no matter what weather you run into.”

Brown also called for the “social contract” implicit in the relationship between the sponsoring organisation, the trustees and the beneficiaries to be rethought. “This needs to start with a re-appraisal of the risks that be can tolerated, the returns that can reasonably be expected, the realistic flexibility that both employers and workers have in their ability to make contributions, and finally therefore, expectations of the benefits that can actually be provided.”

“We should view our risk tolerance relative to the current surplus position of the fund,” Brown says. “It seems self evident that the risk posture of a fund should take into account in some way the solvency status of the fund and the ability or willingness of the sponsoring company to make additional payments in the event of an adverse return outcome.”

Brown also called for “realistic estimates of both risk and return”. He says that one of the most shocking aspects of the last three years has been how badly funds have been hit by just three down years. “Yet rather like when it snows in London, we were caught totally unprepared.”

He said that broadly reasonable expectations for equity returns are the dividend yield plus 2 to 2.5%. “Depending on conditions in your local market, this means that in most countries today our savings plans should be based on equity returns of 4% to 5% real, and no more.

He concludes: “Given realistic expectations for what both companies and individuals are prepared to contribute, some reasonable assumptions on mortality and working life, we can now reset the benefit expectation and allow individuals to make some personal life style choices.”