Pensions World

Allison Plager, financial journalist, explores the relatively new, to the UK at least, concept of fiduciary management

Pension scheme trustees’ lives do not get any easier. As well as coping with the myriad regulations that have been heaped upon them over recent years, they have also had to cope with the worst recession in years. Making sure that the pension scheme will have enough money to pay its current and future pensioners has never been more challenging.

Trustees do have help they can call on, for a fee. The traditional pensions consultant is there to explain and advise on various aspects of the scheme, not least investment, but it seems that some trustees need more.

This is where fiduciary management comes in. The concept was born in the United States and has been embraced in the Netherlands over the last decade, but in the past two years has begun to be used by UK pension scheme trustees.

Uncertain path

Pension schemes have always invested for growth, which is fine when the markets are going well. Increasingly, however, trustees realise that they need to match their assets with their liabilities and liability driven investment is a burgeoning area. To do this, trustees need to have a proper understanding of the scheme’s liabilities, which is difficult, particularly given that most trustees are lay and do not possess a deep financial knowledge. Schemes with a professional independent trustee are likely to be in a stronger position, as are those large enough to have an in-house investment team. The latter tend to be major FTSE 100 companies, so it is trustees of medium and small sized pension schemes who are likely to find life most difficult.

SEI’s Ashish Kapoor says that it is less to do with size of scheme, rather that “trustees are recognising that they cannot handle everything and need experts to help them”.

As Ritesh Bamania of UBS says: “The recent pensions roller-coaster ride has caused severe volatility for pension schemes and their funding ratios. Pressure from the Pensions Regulator has also increased, leading trustees to focus on risk reduction while maintaining return potential. Many trustees are now looking for more help than a traditional pensions consultant would ordinarily offer. This can lead trustees to delegate some functions to a fiduciary manager, freeing up their own time to concentrate on the larger risks.”

The idea might be even more appealing for schemes which are closed. Such schemes become a legacy issue for the company concerned and, in some cases, the distant wish may be to prepare the fund for a buyout. Bringing in a fiduciary manager may expedite the whole process.

Who are they?

The market for fiduciary managers in the UK is relatively compact currently. Their pedigree is interesting. Table 1 shows a selection of UK fiduciary managers; some of the names will be very familiar, eg Mercer, Hewitt, UBS, while others less so, for example, SEI and Mn Services. As the table shows, some consultants have set up a fiduciary offering, as have some investment managers. Then there are the specialists who only offer fiduciary management. But what exactly does a fiduciary manager do?

Terry Ritchie of Capita Hartshead likens the role of a fiduciary manager to that of a project manager: “He manages the whole portfolio, for example, he can change investment managers or investment weightings without consulting the trustees. He has more scope than a traditional consultant, and can make decisions quickly, although there may be parameters set by the trustees.”

Bearing in mind that the market for fiduciary management is relatively young in the UK, Mr Ritchie notes that pension trustees are interested in it, but want to understand what it is: “inevitably fiduciary management will not appeal to all trustees, as some may not be comfortable effectively passing the responsibility of the scheme’s investment to someone else”. But he adds that it is up to the trustees how much of the investment portfolio to pass to the fiduciary manager, “they can give him a proportion to see if the arrangement works satisfactorily”. Likewise, Mr Gwion says that fiduciary managers “offer a range of services, so trustees can choose what they want”.

Recognising trustees’ potential concerns about control, Mr Bamamia says “It’s an education process: trustees are worried that they will lose control of the pension fund if they hand over the management of all pension investments to a fiduciary manager. We address this concern in our model by clearly identifying roles and responsibilities of both parties at the outset and keeping trustees informed on the development of their funding ratio.”

What do they do?

Effectively the fiduciary manager takes over the investment of the pension scheme from the trustees (Table 2). They make the decisions about when and where to invest the assets. Ultimate responsibility remains with the trustees, so it is very important to choose the fiduciary manager who meets the requirements of your scheme. As Gwion Moore of Mn Services says, “fiduciary management is not an investment service per se; rather it is a governance service which aims to improve trustees’ control over the scheme”. He explains that the fiduciary manager “takes over the relationship with third party investment managers” and, while the manager works with other advisers appointed by the trustees, his objective is to “turn advice into action”.

