Structures for Europe
When in a bullish mood investment consultants will argue that Continental Europe is their playground and that the business of asset liability modelling (ALM) and advising on multi-manager structures is booming.
Despite huge variations in the development of funded schemes in Continental European countries, there is one characteristic that most share. Where there are major funded schemes these tend to be very big and largely self-contained. Whether this will change is not clear but at present most of the massive industry-wide schemes do not use investment consultants for asset liability modelling and for the manager selection.
The bulk of the remaining existing funded schemes are comparatively small. This in itself imposes a natural limit on the number of funds which can adopt a US/UK-style multi-manager structure. For their part the UK/US providers of these services must adapt or forget Europe altogether.
Fortunately the seeds of change are firmly planted and should come to fruition much more quickly than has been the case in the UK, where it has taken years of underperformance on the part of balanced managers, and increasing concern over the inappropriate use of peer group asset allocation to change trustees’ attitudes. One reason is the dissatisfied with the performance of balanced managers. Another, of course, is the euro.
William M Mercer was one of the first consultants to recommend to larger clients the attractions of the passive core/active specialist satellite structure. Tim Gardener, head of European consulting says, “We have no doubt that over the long term, multi-manager is the way forward for European pension funds, but this will not happen overnight.’
Given the local nature of most existing arrangements, where funds tend to appoint a balanced manager or insurance company from the limited range of domestic players, it is a considerable leap forward to use a range of external managers. When all is said and done, the UK does not have a monopoly on conservative trustees.
“Nevertheless,” Gardener said, “following the impact of the euro, we believe the move to multi-manager structures will accelerate rapidly on the Continent within two to three years. Those funds which are not proactive in seeking specialist managers will soon come to realise that by default they have become pan-European equity and Eurozone bond investors. As such, their requirements are unlikely to be fully met by domestic managers.”
In the UK, Watson Wyatt’s ‘Structured Alpha’ strategy uses a core of active balanced and index funds with the key focus on satellite or ‘absolute return’ managers which aim to give an outperformance of 3% per annum. Currently the service is directed towards the very large £1bn+ schemes where the client can establish a trustee investment committee which can respond swiftly to the frequent monitoring decisions required.
For Continental European funds that tend to be smaller in size a simpler structure has been adopted which uses index funds for the core and specialist active funds for the satellite element. “This is more suitable for smaller schemes and offers improved transparency and governance,” says Brian Hill, senior investment consultant at Watson Wyatt.
Hill says that consultants have the euro to thank for the increasing recognition of the importance of asset liability modelling. “The euro has forced funds to address their domestic and foreign asset allocation and they are using ALM techniques to achieve this. Those funds which have undertaken an ALM exercise tend to set long term performance targets and have a clear idea about the risk/reward ratio of their chosen asset allocation structure”.
The ALM in turn has encouraged the use of index funds. “The ALM assumes market returns, therefore the natural position for clients to start from is, ‘Why not index?’. There is a belief, right or wrong, that it is sensible to use index funds for the efficient markets - for example the FTSE 100 and the S&P 500. Structured Alpha recognises that skilled and specialist active managers do offer the opportunity to outperform in both efficient and inefficient markets. Many European clients view the evolving Euro market as being inefficient and therefore there is a willingness to appoint specialists for the domestic European equity and bond mandates.”
The comparatively small size of many European pension funds does not lend itself to specialist segregated mandates. Often, by the time the fund is split into the correct asset allocation following the ALM, the mandates are too small to meet the minimum size accepted by managers for a segregated service.
“However, since all European funds are taxpayers - for example they would pay capital tax and withholding tax, among others - the treatment of pension funds and mutual funds is similar,” Hill explained. “For both of these reasons it makes sense, where the mandate is too small to qualify for segregated management, to go into the selected managerís Luxembourg or Dublin based SICAV, for example.”
Watson Wyatt has observed a ‘considerable willingness’ on the part of managers to provide an institutional service, including annual presentations, for pension fund clients with as little as $5m invested in the mutual fund. “Therefore it is possible to build a multi-manager structure for these clients using solely SICAVs or using them as part of an efficient investment manager structure,” Hill says.
The main markets in which Watson Wyatt uses structured alpha are the Netherlands, Switzerland, Belgium, and the Scandinavian/Nordic regions. The use of consultants in the Netherlands to replace internal managers is becoming quite common, while schemes undergoing privatisation - in Belgium for example - reportedly have been attracted to structured alpha due to its analytical approach.
The number of consultants operating in Europe is on the increase. In particular it is worth examining the role of the US-style manager of managers (MoM) providers which advise on and implement the asset management structure.
Frank Russell has been virtually a lone voice in Europe for many years. However, Northern Trust, which has been making good progress in the UK, is preparing to launch its MoM service in Europe and this year plans to switch its pooled funds from unauthorised unit trusts to variable capital corporations (VCCs) – the Dublin International Financial Services Centre version of open end investment companies (OEICs).
The big newcomer on the manager of managers front in 1999 was SEI Investments, which currently is busy adapting its US product for the European market and poaching leading consultants to build up what looks like an impressive UK and European team.
For its continental European clients Frank Russell, controversially, combines investment consultancy and manager of managers services in RIAM – Russell Integrated Asset Management. This is a complete package from the initial asset liability modelling through to the selection and implementation of the multi-manager structure.
Andreas Schneck, sales manager for Continental Europe, said that over the past 18 months pension funds had become more comfortable with a service that provides both services. The range of funds the company uses are run by SG Russell – a joint venture with Société Générale – and these are available to clients in France, Germany, Austria, Switzerland and Italy.
Despite its inherent attractions, the jury is still out on whether there is a mass market for a service which offers consultancy alongside asset management, but as far the Continental European market is concerned Frank Russell, for one, has nailed its colours to the mast.