The rise of fiduciary mandates
The decision of private Pensioenfonds Vervoer earlier this year to give Goldman Sachs Asset Management a fiduciary management mandate across all its assets has revived the debate about fiduciary management in the Netherlands.
There are those who argue that there is nothing new about fiduciary management, and that pension funds in the Netherlands have been practising it for decades. It could well describe the role of the ABP pension fund, for example. Fiduciary management, in this view, is simply old wine in new bottles.
There are others who say that the very fact that GSAM has entered the fiduciary market suggests that there is something new here. Asset managers based in the US have long experience of a kind of fiduciary management that is far more strictly defined than the European model. By exporting their expertise to Europe, US asset managers are importing new wine in new bottles.
So does Vervoer's decision presage a change in the way pension fund assets are managed in the Netherlands? The Vervoer decision was perhaps atypical. Vervoer is a large industry-wide fund with e5.4bn in assets. The real demand for fiduciary management is likely to come from smaller and medium-sized corporate pension funds.
These funds are confronted by a battery of pressures, including compliance with the new International Financial Reporting Standards (IFRS) and the new solvency requirements of the Financieel Toetsingskader (FTK).
Faced with these pressures, corporate finance officers are looking for ways to reduce the impact of their pension fund on the corporate balance sheet. Benoit Fally, managing director of State Street Global Advisors Limited (Brussels), the entity in charge of business development and client service in the Benelux, suggest they have three options - to move the management of their pension fund assets to an insurer, to leave things as they are, or to look for a fiduciary manager.
"Option number one is expensive because if you go to an insurer you pay an annual premium which is probably higher than the total cost of running pension plan, and you are also locked up with all sort of special clauses which means that you can never get rid of the insurance contract." Fally says.
"You can take the second option, to leave things as they are, but you need to professionalise the staff, which probably means hiring new people. This is something that pension plans may be reluctant to do, since they are a cost centre rather than a profit centre and therefore cannot justify the expense of new hirings.
"So you are left with option number three, using a fiduciary manager. This is an attractive option. It is cheaper than an insurance contract, and you are still left with a professional team - the fiduciary manager - that is going to run your assets and take difficult decisions in terms of asset allocation.
"In this way a pension fund can generate a nice return, perhaps minimise its pension contribution, and comply with the accounting and supervisory regulations."
Dutch pension funds are showing an increasing interest in fiduciary management for a variety of reasons. Rudolf Hagendijk, chief executive officer of Mn Services, says one of the main reasons why small to medium size pension funds are moving towards outsourcing and fiduciary management is the growing complexity of the pensions and investment business.
"What a fiduciary manager can do for the management and board of a pension fund is to essentially reduce complexity without taking the steering wheel out of their hands."
The increase in regulatory and accounting requirements is also a major factor, he says. "Compliance with new regulations and accounting standards certainly plays a role. Small pension funds usually have a limited staff, so they are certainly not in a position to do all these things themselves in a proper way."
The combination of regulatory and accounting requirements is putting pressure on corporate pension plans, and encouraging corporate finance officers to considered fiduciary management, says SSGA's Fally.
"The changes triggered by FTK in terms of funding ratios and matching assets to liabilities, the changes implied by IFRS meaning that the P & L of a pension plan may be reflected in the P & L of the corporate sponsor, all create an additional number of constraints which make the professional management of a pension fund more difficult and increase the visibility of the pension fund results for the corporate treasurer," he says.
"In the past some corporate treasurers, by no means all, saw their pension plan as a way to make money. That was the case in the 1990s where if you had a proper allocation to equities you were able to take pensions holidays over a long period of time.
"That is no longer possible and corporate treasurers now want to neutralise the risk associated with pensions."
On the positive side, pension funds are looking for better performance than they are currently getting from their asset managers. Ruud Hendriks, head of institutional continental European marketing at Goldman Sachs Asset Management, says that successive years of underperformance have encouraged a number of Dutch pension funds to make the move to fiduciary management:
"If they had produced stellar investment results for five years in a row, the chances that they were in for a major change would have been substantially less. So I think it's only fair to say that performance that were not so good have played, and will play, an important role in persuading pension funds to look for a fiduciary manager."
Fiduciary management is a something of a misnomer in the Netherlands. The arm's length governance structure of Dutch pension funds, whereby the pension fund is a separate legal entity, independent of the sponsoring company, means that only the board of the pension fund board can be the fiduciary manager in the legal sense.
In this respect, it is important for fiduciary managers to know where their responsibilities lie. For Hagendijk, the demarcation lines are clear: "The strategic decisions will always remain with the pension fund management and board, but the execution of investment management and the operational side of the business can easily be outsourced to a fiduciary manager.
"The pension fund management and board sets the benchmarks and the strategic asset mix, and the fiduciary manager takes over from there and acts on behalf of the pension fund."
