Debbie Harrison examines this latest US incursioHistorically, small to medium sized pension funds in Europe have had a restricted choice in their asset management strategy ranging from insured contracts to one, or at best two balanced managers. Following a period of disappointing results in most markets, the 1990s witnessed a rash of new appointments, many of which proved both disappointing and costly.
A recent survey carried out by the Financial Times and Westminster Business School* discovered that among UK trustees, almost half (47%) were not happy with the performance of their pension fund. Of this group, there was a greater proportion of dissatisfaction among trustees of smaller schemes (£0-50m) (E81m), a feature common to other European markets. The survey showed that these funds share several important characteristics:
o They are likely to employ only one asset manager;
o They are unlikely to have changed their manager in the last five years;
o They do not receive reports from an independent investment monitoring service;
o They are looking for an improvement in the monitoring of their asset management arrangements, and
o In some cases, they would prefer an expert to implement the asset management strategy.
Trustees have found that with a traditional structure of one or possible two balanced managers, keeping the performance on target is a hit and miss affair. After all, investment managers and markets, sectors and styles are all unpredictable when examined in isolation. Arguably, therefore, any asset management model which relies on certain managers, sectors and styles being in favour at any particular time is fundamentally flawed.
Moreover, experience demonstrates time and time again that there is a strong likelihood trustees will sack the manager whose performance is just about to improve, and hire the manager whose performance is poised to plummet.
Pension funds keen to break out of this vicious circle must also recognise that not all underperformance is attributable to poor investment management. Losses frequently occur as a result of ‘implementation leakage’. For example, trustees may expose the scheme to inappropriate style bias, take too long to fire a poor performing manager, and mis-manage the process of transferring the fund from the old to the new managers. Such losses cannot be avoided simply by changing the manager. It is equally important to look at the processes.
One possible answer to some of these concerns is multi-manager, multi-style services run on a pooled ‘manager of managers’ (MoM) basis, where the trustees out-source to the provider the responsibility for hiring, monitoring and firing the managers. Although MoM carries an extra up front cost (see box below), where the provider manages the implementation process and carries out professional transition management, long term costs can be reduced significantly and performance maintained throughout the transition period. Unlike in the US, here in Europe transition management is an under-utilised service although gaining acceptance.
Pension practitioners tend to either love or hate the concept of ‘manager of managers’, affectionately known as MoM in the US. Proponents argue that this is the state-of-the-art as far as asset management structures are concerned. Critics retort that MoM is an American gimmick which is over priced, over engineered and over here – and as such should be sent back to the other side of the pond as soon as possible.
The FT’s report challenges the critics’ view and suggests that MoM is a robust product which can cope well with short term volatility and provide satisfactory long term results for European pension funds at a competitive cost. As such it may well be a solution to the very serious concerns about the investment risk which defined contribution (DC) schemes place on trustees and, in particular, on individual scheme members.
Of course, the fact that providers of multi-style and MoM structures are successful in the US does not automatically open the door to European pension fund markets. Adaptation will require more than slick marketing. In the UK, for example, MoM needs to be placed on a firm legal footing and within a sound regulatory framework which formally allows trustees to outsource the job of appointing the asset managers. This may require an amendment to the Pensions Act 1995.
So, which organisations have entered the brave new world of multi-manager, multi-style manager of managers services? The most active players, or would-be players, formed a professional body in January – the Association for Multi Manager Investing (AMMI)**. The group currently comprises Northern Trust Global Investors (NTGI), whose managing director Tony Earnshaw is chairman, Frank Russell, GAM, SEIC, Stamford Associates and William M Mercer.
MoM providers currently fall into three broad categories:
o The simplified version uses just one manager per asset category, so it is not multi-style. The best example of this is the William M Mercer’s Flexifund which was originally designed by Sedgwick Noble Lowndes before the take-over. Mercers is also about to announce its decision on whether it intends to develop the existing product and enter the MoM market more fully.
o Multi-style MoM on a consultancy basis is offered by Stamford Associates.
o Multi-style MoM as an institutional asset management product (where the provider holds the assets under management) is offered by Frank Russell, NTGI, and, from mid-2000, SEIC. Frank Russell’s product for Continental Europe incorporates consultancy, including asset liability modelling. SEIC is sticking purely to the asset management product, while NTGI is debating which of these routes is most suitable for its launch into Europe later this year.
o Multi-style MoM as a retail product. Global Asset Management (now owned by Union Bank of Switzerland) offers MoM to a small number of pension funds but its primary target is very wealthy individuals. In the UK Skandia offers MoM funds in the mainstream retail market.
