By definition Fiduciary Management (FM), ‘an investment governance solution that involves the trustees delegating certain elements of the investment process to an investment expert – the fiduciary manager1 (FM), is designed to help and support asset pools to become more effective in their investment arrangements through the use of outsourcing.
There are currently around 10-15 bono fide commercial fiduciary managers in the UK. These range from boutique investment houses and large asset managers that offer bespoke solutions, through to investment advisors that have flipped their business models to generate flows from existing advisory clients.
The sector’s “sweet-spot”, and when it becomes appealing to outsource, is where Assets under Management (AuMs) of sub-£1Bn are being run and DB schemes that might have a funding deficit, but do not have the resources to adapt or implement the investment strategy and associated portfolio. By offering a target return to a manager, that headache goes away – at a cost.
There is another type of Fiduciary Manager, which is less explicit - Organisations that have set-up internal investment management teams that run assets for multiple pension funds or sections. Clearly, they have a mandate set by stakeholders to use their size to deliver value under fiduciary duty. Commercial imperative is not the goal here, but being cost effective is.
Outsourced Chief Investment Officer (CIO)
So what exactly is being outsourced and what is retained? The notion of an “Outsourced CIO” has become more prevalent in recent years, and it should do exactly what it says on the tin. This would include the intricate investment decisions made through the investment process, including manager selection. Largely all the activities that would be actioned by a large internal team.
For sure, this would give smaller funds the buying power, access to resource and skill that would not be otherwise available to them. This becomes relevant when tapping into illiquid asset classes such as Private Markets, where skill and expertise are in short supply. The manager will use its size, scale and ability to incrementally add new strategies that small funds simply cannot. In fact some managers offer a ‘sleeve’ of the portfolio that may be outsourced, rather than taking the whole ‘jacket’.
But what is retained with the fund? If it’s full outsourcing, very little. Just the Board that looks in on the fiduciary manager in an oversight capacity.
It all sounds like a partnership that resolves many problems in the ever complex world of investment management, but does it work? By having a proxy internal team, can the manager, deliver value?
Demonstrating value
From our research and experience, large internal teams do indeed correlate with being cost effective. That means they take out the cost of paying for complex external mandates, in particular, the largest cost line items such as multi-manager mandates or fund of funds.
From one study2, the level of internal management had the largest impact on the number of investment full time equivalents (FTEs) in the organisation and on costs. More internal management resulted in more FTEs but lower costs, because internal management is much lower in cost than external management. For every investment front-office FTE, there were approximately 1.7 governance and back-office FTEs. Funds with more internal management performed better after costs. Use of internal management increased with fund size. So far so good.
The manager must be able to demonstrate that it can offer the findings outlined above at a price. Meaning it can deliver the performance cost effectively – i.e. ‘it is ok to pay more provided you get more’.
The critical twist for fiduciary managers, commercial or otherwise, is are they better at this than the next guy? A lot of good analysis, graphs and presentations will be put forward, but is there any independent verification?
What next?
Trustees, pension managers and wider pension fund stakeholders are becoming more astute at what they want from outsourcing. Big Four consultancies provide services that nudge clients into review and assessment of managers – some objective, some subjective.
The only true measure of future success could be measuring manager cost-effectiveness at a peer group level. Surely everyone would be happy to do that.
Wouldn’t they?
Tej Dosanjh, MBA, Director at CEM Benchmarking
1 EY definition of 'What is Fiduciary management?'
2 CEM whitepaper 'How large pension funds organise themselves'