Using a fiduciary manager enables a pension board, which is normally made up of representatives of labour unions and employers, to plug into some pensions know-how, says Hagendijk. "With fiduciary management you can tap into the professionalism and knowledge that the management and board of smaller pension funds often lack."
Yet fiduciary managers must know where to draw the line, when to leave pension fund boards to make strategic decisions based on the technical advice of the fiduciary manager, he says.
"The essence of the fiduciary management role is that you know your position. That means you have to know when to step back and say something is not your responsibility. At some point you may have to say to a pension fund: ‘Although I will not take control of your pension fund, I will help you in any way I can to fulfil your responsibilities.'
"It's a balancing act, but at least in the Netherlands it works."
Besides knowing your place, it is also important to know your customer. What are the characteristics of the pension fund - is it mature or immature, growing or dying? What is its chief objective, matching immediate liabilities or generating future returns?
Jan Bertus Molenkamp, senior manager for fiduciary management at Kempen Capital Management, says that these sort of questions distinguish fiduciary management from multi-management.
"Multi management is a strategy from the asset side - how can I optimally invest in a particular asset class - whereas the starting point for the fiduciary manager is liabilities."
Yet the first step for a fiduciary manager is not matching a pension fund's liabilities but establishing its profile, Molenkamp says.
"When a pension fund asks us to construct a portfolio, the first thing we do is ask the board a series of questions. What are your liabilities and how they will develop? What is your ambition - do you want to give your members a hedge against inflation and pay for inflation increases? How much risk do you want to run versus your liabilities?"
"When you know the answers, you can then construct an overall policy, including an asset management policy, which complies with all these issues and offers a good return and hopefully the best results for the pension fund members."
For a fiduciary manager, getting to know a customer is often a protracted business, says Hendriks. "If you're going to be a partner with a pension fund it pays off to have lengthy discussions before.
"I would compare the situation with getting married. It takes a while before people get married and sometimes it never reaches that stage. The same is true with fiduciary management. We spend an enormous amount of time at the pre-signing stage with clients because we want to be sure that they understand what fiduciary management involves.
"It's a major step and they had better be aware of all the consequences of that step. Sometimes the relationship leads to a marriage. Other times people say no, we'll continue managing the way we have done it."
Although there is a consensus among asset managers as to what constitutes fiduciary management, there is less agreement about how it should be approached. Some of the leading players in the fiduciary management market take diametrically different approaches. The main difference in terms of a business model is whether fiduciary manager elects to be simply a provider of third party services and products, or whether it includes its own products and services in the package. Some asset managers who offer fiduciary management have adopted a ‘horses for courses' approach to the use of internal and external managers. Mn Services and Kempen Capital Management, which hired its fiduciary management team from Mn Services, both include their own products.
Hagendijk of Mn Services says his policy is to use in-house skills where they are appropriate. "Our philosophy is that we manage European investments from our headquarters in Rijswijk because we think we can monitor the European market more closely from there. But for US or Far East investments we will use local players because they have so much more knowledge of the market."
This does not prevent Mn Services firing its own managers if it has to, he says.
"Our managers have to perform like other managers. Best execution is one of the prime principles of fiduciary management. So when my own managers do not perform according to the benchmark, then I'll have to chose another."
The choice of a fiduciary manager as asset manager will sometimes be inevitable. Fally at SSGA point out that the choice of passive managers is limited to a few large players. "We are one of the largest passive managers in the world, and if we come to the conclusion that a client needs to have passive management, we tell them that we would like to do it ourselves," he says. Others asset managers have chosen to be providers of third party products and services only. This approach was pioneered by multi-managers, notably the Russell Investment Group and SEI Investments. The model has also been adopted by Goldman Sachs, and was one of the reasons why Vervoer awarded GSAM a fiduciary management mandate.
Refusing to hand business to your own managers pays off in the long run, says Hendriks of GSAM, even if means a short term loss of assets under management. " When we won the mandate from VGZ four years ago they had four balanced managers, managing e250m each. One of those balanced managers was Goldman Sachs Asset Management.," he recalls.
"After five years they reviewed the situation and found that although they had paid substantial fees they had got benchmark results, and that over that period none of those four managers had really outperformed . So they said let's go for a fiduciary management structure.
"We won that piece of business and the first thing that we did was to hire only non-GSAM managers. That has cemented the relationship with VGZ extremely well because we had done what we had said we would do."
A distinctive feature of GSAM's approach is that it works exclusively with segregated mandates. Hendriks says that this enables them to customise a fiduciary mandate to fit a particular pension fund.
"With the segregated mandate, we can tailor that mandate to the wishes, the guidelines and the restrictions of that particular client. There's nothing wrong with a fund, but a fund is a fund. You can't tweak your own guidelines in a fund. You have to take it as it comes.
"We would rather work with segregated mandates whereby we can take into account the specific wishes and guidelines and restrictions of individual clients."
