Pension Funds Online

Fiduciary Management: The Governance Solution for your Pension Scheme

For many UK defined benefit pension schemes, the past decade has been characterised by high levels of investment volatility, but ultimately disappointing returns. This has led to a renewed focus on the governance of the investment process for pension schemes.

Following the 2001 crisis, fiduciary management has been adopted by many schemes in the Netherlands. Similar models are also common in the United States and Australia. Fiduciary Management is a holistic approach to the management of pension assets with the key objective to enable the scheme to achieve its strategic objective. In the model, the fiduciary manager helps trustees define a clear investment strategy, implements, monitors, and manages investments in accordance with that strategy, and is also accountable for the results relative to the investment strategy.

Current Governance Issues

Trustees are ultimately responsible for all decisions, strategic and operational, of the pension scheme. Focusing on investments and ignoring all other aspects of scheme design, administration and various legal and regulatory duties, trustees are responsible for:

·         Setting a funding objective and investment strategy that balances the interests of the different pension stakeholders and the liabilities of the scheme.

·         Deciding which asset classes to invest in and how to maximise the trade-off between risk and net-of-fee return in each asset class.

·         Deciding whether, and if so, how to implement a derivatives overlay portfolio to hedge currency, interest, and inflation rate risk in a risk-controlled manner.

·         Deciding if and how to dynamically manage the portfolio to take advantage of opportunities and protect against emerging risks.

·         Deciding how to manage the scheme’s cash position to meet the liquidity requirements for pensions in payment, margin and collateral calls, and capital commitments, while minimising the cash drag on performance.

·         Ensuring cost-effective safekeeping of the scheme’s assets and minimising the tax drag of withholding taxes.

·         Deciding whether and, if so, how to generate additional income through securities lending in a risk-controlled manner.

·         Setting and implementing a policy on socially responsible investment and corporate engagement, including voting.

·         Monitoring investment risk and performance and adjusting the investment strategy and/or implementation of the strategy accordingly.

·         Reporting on the scheme’s performance to members.

Trustees generally don’t have the time or the specialist expertise to decide and manage all these aspects independently. In the current model, trustees have tried to solve this problem by retaining investment consultants to help them set investment strategy and to select asset managers for specific parts of the portfolio. There are several problems with this model, however:

·         Because investment consultants provide independent advice, but are not accountable for the results, their advice tends to be static, reactive, conservative, and ambiguous. Investment strategy should be dynamic, should reflect the funding level and should take advantage of medium term scenarios, temporary opportunities and emerging asset classes.

·         For the same reason, manager selection advice tends to focus on selecting the manager with the best historical investment performance, rather than operational due diligence, negotiating competitive fee structures, verifying that tax drags and custody costs are minimised, that securities lending takes place properly, that securities lending revenues benefit the client, and that trading commissions are recaptured where possible.

·         While selecting the best possible manager for each part of the portfolio is in principle a sound approach, who ensures that all the parts that are managed by specialist managers fit together into a consistent whole that complies with the investment strategy and who is responsible for coordinating the actions of the specialist asset managers? Even if the trustees have delegated tasks to an investment committee and even if that investment committee meets on a monthly basis, it tends to take trustees several months to make a decision. If a decision takes that long to make, let alone implement a decision, then you are not really in control.

Fiduciary Management: Towards Better Governance

Like an investment consultant, a fiduciary manager provides strategic investment advice. But unlike an investment consultant, a fiduciary manager also takes responsibility for the advice given. Because of this accountability, a fiduciary manager takes a holistic approach to implementing a scheme’s investment strategy. Rather than allocating all risk to equity and focusing on selecting the “best manager”, the fiduciary manager aims to diversify risk across many more asset classes, to select the “best portfolio” of managers and to negotiate the best possible investment management agreements and fee structures for the scheme. In addition, the fiduciary manager takes a dynamic approach to implementing the investment strategy to reflect medium-term economic scenarios and the funding level. The fiduciary manager also ensures that the overlay portfolio cash position are coordinated with each other and with the underlying assets and liabilities and that all types of risk and performance are monitored and managed continuously at all levels in the portfolio, a fiduciary manager also ensures that custody is organised properly and cost-effectively, that securities lending fees benefit the scheme at an acceptable level of risk, that withholding taxes are reclaimed to minimise the tax drag, and that trading commissions are recaptured to the extent possible. And finally, a fiduciary manager reports back to the trustees on an integrated basis at the level of individual managers, asset classes, the asset portfolio, and the balance sheet as a whole.