The idea is to offer trustees a fuller service than, say they would receive from an investment manager who may only deal with one aspect of the pension scheme. As UBS’s Mr Bamania explains “asset managers, such as ourselves, are enhancing their offerings from purely traditional products to more comprehensive solutions. This requires an asset manager acting as a fiduciary manager to have a much larger involvement with the trustees compared to a traditional asset manager. The fiduciary manager will devise and manage a solution in line with guidelines agreed with the trustees. The aim is to use return-generating assets to outperform liability returns, ensuring that the pension funding ratio improves. This strategy has to be dynamic so as to allow for market fluctuations and, in the worst case scenario, market crashes.”

Trustees usually meet only two or three times a year, so their decision making on any matter is inevitably protracted. Mercer’s Dan Melley suggests that bringing in a fiduciary manager passes the investment decisions over to “experts who deal with investment issues every day”. He compares the situation to a company board which has ultimate responsibility but appoints others to implement strategy.

An expensive option?

Are fiduciary managers really worth the money? Mr Melley says that trustees should consider the total cost rather than just the fiduciary manager’s fees. “Trustees normally pay a consultant and often an investment consultant, as well as the fees of the investment managers. A fiduciary manager should be able to reduce the investment management fees because of the economy of scale, so overall, the total cost should not be that different.” As Mr Bamamia explains:

“A fiduciary manager is in a good position to negotiate rates with investment managers because he is likely to be dealing with the same manager on behalf of more than one pension fund.”

Trustees have to decide on the fiduciary manager. The selection process can be carried out in much the same way as for individual investment managers, most likely with the help of a consultant, thus giving trustees the opportunity to obtain a full picture of the various offerings and cost.

When it comes to cost, fiduciary managers can be viewed as expensive, so says Mr Ritchie: “It is important to check like for like. Trustees need to look at the services offered by each manager and decide whether they will add value. They should be clear in their own mind as to what their objectives are, which is why it can help to use a third party to help with selection. This might add to the cost, but the third party will have a good understanding of the differences between the various fiduciary managers.”

Illusion of comfort?

It is important that trustees ensure they are getting value for money from their fiduciary manager. For example, Simon Jagger of Jagger Associates says: “We have been asked to evaluate the likely fees for some cases if they were being done via the traditional approach, to contrast with the fiduciary management route. It has proved very difficult to see how consultancy plus even quite active asset management could be worth as much that charged within the fiduciary wrapper service. Trustees really need to think if it’s worth it, or whether they are just being sold a marketing line under an illusion of comfort.”

Then there are the niggling doubts as to whether the manager chosen is performing as expected. However, as Mr Melley says, “in a traditional advisory relationship no one monitors the adviser”, so it is necessary to appoint yet another party to check the fiduciary manager. On the whole, trustees tend to say it is their job to make sure the adviser is satisfactory. Mr Ritchie reflects this saying: “You don’t appoint another consultant to check the scheme’s consultant is doing a great job. Trustees have to trust and believe in their own due diligence in appointing the manager.”

It will, furthermore, be clear if the fiduciary manager is not doing a good job, says Mr Kapoor, based on the funding level of the pension scheme. If it rises, he will be doing well, and vice versa.

Benefits

It remains to be seen how quickly or not trustees take to the idea of fiduciary management. However, in a time of constant regulation and increasingly complicated investment techniques, someone who is prepared and has the skills to take over the pension scheme’s investment would be a useful addition to the trustee’s armoury. Mr Melley says that trustees “tend to take some time to get comfortable with the idea of passing over responsibility for investment”, but his experience is that the use of fiduciary management is growing.

Trustees who are overwhelmed by the whole investment aspect of their pension scheme may welcome the idea of appointing a manager who will do all the hiring and firing of investment managers, deal with risk, watch the market and make all their investment moves for them.

Allison Plager is a financial journalist; allison.plager@lexisnexis.co.uk