One drawback of working only with segregated mandates is that it is difficult to gauge performance independently. Bart Heenk, managing director of the Benelux region at SEI, points out that "with segregated mandates, it is difficult to establish a track record because there are no independently verifiable sources to confirm it. Russell and ourselves have funds which are listed and have a daily NAV which you can look up on Bloomberg."
One way in which fiduciary management providers can create a unique selling proposition which will differentiate them from the opposition competition is by widening their fiduciary offering.
Part of the sales pitch of SEI Investments Europe which last September won a e265m fiduciary management mandate from Stichting Pensioenfonds Interpay Nederland, is that it provides guidance on the link between the pension fund and corporate finance. The link has become an issue in the Netherlands and the UK, where the impact of corporate pension funds on corporate balance sheets have alarmed chief financial officers.
SEI has taken a corporate model developed for the US defined benefit market about four or five years ago and adapted it for the Dutch environment specifically the accounting environment for IFRS and the regulatory environment for FTK.
"The model works by looking at the interaction between the choices you make in asset allocation in the pension fund and the balance sheet and the P & L account of the corporate, " says Heenk.
"We can model this 10 years forward, based on input from the CFO of the corporate sponsor as to how the business flow will develop. The model will look at things like credit ratings, funding requirements, and expected cash flows over the years. We look at the financial ratios if they have loan documentation or corporate bond documentation which contain covenants. We can monitor or analyse the effect on those covenants of both the asset allocation and the economic environment. We also do a lot of scenario analysis - what if inflation rises, interest rates increase.
"We've tried to keep things fairly simple because it is hard enough to appreciate all the interrelations between the corporate and the pension fund, and if you start to make it stochastic it becomes too difficult to interpret. So it's a deterministic model, but with a lot of stochastic analysis alongside.
Once we have focused on a certain aspect of corporate finance with the pension funds we can then use stochastic modelling to see the range of outcomes.
"We are not telling them what to do. We are handing CFOs a tool which enables them to come to well-informed decisions."
However, SEI must convince the pension fund manager first, says Heenk. "The difficulty is that when you approach a CFO with this model he will be generally be pleased and interested, but the pension fund director may feel sidelined.
"So we go to the pension fund first and sell the idea of creating a better dialogue with the sponsor, so that the pension fund director can understand what the effects are on the corporate finance situation and vice versa."
The model is not unique, Heenk says. Philips has modelled its pension fund liabilities and assets around the world in the US, the UK, Germany and Holland in a similar way.
This kind of corporate modelling comes close to stepping on the toes of Dutch consultants, notably Ortec, who use stochastic models and scenario analysis extensively in their work for Dutch pension funds.
Yet there is no conflict of interests here, says Kempen's Molenkamp: "We work alongside ALM consultants like Ortec, Watson Wyatt and Mercer. They will conduct an ALM study and, if we act for our client as fiduciary manager, we will communicate with the ALM consultants and together we will establish together a sound policy.
"In most cases an ALM study gives us a kind of rough picture and we then try to make this implementable, enriching it with further categories and other risk assessments."
The dividing line between consultants and asset managers have already been crossed, Hendriks of GSAM points out. "The traditional demarcation between a consultant and an asset manager is blurring. Many consultants, not only Frank Russell, are starting to enter the asset management field, and for very good reasons. They also see that managing assets is a way more profitable piece of business than sending an invoice for a piece of consultancy."
In the Netherlands the situation is rather different. One leading ALM provider, Ortec, has 80% of the market. Inevitably, therefore, fiduciary managers will be working alongside them, says Hendriks.
"Pension fund boards may come to us and say we trust the judgement of the provider but it's good to have a second opinion. So we work together with the provider.
"What the board is trying to get to is a level of comfort that the ALM study that they get makes sense." Yet Dutch pensions funds may see fiduciary management as one more layer of costs, like a manager of managers.
Molenkamp of Kempen says this is misguided: "A lot of people are penny wise and pound foolish, in the sense they are really focusing on how much basis points will I have to pay a fiduciary manager instead of what shall I get in return," he says.
"The problem, of course, is that you cannot compare future returns with what you would have achieved if you had stuck with the same approach. This is because of the way a fiduciary manager is organised. A fiduciary manager is focused on maximising the returns net of fees and commissions at all stages in the process. "One way of looking at it is that if a pension fund doesn't use a holistic and integral approach, as embedded in fiduciary management, it could losesome savings opportunities. So fiduciary management is for examplealso about keeping down the costs of custody, and putting securities lending in place."
Rewards should be based on performance, Molenkamp says. "We would like to have an alignment with the client so that there would be a kind of base fee and a performance fee based on the whether the client reaches the goal that they need to reach, based on their liabilities."
Fiduciary management needs to prove itself in this sort of way if it is to shake off the criticism that it is an old idea dressed up in new clothes.