Steadying the ship
Andrew Waring of the UK Merchant Navy Officers Pension Fund tells Nina Röhrbein how the 2008 financial crisis led to a fiduciary management structure
The year 2008 made it into pension funds’ record books as the year of the financial crisis.
But for the Merchant Navy Officers Pension Fund (MNOPF) it was the year that brought about a structural sea change.
“The current fiduciary structure evolved out of 2008 and the debt crisis,” says Andrew Waring, chief executive at MNOPF. “It was about addressing a key challenge in the industry at the time - governance. The pension fund wanted to create much stronger ownership and accountability for the development and the implementation of its investment strategy. But because it is not large enough to warrant an in-house investment team with the strength it would need, we decided to outsource it.”
And so the pension fund started a fiduciary management mandate with consultancy Towers Watson on 1 January 2011. But Towers Watson is not referred to as the fiduciary manager - its role is that of delegated chief investment officer (DCIO).
“Having a DCIO in Towers Watson means having full access to the breadth and depth of their resources,” adds Waring. “Typically trustees spend a lot of time dealing with manager selection but having a DCIO allows us to focus on strategy.”
Prior to the DCIO appointment, Towers Watson was the scheme’s investment adviser, with the MNOPF trustee having the final decision on investments. By October 2008, the pension fund had already moved towards a DCIO role but it did not delegate fully.
However, Towers Watson was not automatically chosen for the role of DCIO. After the consultant’s initial 12-month appointment, MNOPF conducted a full market search with KPMG among the asset managers, consultants, advisers and insurers that presented themselves as of fiduciary managers. This led to a final fiduciary shortlist of Towers Watson and asset manager BlackRock, the former of which was duly appointed.
MNOPF’s Investment Committee is responsible for the selection of asset classes and their central benchmarks. The implementation of investment strategy is then delegated to the DCIO, who decides on the asset allocation within agreed ranges and is responsible for the hiring and firing of managers, negotiating manager fees on the trustee’s behalf as well as signing the investment management agreements as an agent in the name of the trustee.
“In a fiduciary structure, it is unusual for the DCIO to be able to hire a manager and only tell the trustee afterwards,” says Waring. “When it comes to the recruitment of managers, in a lot of fiduciary mandates, the fiduciary still goes back to the trustee for approval. Such approval dilutes the clarity of accountability. Instead we have an ongoing dialogue with the DCIO and receive regular updates on changes in managers.”
Waring’s executive team in Leatherhead, in the UK county of Surrey, south of London, is responsible for monitoring the running of the fund. The executive team formally meets the DCIO on a quarterly basis to review managers, performance and risk.
The executive team and the DCIO then report on risk management and returns to investment committee meetings on a quarterly basis alongside more detailed discussions on strategic matters.
On top of that, in June 2011 MNOPF appointed Hymans Robertson as an independent investment adviser. In this role, Hymans Robertson attends the investment committee meetings and, with its expert oversight, provides checks and balances.
“Although there have been frank exchanges of views, the investment adviser is not trying to fight the DCIO,” says Waring. “We made sure we chose firms that would be able to work together and create an effective relationship. And in trying to address all the perspectives of the trustee, its role and fee is more akin to that of a non-executive director than that of an investment adviser. The investment adviser can challenge the DCIO’s ideas, which the other directors cannot do to the same level of understanding. This makes MNOPF much more like a corporate in its governance model than most other pension funds.
“We are the biggest fund in the UK to go down this path and this cutting edge model has attracted a lot of interest, not just in the UK but across Europe, particularly in the Netherlands.”
One of the first tasks of the investment adviser was to work out how to properly evaluate the performance of the DCIO and put in place that measurement programme. The DCIO’s performance is now assessed according to various yearly, biannually and quarterly metrics although it has yet to go through its full cycle of measurement.
“Ultimately it is to do with performance, operation, client and cost control and having the right quality of resources to deliver the required services,” says Waring. “I am sure the DCIO finds it quite intrusive but it is a big appointment.”
Quarterly investment committee meetings start with a private session between the investment committee and the independent investment adviser before the meeting gets underway with everybody involved. After the meeting, the investment committee runs a private session with the DCIO.
