The shockwave of the announcement by trustees of the £4bn (e6.2bn) Unilever Superannuation Fund (USF) on October 7 that they had started proceedings in the high court against Mercury Asset Management (MAM) – alleging negligence by the investment manager, is already registering strongly in the UK pensions community.
And the basis of the claim by Unilever, that MAM – now owned by Merrill Lynch – was in breach of contract in failing to take sufficient account of the risk of under-performance in its management of USF assets, could have profound implications for future scheme/investment manager contracts.
MAM was re-appointed as one of USF’s investment managers under new contractual terms from 1 January 1997, having previously managed USF portfolios for some 10 years, to run securities then worth approximately £1,090m.
According to USF, during the first four quarters of the new contract, MAM’s overall portfolio under-performed an agreed downside tolerance stating the return was expected to be no more than 3% below the benchmark for any four successive calendar quarters.
USF trustees terminated MAM’s contract in March 1998, by which time the under performance had increased to 10.5% over the five quarters since reappointment.
Richard Greenhalgh, chairman of the board of trustees of USF, commented: “The trustee board’s decision to initiate legal action was not taken lightly and comes after a detailed review and lengthy discussion with our advisers. In the absence of a satisfactory settlement, it was clear that the trustees had a fiduciary duty to take proceedings in the interest of, and on behalf of the fund’s members.”
He added that the advice given to USF trustees was that the UK equity portfolio selected by MAM was too risky for the agreed investment mandate.
“It should have been clear to MAM that if the investment judgements they made turned out to be wrong, there would be an under-performance far beyond the agreed downside tolerance.”
However, he stressed that USF fund members would be unaffected, regardless of the outcome of the case.
In a rebuttal, Merrill Lynch Mercury Asset Management says Mercury will ‘vigorously contend’ the Unilever legal action and is ‘confident’ the claim will be defeated.
Mercury says it was reappointed to the USF on the strength of its ‘good long term performance record having been the client’s best performing manager overthe nine year period.’
Mercury adds that USF has chosen to concentrate on only a comparitively short period of underperformance and has wholly ignored the manager’s previous nine year outperformance record.
Even accounting for the downturn in performance, Mercury says its long-term record for USF remains close to the benchmark and is markedly better than the long-term record of many of USF’s previous other managers.
However, other pension funds have already indicated they may pursue similar action to the USF trustees.
Geof Pearson, group pensions manager at the scheme of UK retailer J Sainsbury, explains that the scheme is also examining the performance of MAM on its investments as a result of a similar ‘downside risk clause’ to that of the USF fund in the Sainsbury contract. “We’ve made no secret of the fact that we’ve been studying the issue.” And he adds that the Unilever case is likely to be the thin end of the wedge. “I think the people who view this as a one off are out of touch. People must be in cloud cuckoo land. Even if there isn’t an explicit downside risk situation in their portfolio, there is an implicit downside tolerance that can be assumed. Theoretically, if you take an exaggerated example of giving a manager say, a 1% outperformance target and the downside is 50%, I don’t think a judge would consider that to be reasonable.
“It is all about confidence and when you give these managers your money you do it instead of going into a tracker fund which gives you market returns and means you can sleep relatively easy at night. Most funds only ask for 1% outperformance relative to the benckmark.”
Pearson says the issue is in the hands of lawyers but he adds that the company is looking closely at the Unilever case before proceeding. “Our situation is very similar to Unilever and to my mind we should follow in their slipstream if they are successful.”
At a conference in Milan last month, Pearson also suggested that pension fund investment mandates should have a ‘penalty level’ applied for manager performance.
Sally Bridgeland, head of investment research at consulting actuaries Bacon & Woodrow, says it is an issue which is arousing increasing awareness.
“We have seen a lot of interest from clients in how we can word mandate structures and fee issues to try and reflect the fact that risks for pension funds are becoming more short term, particularly with the minimum funding requirement and the accounting pension cost changes that are coming in which will increase volatility.
“It is not just about performance it is about risk too. Generally there is a trend to want to control risk more tightly and funds are particularly worried about protecting the downside, not just the volatility.”
Bridgeland says clients are now looking to incorporate these variables, either in the manager agreement or the fee structure.
However, Robin Ellison, pensions lawyer at Eversheds says he would be ‘astonished’ if the Unilever/Mercury case actually gets to court. “I think a deal will be reached because the courts are very encouraging of mediation in such cases. If it does go to court, Ellison believes the specifics of the contract will be paramount. He adds “The courts will have a pre-disposition not to open the floodgates.” Hugh Wheelan
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