Telling it how it is
Client reporting has improved greatly in recent years. Fund managers now produce reports that are almost as slick as those of management consultants. Most pension trustees and officers seem to be happier with what they receive today compared with five or 10 years ago.
Standards had to be raised. It was inconceivable that institutional clients could live forever with some of the typical deficiencies in reporting: inaccurate figures, irrelevant text and poor design. A lot of the information given was inconsistent or redundant; key portfolio events and corporate changes were sometimes not reported at all.
Quality was not the only issue. Reporting consisted of piles of papers, sent out ad lib. In fact, quantity in itself had become a problem. What used to be a simple portfolio valuation had developed into a series of reports, to be delivered with increasing frequency. They cover:
o Key guidelines and facts about fund/mandate;
o Basic portfolio information (valuation, transactions);
o Portfolio analytics;
o Performance measurement and attribution;
o Risk analysis;
o Cost reporting, transaction cost analysis, brokers used;
o Market information and commentary;
o Portfolio interpretation, including future strategy;
o Accounting information and cash management;
o Regulatory reports, for example, operational risk control or custody arrangements;
o Other areas, such as forex dealing and securities lending.
Some asset managers responded earlier than others. They have realised that good client reporting is essential, particularly for client retention, when things are not going so well with investment performance. Specialist departments have been established. Considerable investments have been made in people, systems and interfaces with internal and external data sources. In addition, performance reporting standards have been agreed, while consultants are giving advice on how reports should look.
Is it all settled then in the area of client reporting? Unfortunately, the answer is no. The concerns are not so much about the leftovers of old bad habits but about new big issues that are emerging for both providers and recipients of client reporting.
For asset managers client reporting is an increasing cost burden. As much as they try to ‘standardise’ reporting solutions, institutional clients ask for a higher degree of ‘customisation’ which is very expensive. At the same time, heavy investment in new technology is needed for both back- and front-office operations to produce more and better data, faster.
As regards new regulations, new financial instruments and new client products, the pace of change is not getting any slower. New forms of distribution, for example, via the internet, result not only in technical but also in organisational challenges. How to become more interactive with your clients and consultants? New specialist providers emerge which offer outsourcing solutions, but even this is unlikely to be a cheap or quick fix.
Unfortunately, pension funds will not be able to give their delegate fund managers much relief in the future – rather the opposite. There are fundamental changes happening in pensions investing that will have a substantial effect on client reporting.
Take liability driven investment (LDI) as an example. Many pension funds are looking at investing their assets closer to liabilities. However, ‘liabilities’ as a benchmark is of a different nature; it is not just a number you can look up somewhere. Liabilities are fund-specific, changing all the time and driven by all sorts of factors (demographic, markets, corporate, regulatory) and this makes reporting rather complicated.
Another example is the use of new asset classes and instruments. When pension plans diversify across a broader range of asset classes, people are faced with very different reports. It is not just about style and formats – each asset class has its specifics. For example:
o Some performance attribution systems already struggle with government bonds, let alone high yield bonds or interest rate swaps;
o Portfolio analysis is fundamentally different for real estate, private equity and commodities: investment criteria, valuation practices and key statistics are all different.
o Investment time horizons may vary from intra-day in certain hedge fund strategies to over 20 years in infrastructure funds;
o Traditional risk measures, such as variance, can be useful but how do you report on the ‘interesting’ risks, such as liquidity, concentration, counter-party or mismatch?
o How to do justice in reporting to overlay and portable alpha strategies? If transparency is an issue, how to handle the additional layers introduced via fund of funds?
One can argue that good specialist managers will be able to provide adequate reporting in alternative strategies. After all, fund managers have been told many times that reporting should reflect their particular investment style and horizons.
However, things are a bit more tricky. Pension fund fiduciaries not only need to digest, say, a dozen different reports with different analytics. They also need to be aware of the ‘aggregation’ issue that is even more worrying: the total is not the same as the sum of the pieces.
For example, even if you have the most perfect risk report for each portion of your pension plan, it is not just a question of adding them up. Risk is not additive; you need to look at the correlation between the various asset classes. From a client’s perspective, there is not much point in over-analysing the sub-portfolios without putting them into the context of the overall pension fund.
Another example is asset allocation. Despite its primary importance for the pension fund performance, it is typically under-analysed and under-reported. Do trustees get a proper report that tells them of the effects of (tactical, strategic, dynamic) asset allocation decisions (made or not made)? The contribution of (not) rebalancing their assets? The risk of (not) being invested in certain asset classes?
Fund managers may respond that such top-down reporting would go beyond their remit. In fact, pension funds tend to receive reports not only from their asset managers, but also from custodians, administrators, auditors, performance/risk measurement shops, actuaries, consultants and/or internal resources. However, all these reports tend to cover only some aspects of pension plan investments.
This leads to the important organisational dimension of the problem: Who should bring the different reports together (and reconcile any inconsistencies) and report on pensions investments as an aggregate? How to structure reporting that reflects the contributions made at different levels of decision-making, for example, by pension boards, investment committees and fund managers?
The solution may vary between countries and pension schemes. Nonetheless, fund manager reporting needs to be embedded in a well-structured, integrated reporting framework, and this is as much a challenge for a pension fund’s managers as it is for asset managers.
There is a final point. Client reporting needs to keep pace not only with the developments in investment but also in regulation and governance. This also raises the expectations on a pension fund’s own communication with regulators, members, sponsors and the public. As a prerequisite, pension funds require top quality data and commentary from their delegate asset managers.
This is particularly important in the case of DC plans, where the ‘clients’ effectively are the thousands of ‘anonymous’ members. This is often still not recognised sufficiently. In the end, whether the client is a DB pension board or a DC plan member, good client reporting is a risk management tool for the recipient, helpful in making good decisions for the future. Time for a proper review!
Georg Inderst is an independent consultant based in London, email@example.com