The centre takes control
A growing number of multinational corporations are taking an increasing interest in the global co-ordination of their pension plan assets from corporate headquarters, according to our recent survey.
This article examines the reasons why this is happening, focusing particularly on the perspective of European-based multinationals. It also reviews the survey’s key findings on the policies being adopted by multinationals and sets out a process by which multinationals can consider undertaking coordination.
To illustrate the important issues at stake, let us consider an example of a European multinational with substantial pension assets in a number of countries around the world.
This multinational has pension assets of e10bn, mostly in defined benefit plans in the UK, Netherlands, Switzerland, Germany, Belgium, US, Canada, Australia and Japan.
Each local pension plan has its own approach to governance and monitoring, decides its own investment strategy and selects its own investment managers, custodians and consultants.
As a result, in aggregate, these pension plans employ 30 different investment management firms, 12 organisations providing custody and seven different consultancy firms.
This multinational company operates in an increasingly competitive business environment. A new CFO has recently taken over and the company is undertaking a global review of its lines of business and its cost structures.
What are the key issues that the CFO is likely to identify when reviewing the corporation’s global pension plan assets? With the bulk of current plans being defined benefit, the CFO will realise that the corporation is responsible for the balance of cost: any shortfall between assets and liabilities will impact on the corporate bottom line.
We can then group the key issues facing the CFO into three main categories:
q risk, and
Firstly, in terms of return, there are likely to be inefficient or ineffective procedures for the governance and monitoring of local pension arrangements. Poor quality investment managers may be being employed; local fiduciaries may not have sufficient time or expertise to review and monitor the investment arrangements thoroughly. There may be inconsistency in key investment decisions, for example with some funds using currency hedged benchmarks, while others are using unhedged benchmarks.
When considering risk, the new CFO will soon realise that the corporate centre has no clear picture of the risks that are being taken in each of its local pension plans and little awareness of which of these risks are likely to be material. For example, the Swiss plan might have substantial assets with a single manager with a pronounced style bias. Poor performance by that manager might have a major impact on the total investment return earned and increase the likelihood of the corporation having to make good the shortfall.
Turning to costs, the CFO might suspect that the investment management, custody and consultancy costs being borne by the corporation as a whole could be significantly reduced by using a smaller group of managers, custodians and consultants.
These are only some of the areas in which the global pension plan assets present risks to the corporation but also offer opportunities for better investment returns and lower costs.
Internal studies that we have carried out and also direct client experience suggests that, if appropriately managed and controlled, there are opportunities for the corporation to significantly improve its financial results:
q investment returns can be enhanced by 0.5–1.5% a year;
q risk can be reduced by 25–30%, and
q costs can be reduced by 20%.
On our example company with E10bn of assets, this could mean savings of some e100m–150m a year, with lower levels of risk. This is likely to provide the CFO with compelling evidence to implement an urgent programme of global coordination of pension assets.
Nevertheless, there are potentially major hurdles to overcome: for example, how to achieve the corporate objectives while still respecting the role of local fiduciaries. Furthermore, how can a multinational which has historically operated on a decentralised basis start to achieve coordination between its local plans?
These barriers are not insignificant and have deterred many multinationals from taking appropriate action in the past. However, the business case for taking a more coordinated approach is clear.
We recognised the growing interest from multinational corporations in these issues but found there was little empirical data on the amount of coordination being undertaken. We therefore conducted a survey of multinationals to learn more about their current global pension asset management practices and their future intentions.
Responses were received from 83 multinationals with headquarters in various locations around the world. 38% of respondents were from Europe, 48% from the US and 14% from the rest of the world. Half of the survey respondents reported some degree of corporate involvement in, or oversight of, local pension plan investment decisions.
The key role played by local fiduciaries in investment decisions means that total control of local decisions is not possible, nor indeed desirable. However, this has not deterred headquarters from seeking some form of involvement in local investment decisions. Of those not exercising oversight today, more than 50% expect to do so within the next two years. This increase indicates a growing interest in global coordination.
