Working in an unwelcoming environment
Although the pension consulting market is still very small, competition is fierce, Charles Neilan finds
Consultants to the Italian pension sector face the challenge of working in a changing, unwelcoming environment. Nevertheless, competition between consulting firms is high, especially between smaller firms with a foothold in the market and larger international firms that only recently opened up offices.
All three major international consulting firms - Watson Wyatt, Mercer and Hewitt - have set up operations in the past years. They found a situation where small consultants have a large share of the market and are not giving it up to larger competitors.
At the same time, pension schemes and firms are becoming more aware of what kind of expertise larger consultants can offer. A year after the last pension reform, which increased assets under management and members for a number of pension schemes, two effects are evident: the demands of schemes' managers are becoming more sophisticated, and their ability to commit to paying higher fees for consultancy work has also increased.
Fonchim, the 167,000-member chemical workers' pension fund, has just named European Investment Consulting and Mercer as joint consultants to help it select new managers.
"We need to appoint consultants to do the technical work," says Fonchim director Andrea Girardelli. "There is a degree of turnover in the board, which means sometimes board members have less expertise in the technical aspects of running a pension scheme. It is right for the board to have a more managerial role whereas the consultants can help do the technical bit."
Watson Wyatt set up a permanent office in Milan as early as 2002 as it was hoped the reform would kick off the following year. It had to wait for five years for the reform to be implemented but in the meantime the office had grown from two to 12 people, including a team of actuaries, and turnover grew from €200,000 to €2m in the year to end-June 2007.
"In the course of the last three or four years consultancy work for firms has increased, albeit it still is a niche market," says Alessandro Brioschi (pictured right). "At Watson Wyatt we have worked on around 50 projects to help firms set up pension plans. This has been the result of huge effort. We had to convince firms they should hire a consultant. The market is still small, especially in terms of assets under management, and this means the pension schemes' only aim is to keep costs down."
Brioschi outlines the increasingly varied nature of the business: "Work increased especially during 2007. We have worked both with firms that wanted to join a collective pension scheme and ones that wanted to set up their own open pension plan. We work especially with firms whose life is not influenced by trade unions, for instance multinational corporations that have a presence in Italy. We have worked a lot in the retail sector and with international financial institutions, sectors where trade unions do not have an influence."
The sluggish response to last year's TFR reform was to be expected, the consultants say, and the situation is not expected to improve in the foreseeable future given that the market has been "completely still".
While there are many constraints in the sector, when consultants are left to work with firms with a degree of freedom, pension plans have been implemented efficiently, they say. "When firms are able to set up their own open pension schemes, and present a credible communication strategy, employees can make a conscious choice and as much as 50% of them end up joining the scheme," says Brioschi.
Practices in the sector have changed dramatically. Up to a few years ago pension schemes and firms hired academics or small local operations to carry out consultancy work, which underlined the low initial level of development of the sector. "Before we arrived they hired ‘labour consultants' or even insurance brokers," Brioschi says.
The role of consultants is all the more challenging in an environment where governance and conflicts of interests are often overlooked. "You only have to think about the fact that, in some cases, asset managers themselves carry out consultancy work."
He adds: "The regulator, Covip, has tried to tidy things up a bit but nothing concrete has been done. The problem of governance and conflicts of interest is huge. If you look closely at the situation, you could say that pension schemes are partly in the hands of trade unions. Sometimes you find people with a very low awareness of retirement and investment issues on the boards of pension funds. There are some characters who want to keep their seat rather than work for the members of the pension scheme."
This raises the value that consultancies can add. "The added-value we offer can also consists of bringing in governance models that are used in other countries."
However, it is not an easy job in a situation where schemes are wary of overspending. "The problem is that a lot of funds are not capable of using consultancy services, including on the issue of governance. Often we are only requested advice on strategic asset allocation."
Small consultancy firms are holding firmly to their position in the country, as they benefit from having a firm grasp of what has happened in the past within the market.
Ottavio Santoro, founder and manager of Rome-based consultancy Attuariale, recognises that the demands of pension funds have become more sophisticated. "Pension funds want to become more aware of what their balance sheets look like, and sometimes want to run stress tests to see what kind of variables their balance sheets are influenced by. There especially is an increased interest in monitoring liabilities and looking at them as a function of assets when portfolios are revalued."
Santoro set up Attuariale in 2004 after a career in insurance and investment management, to provide several services including IFRS accounting to pension funds, banks, quoted and unquoted firms.
Some of the changes arising from the reform were unwelcome, Santoro says. "A major mistake was the establishment of guaranteed investment lines within collective schemes as they shorten the natural long-term horizon of these schemes."
The decision was political and influenced by the trade unions in particular. A situation was created where "resources are fragmented over different lines when the level of assets is not yet adequate," he adds. "This happens with open pension funds especially. These have seen few people joining them, and opening many different lines of investments means assets for each line are even smaller, which drives up the costs of managing the assets further."
Another crucial point is the short duration of mandates, Santoro adds: "Three years is not enough for a ‘virtuous circle' to be created. It's not enough time to ‘optimise' the investment programme." This, to Santoro, explains the poor performance of Italian pension schemes.
What should the government's aim be? According to Brioschi, the government should take a break now. "In a way it would be better if it did nothing more at this point other than keep promoting the investment culture," he says. "The information campaign the government ran did not have the desired effect. If people keep being told that the law has changed, they will never make up their mind."
However, action is needed to reduce tax rates. This is a real hurdle that still paralyses the market, even for those segments of it that are naturally more receptive - companies' executives, for instance. "Private pension schemes don't provide attractive fiscal advantages to executives during the contribution phase," Brioschi says. "When a firm compares the different options, collective schemes are much less expensive. The added value that open pension schemes offer is overshadowed by their less attractive tax rates, even if firms are keen to join open schemes."
Tax is not only punitive in the contribution phase. Brioschi points out that returns on investment are also taxed heavily. Until this changes, it will be difficult to see more international competition in Italy and more active management.
A low level of assets under management, a focus on keeping costs low and high taxes are pricing out international asset managers. "When the only thing asked of managers is to make 10 bps over a benchmark, you can understand why often international firms don't even participate to bids," Brioschi says. "They can't do any active management which is what they are specialised in doing."