Veering towards pooled solutions
According to a recent survey by the UK Investment Management Association (IMA), total pension assets managed by its 113 members in the UK market amounted to £2trn (e2.9trn) at June 2003. It is hard to find an accurate figure for the percentage of this total which is run through pooled funds. Leading industry survey the CAPS Pooled Pension Fund Update (CPPFU) charts the performance of 50% of the industry by number of funds. Funds surveyed account for total assets under management of £254bn at December 2003.
The funds included in the UK pooled fund universe comprise a number of different fund structures. Insurance funds dominate, though unit trusts and open-ended investment companies (OEICs) are also represented. Funds are free of capital gains tax but pay tax on dividend income from equities.
The indications are that the pooled fund market is expanding. Over 10 years (see table) the number of funds included in the CPPFU have risen from 444 to 687. This is partly a result of growth in demand for new types of asset. In 1993, for example, there were only two long-term UK bond funds and eight international bond funds. Last year the survey recorded 53 and 35 funds respectively. There were no emerging market funds represented in 1993. In 2003 there were 25.
There are also various factors driving an increased take-up of pooled funds among pension providers. Jon Little, chief executive officer at Mellon Global Investments, whose UK investment division is Newton Investment Management, sees three main trends.
Some fund managers are making a virtue of pooled vehicles for clients in the £10-30m bracket who would in the past have opted for a small segregated fund. Pooled funds help in performance terms and also in controlling costs. “This theme is driven by foreign managers in particular. They say that their minimum fees are too high to justify a £10m segregated fund,” Little says.
Another widespread trend is the move towards specialist benchmarks. Here a fund which might have had £50m under a balanced mandate now spreads it across a number of vehicles with specialist managers – say £5m in Asia and so on. In Little’s view this trend is driving demand “though each fund manager might only get 10% of the mandate”.
Finally, changes in regulation are also helping to open the way for wider use of pooled funds. Gross pricing is now allowed in OEICs and fund managers can adopt a pricing policy which is transparent, avoids dilution, and allows realistic institutional charging levels within a fund, as sub-funds under the same umbrella can be charged differently for retail or institutional purposes. As a result, “Clients are not paying for retail trading within a pooled fund,” concludes Little.
This argument is likely to present a powerful reason in the future for investment management groups to convert traditional unit trust style funds into the more flexible OEIC structure, which in turn could pave the way for groups to amalgamate their retail and institutional funds.
A trend towards amalgamation would not merely be a cost-cutting exercise, but would chime with changing institutional investment requirements, says Alan Mearns, marketing head at Mellon. “Historically, retail funds have been higher risk, high alpha vehicles compared to the much more conservatively run institutional funds operating to tight benchmarks. Now, institutional investors are becoming more high alpha, absolute return investors. Many launches in the past two years have been institutional versions of retail funds – ‘best ideas’ type vehicles. Higher octane products for the institutional market.”
Jane Welsh, a senior investment consultant at Watson Wyatt, is also seeing a growing tendency among clients to use pooled funds. “A big theme in the last 18 months has been larger funds looking to diversify into new areas. Historically, large funds haven’t touched pooled funds, but they are turning to them in areas like emerging market and high yield debt, hedge funds and private equity.”
Emerging market debt is a particular instance of the attractions of the pooled route. Because of the advantages of specialised management, efficiency and built-in administration and custodianship, “in the new asset areas it makes no sense to remain segregated. Even multi-billion pension funds are using pooled funds more, and most passive management is pooled”, says Welsh.
Little reinforces the point. “We have clients near the £100m mark who are happy to be pooled, and the biggest investors are getting bigger if anything.” Pooled funds carry a long list of tempting advantages, says Little. They offer daily pricing, easy cash flow, plenty of information, asset segregation, an independent board and an independent annual audit. Mellon currently has around £9bn in institutional segregated money in the UK, compared to about £2bn in pooled funds.
As pension funds split large portfolios between a number of fund managers, where in the past a single manager might have been used, managers are finding that their reputation for a particular investment speciality is what is in demand. The last five years “have seen the emergence of more and more boutiques, and this has injected new life into the industry”, says Welsh.
At the other end of the size scale Standard Life has some experience of the same phenomenon. “Pension funds are choosing the best manager by asset class”, says George Walke, head of Standard Life’s UK institutional business. In Standard’s case this means UK equities, bonds and property. Of nearly £19bn in pension money under management, the company has £2.3bn in segregated funds and £4.2bn in pooled funds, with a massive £12.5bn in retail pension schemes.
He also outlines a number of investment trends. The move towards ‘benchmark brief’ business, where pension funds set up a scheme-specific benchmark rather than relying on peer group benchmarks, has been marked. “A lot of existing clients are converting to this”, says Walker. The fund with its advisers agrees a set of benchmarks to match assets and liabilities. The investment manager then uses a combination of pooled funds to meet the benchmark. “It’s a halfway house between a managed fund and a segregated fund proper”, Walker adds. Standard Life operates a £10m minimum on its benchmark brief service compared to £50,000 in individual pooled funds
The trend away from equities and towards bonds is an accepted phenomenon in the whole UK pensions industry, as reported by the Investment Management Association in a survey published at the end of May. It is widely expected that equity allocations will progressively fall from the 56% currently held by pension funds to something like 31%, the current life fund total.
In the pooled fund universe this is reflected by a proliferation of new specialist products, Walker explains. “Five years ago you had a fixed interest fund with a bit of everything. Now you have a range of bond funds including index-linked, overseas, corporate bonds, gilts, long gilts and long corporate bonds.” Standard Life’s perception is that the money being used to increase bond weightings is largely coming from cash flow, as trustees are reluctant to sell equities. Welsh, however, sees the core low-risk UK equity portfolio as the asset class most under pressure from the move to bonds as well as from greater diversification. Core equity management can in any case be taken care of through index funds, which also keep costs down.
The UK industry can look forward to a period of significant change and increasingly fierce competition, as market pressure demands new products which are better supplied through pooled rather than segregated solutions, and regulatory and demographic change demand a new breed of asset allocation model.