Towers Watson was appointed on a three-year contract but Waring says a relationship with a fiduciary manager is for the long haul.
“If our relationship is working, it will continue beyond the three initial years,” he says.
MNOPF comprises two sections, which are run as one scheme but almost treated as separate entities. As part of the pension fund’s strategic investment agenda, the trustee has agreed clearly defined journey plans for each section. Time horizons, return targets and risk budgets are specific to each section and reflect the current level and strength of the employer covenant. They are continuously reviewed.
The £1.3bn (€1.65bn) old section holds all the benefits accrued up to 1978. In 1978, members moved from the old to the new section, meaning many have benefits accrued in both sections. It currently has a funding level of 96% on an all-Gilts basis after dropping to 82% in the wake of the financial crisis.
Following a buy-in with insurance company Lucida, it is on track to settling all its liabilities. In September 2009, £500m of pensioner liabilities were transferred, followed by another £100m in May 2010 as a rider to the existing policy.
“MNOPF is a last-man-standing scheme, meaning that in theory we have a strong employer covenant,” says Waring. “However, in practice it would be difficult to collect further contributions for the old section, and therefore it is in the members’ interests to settle those liabilities with a reputable insurer. Because credit spreads over Gilts are still relatively wide there is an opportunity to look at settling more of the liabilities, which is why we are on an active settlement watch. We hope to be able to secure all of our members’ benefits within the next five years, maybe even in a much shorter timeframe.”
The portfolio of the old section is overwhelmingly invested in low-risk assets such as insurance, Gilts, credit and cash. It holds only a fraction in equity and direct property and is almost 100% interest rate hedged. Its journey plan targets 105% on a Gilts basis by 2020.
“Having a DCIO makes the whole settlement transaction efficient and quick,” says Waring.
The £2.2bn new section still has active members, mainly aged 50 years and above, meaning their number falls by approximately 100 a year. It has a funding level of around 65%. The new section also targets 105% of liabilities on a Gilts basis by 2025. But unlike the old section, the new one has the benefit of active contributions from employers as well as investment returns to reach its journey plan target. In addition, following the March 2009 actuarial valuation, the scheme started collecting £408m of new deficit contributions. It has already collected almost half of those.
To reach their journey plan targets, both schemes have benchmarks in place, which are reviewed every quarter. Since Towers Watson started its full DCIO mandate the numbers demonstrate outperformance. In addition, the pension fund also looks at returns for both sections versus a low governance benchmark, a portfolio of equities and bonds only, to test if the more sophisticated market approach it adopted is working over time.
One of the areas where the DCIO is specifically targeting value is in the area of manager selection. They are required to add 50 basis points per annum through manager selection.
“We have the belief that diversity in asset classes and managers can produce good returns with reduced risk,” says Waring. “And we do think that early mover advantage can be exploited.”
Following the appointment of Towers Watson, the number of asset managers for MNOPF rose from 15 to 35. This included an emerging market equity manager, three new private equity managers, six new hedge fund managers, three alternative beta managers and two non-investment grade credit managers. In addition, it added another six asset classes - commodities, emerging market currency, reinsurance, global and sovereign investment grade credit, non-investment grade credit and currency hedging - to its existing asset mix.
“Before appointing our DCIO, we had one low-risk hedge fund,” says Waring. “Now we have a high quality portfolio of hedge fund managers.”
And this portfolio in particular helped produce the recent good returns.
The diversification took place at the expense of equities. Over the last three years, direct property holdings have also been reduced. According to Waring, there is a desire to hold more global real estate through funds rather than through direct ownership.
“There have been a couple of tactical opportunities we have taken advantage of but overall the investment opportunities resulted from our change in governance,” says Waring. “Like most funds, we have spent the last few years trying to raise our interest rate hedge. In the new section, we would be more comfortable with a 60-70% interest rate hedge rather than the current one of 40%. But it is difficult to increase the hedge at the moment. Nevertheless, the real problem is rising liabilities because despite additional contributions and the performance of our assets, the funding level of the new section has fallen slightly over the last year.”