The new quasi-consultants
The specialist pensions groups at the investment banks have a lot to offer trustees. They can be a valuable source of expertise particularly when it comes to using complex financial instruments to solve the liability mismatches plaguing many funds. But just whose side are they on, and is their advice to be trusted?
In some ways, the advice offered through the pensions groups can be seen as quasi-consultancy. But is it independent? Nick Horsfall, senior investment consultant at Watson Wyatt says that there are certainly some services the investment banks provide which are consultant-like. But they are more transaction-led.
“I’ve never seen a report from a bank which says no transaction is required, whereas you quite often see that from us… so there is definitely a difference.”
But the quality and perspective of advice from investment banks can be sound. “Certainly a lot of the advice we see from the banks is objective, and it’s good,” he says. However, some of their reports and analyses do not seem so objective. “We spend a lot of our time giving advice on banking conclusions. We think some of the time their answers are wrong.”
Looking to the future, Horsfall predicts it will be more and more common for banks to be providing advice to pension funds, and increasingly common for consultants to be working alongside pension funds, giving comfort to trustees.
Although pensions consultants can give pension funds advice on how best to match their liabilities with their investments, investment banks are able to go further than this. “The real thing is that we can execute the solution,” says Keith Jecks, global head of the pensions advisory group at ABN AMRO. “For example, when the solution is an overlay of swaps, someone has to put that together. The banks are doing that.”
But in the UK, at least, investment bank advisory services for pension funds are not replacing consultants, he says. “We seek to work alongside the consultants,” he says.
It is very rare than ABN AMRO’s pensions advisory group would charge fees for advice, he says. However, there are some cases where a pension fund client comes to the group looking for a different perspective on advice that it has received elsewhere. For example, fees may be charged where a fund asks for an ALM study to be carried out on a non-tied basis, he says.
Or, for example, a large DC plan, where the liability profile is quite simple, and there is no need for a detailed ALM study. “They need the kind of asset modelling where the risk/return profile changes if you put in a different solution,” he says. Banks are better placed than consultants to offer this, because they are better at coping with complicated derivatives, he says.
They can show the client various possible return scenarios, says Jecks. “Banks can generally handle that better.”
“Conversely, if you’re talking about a plan with complex benefit structures – a defined benefit plan in the UK, for example – then the consultants are typically better at handling that than the banks.” Consultants are more closely associated with the actuaries who would do this.
Eric Viet, head of the Europe Pensions Group at JPMorgan says the service the pensions group offers is very different to work that consultants do. “We are not actuarial consultants,” he says. “We don’t do asset manager selection and fund selection. We analyse risk and do ALM studies, but the main driver for us is the corporate balance sheet.
“We don’t go into asset allocation. We may suggest that the fund is not well diversified, or there is too much in one asset, but that is mainly from the perspective of the corporation,” he says. The bank is well aware of possible conflicts, and it does not advise trustees, he adds.
But although much of the work with pension funds does involve creating funding products that involve the use of derivative financial instruments, Jecks says the pensions advisory group is not simply an offshoot of ABN AMRO’s derivatives desk.
“In our case it never has been,” he says. “It was set up separately from the product groups, and it includes more plain vanilla banking.”
The pensions advisory group involves services from several of the bank’s capabilities – risk management products, asset management products, custody and transition management, he says. The derivatives capabilities are simply one part of all of this.
JPMorgan uses derivatives in the solutions it comes up with for pension funds, but there is a clear separation between the pensions group and the derivatives desk. “Derivatives are the products which can be used in the implementation of the solution, and we will work with them when it comes to implementation and pricing,” says Viet. But there is a Chinese wall between them, he points out.
“We focus on the corporate side of the equation.”
Mark Azzopardi, who heads the insurance and pensions group within fixed income at BNP Paribas, says the investment banks can be objective and that BNP Paribas’ advice is based on sound financial theory. “But I recognise we might be perceived as not being objective,” he says. Trustees are probably best off getting advice from consultants as well as hearing what the bank has to say.
As to whether pensions groups at the banks will be a permanent feature of the business, Viet sees the model as a long-term one. “There is a lot of need at the moment, and I don’t think the issues will be solved overnight,” he says.
But perhaps in the future, if the solutions being offered become ‘plain vanilla’, then there will be so many providers there will no longer be a need for specialist units to help sort the problems out. But that will take some time, he says.
During the last two years, the focus has changed somewhat, with asset managers stepping into the debate to offer better products to pension funds. Now, says Viet, the bank is working with both corporations and asset managers.
The way the future pans out will be interesting, says Azzopardi, particularly given that there are two competing business models in the market at the moment. On the one hand, there are the banks who will put risk management solutions in place directly with the pension funds, and on the other, there are the fund managers intermediating similar but less tailored products, which they themselves source from the investment banks, on a standard product basis.
Fund managers are buying the services from banks and using them in packaged products. Some pension funds may prefer to go to a fund manager for the all-in-one solution, but it is not necessarily the most efficient or even the cheapest way to do it.
Axa Investment Management has been involved in liability-driven solutions for 10 years or more, in terms of duration matching, says Kathleen Currie, director, structured solutions at Axa. In terms of its activity in the UK market, it has been offering LDI for about two years, she says.
“I really do believe it’s something that will become the norm,” she says. “More and more people are talking about it, and more people are implementing it… It makes sense to be reducing risk as the population ages. It’s something actuaries have pointed to, and this is just a way of crystallising that.”