As far as multi-style is concerned, the progressive investment consultants include Stamford Associates, Watson Wyatt, Mercer and Hymans Robertson. Stamford Associates is alone in this group in running a full MoM service at present. With Stamford, the trustees have the right to veto the arrangement but do not otherwise get involved with the manager selection.
Watson Wyatt’s sophisticated structured alpha service relies on trustee involvement at present but could easily be developed into a MoM if the consultant decides to go down this route. Stamford and Watson Wyatt operate on a performance-related fee basis. Both are proving instrumental in extending the boundaries of ‘hands-on’ investment consultancy.
Frank Russell is one of the earliest asset manager MoM providers in the UK market and recently established a venture in France with Société Générale. The company uses multi-asset, multi-style and multi-manager on an active basis, so this is different from the passive core/active satellite structure favoured by Watson Wyatt and Mercer. Russell argues that this approach reduces the funds exposure to every risk except the management of stock-specific risk – which is, after all, the chief skill of the asset managers.
The company reckons that for a £50m pension fund the overall cost typically would be 60 basis points (0.6%). Clearly this is higher than that of a single manager, which might only cost 30-40 basis points. However, Russell argues that this represents good value considering that it secures access to 24 specialist managers, asset allocation and rebalancing within the price.
In the UK, the company runs an investment consultancy for larger segregated clients but its main source of fee income is a separate pooled manager of managers company for smaller funds.
Cash is ‘equitised’ to ensure funds are invested as fully as is practical – a technique used by other providers with a US background. This involves buying futures to gain an equity market exposure. The company states that this can add significantly to annual performance.
Cash flow is also used to adjust allocations across managers to minimise rebalancing costs. Russell believes this is the sort of issue that can slip through the cracks with core/satellite and balanced fund structures because, as Russell put it, “The consultant doesn’t have the discretion, the trustee doesn’t have the know-how and the asset manager doesn’t have the desire.”
Until recently, there has been a distinct lack of competition in the MoM market, which, in itself, has proved discouraging for trustees.
This is partly due to the fact that most mainstream UK consultants have tended to rule out the launch of what they believe is essentially an asset management service. In fact MoM combines investment consultancy and asset management skills. To try to pigeonhole it as one or the other misses the point entirely.
NTGI is a more recent entrant to the UK market and is preparing to launch its MoM service in Europe. In the mid-1990s, Northern Trust bought R C B International – an asset manager which had already developed what is thought to be the first manager of manager services in the US back in 1977. Following the acquisition, NTGI developed a pooled multi-style, manager of managers service. Originally, each of its UK funds were unauthorised unit trusts but to ease access to the European pensions market NTGI is changing its core fund structure to a Dublin-based variable capital company (VCC – similar to an open-ended investment company).
The company won the first UK multi-manager beauty parade for Rohm and Hass, knocking out Frank Russell and Global Asset Management in the process. In fact, Frank Russell lost the contest together with its previous position as consultant to R&H, which went to Mercers (see panel).
NTGI takes a more pragmatic view of style management and style blending than Russell and SEI. The company believes styles can be over-regulated and has adapted the strict US methodology of managing style drift to the UK market where managers tend to have a style bias rather than a very formal parameter. This means that NTGI’s managers are permitted a degree of flexibility.
SEIC, like NTGI, is looking to market an asset management strategy in Europe, not a consultancy service. It established a presence in London in 1999 and is currently engaged in building up its team and designing its products for the UK and Euro-pean pensions markets. While its ultimate goal is to sell directly to institutional clients it is also looking at ways to establish a third party arrangement with intermediaries in the pensions market.
The big question now is whether the growing manager of managers movement will encourage – or indeed force the hand of other traditional UK consultants. Watson Wyatt is believed to be ready for MoM, should it decide this route is appropriate but Towers Perrin and Bacon & Woodrow, among others, are still sitting on the fence.
Debbie Harrison is a financial journalist
* This article is based on a new Financial Times Management Report, ‘Competitive Multi-Manager Structures – Primary research and analysis for UK pension fund trustees’
** For details about the Association of Multi Manager Investing group (AMMI) contact Tony Earnshaw at NTGI on +44 171 675 8104