The degree of corporate involvement varies by area. Not surprisingly, the level of interest is highest in decisions that are likely to have the greatest impact, ie, those on investment policy, structure and selection of managers, and monitoring. A low level of involvement and interest in custody suggests that multinationals may not realise how a global custodian could assist them in achieving their objectives of co-ordination.
In their worldwide investment objectives and strategy decisions, respondents were highly focused on liability risks and on outperforming customised benchmarks. Most use asset liability modelling to set investment strategy in some or all countries. However, the survey suggests a gap with respect to global risk assessment. In various places in the survey, respondents indicated that risk is a concern for them, yet only 12% use global risk assessment models.
In general, survey respondents are believers in specialist management and are more interested in active management than passive. In our experience, a major driver of multinationals’ activity at the manager level is the desire to make specialist management available to local plans that do not have the size of assets and resources to obtain it for themselves.
Across all types of supplier, about half of the multinationals now have at least one preferred provider relationship – most commonly with actuaries/benefit consultants. The greater the degree of headquarters involvement, the more substantial the use of preferred providers.
Half of those without preferred providers today expect to introduce preferred provider relationships within the next two years. Moreover, those with preferred providers today expect to increase their number, suggesting that the experience has been favourable. Those using or expecting to use preferred providers say that quality control, consistency and the opportunity for a more effective relationship are more important reasons for doing so than the availability of economies of scale.
Monitoring is seen as a natural area for corporate involvement, with two-thirds of companies regularly monitoring data on the investment performance of their plan assets worldwide. Risk assessment as part of the monitoring process is very highly rated.
Many readers might imagine that US multinationals have taken the lead in addressing these issues. However our experience has indicated that a significant number of major European-based multinationals have also appreciated the benefits of a more corporate focused approach for some time and have been working to coordinate their global pension assets.
Indeed, our survey indicated that European multinationals were as interested in global coordination as their US counterparts. The introduction of the euro may well have provided an impetus to this.
Inevitably there are some differences between the responses given by US and European multinationals:
q A lower proportion of those European multinationals not currently undertaking coordination expect to start doing so over the next two years, compared to their US counterparts. This suggests that the pace of change is likely to be faster for US multinationals.
q A higher proportion of European multinationals have adapted their plan investment strategies for the euro (perhaps not surprisingly, given the greater volume of assets involved).
q A lesser focus by European multinationals on classifying their investment managers and assessing their performance by style (value, growth etc). However, we believe this is a reflection, of the lack of availability (historically) of style benchmarks in Europe: recent developments would lead us to believe this will receive increased attention in Europe in the future.
In most other respects, however, European multinationals appear to have the same fervour and focus on these issues as their US counterparts.
Many multinational head offices are already coordinating the investments of their local pension plans to some degree. The trend towards coordination seems set to accelerate. Those who have started down this path are looking to deepen their involvement, suggesting they are satisfied with the initial results.
This confirms our belief that there are significant and measurable benefits available to multinationals that take a more coordinated approached to their global pension investments.
Robert Baker is head of multinat-ional investment consulting at William M Mercer in London
*Survey of global coordination of retirement plan assets’ copies are available from email@example.com
Coordination in action
Multinationals considering embarking upon global coordination will need to establish a strategic process for doing so.
The process set out below highlights the key steps they need to take:
q Evaluate current practices:
Assess current assets and management structures
Examine governance procedures
Identify key risks
Established priorities for corporate involvement.
q Determine framework for coordination:
Decide global policy
Establish process for disseminating this locally
Assess the degree of corporate support required for local implementation
Devise process for monitoring compliance with policy.
q Undertake coordination:
Identify and implement global preferred providers
Implement global asset liability management
Undertake global monitoring of managers
Evaluate global pooling vehicles.
Not all multinationals will wish to implement the full range of coordination. Each multinational is different in terms of its culture, degree of centralisation, relationship with local fiduciaries etc. Each or all these may impact on its capability or desire to implement global policy locally.