In short, a fiduciary manager enables trustees to be in control. Like an in-house investment team, the fiduciary manager advises the trustees on the strategy and then implements the strategy that is set by the trustees and is accountable for its actions. At all stages, the trustees decide what tasks are delegated to the fiduciary manager and to what extent. Given that mandate, the fiduciary manager then engineers the best possible solution by working with and coordinating the work of the service providers, whether those are selected by the trustees or the fiduciary manager. As such, the fiduciary manager is neither an investment consultant nor an asset manager, but an investment network company that specialises in building and maintaining an integrated solution that is tailored to the scheme. The fiduciary manager can be counted on to deliver the best possible solution for the scheme, because its fee can be linked to the scheme’s strategic investment objectives, or even better, because the fiduciary manager is owned by some or all of its clients with the sole purpose of providing the best possible investment solution.

Some will think that fiduciary management, while a good idea, may lead to higher costs by adding yet another layer of management. Nothing could be further from the truth. First of all, ‘cost’ is not the appropriate metric for a pension scheme: the appropriate measure is the scheme’s net total return on a risk-adjusted basis relative to its strategic investment objective. On that metric, fiduciary management has three positive effects:

·         Lower fees and expenses

Firstly, the fees of a fiduciary manager should be off-set against its cost savings in terms of fees for investment consultancy, manager selection and transition management, asset management, custody and administration and lower tax drags. Even on the cost aspect alone, fiduciary management is often more cost effective than the current cost structure of a typical pension scheme.

·         Higher expected returns

Secondly, the fiduciary manager should be able to increase expected returns by improved diversification across and access to asset classes and managers, dynamic portfolio and risk management, integrated cash management, securities lending, and commission recapture.

·         Lower expected risk

Finally, the fiduciary manager should be able to reduce risks relative to the scheme’s strategic investment objective by improving diversification across asset classes, managers, and counterparties, and by continuously managing these risks on an integrated basis. A fiduciary manager takes away the hassle of important, but operational details, resulting in real and meaningful control by the trustees.

Of course, the degree to which a fiduciary manager will be able to deliver these benefits will depend on the fiduciary manager’s economies of scale, business model, and its alignment with the interests of its clients. For example, if a fiduciary manager’s interests are truly aligned with those of the client, then a fiduciary manager will only select active management if the fiduciary manager truly believes that the active manager, after fees, adds value relative to passive management. And, of course, a fiduciary manager whose clients have combined assets of GBP 50 billion will be able to negotiate better fee structures and has better access to the best managers than a fiduciary manager whose clients have combined assets of GBP 5 billion.

In conclusion, fiduciary management offers fundamental benefits when compared to the current investment consultant – asset manager paradigm. Fiduciary management takes a holistic approach to managing the scheme’s assets relative to its liabilities, in order to achieve the trustees’ strategic investment objectives while allowing trustees to retain full control. Ultimately Fiduciary Management provides a client focused, cost efficient solution that offers significant value add, while achieving a sharing of the pains and gains involved in pension management through ownership, fee structure, or both, and should at the least be a consideration of the majority of UK DB schemes.

Biography of Colin English

Colin English (1955) joined Mn Services in February 2009 as Head of Business Development of Mn Services Investment Management UK and is responsible for the promotion and development of Mn Services’ fiduciary management activities in the UK.

Colin has built a career within the UK Financial services arena, primarily working within actuarial, pension and employee benefit consultancies and specialising in business development and client management roles.

Key positions held by Colin during the past 20 years include Head of Business Development in the UK for both Towers Perrin and at Mercer, as well as being co-founder of a niche pension and employee benefit consultancy. Colin has assisted many major UK companies address challenges and issues in relation to pension and employee benefit matters. Colin’s career commenced in the insurance field, spending a decade working for Sun Life Assurance prior to joining Noble Lowndes and Partners. Colin qualified as a Chartered Insurance Practitioner in 1995.

Mn Services has been managing pension assets since 1947 and is a leading fiduciary manager, supporting more than 20 pension schemes with combined assets of GBP 50 bn. in achieving their strategic goals. Mn Services is wholly owned by pension schemes that are its clients.