INVESTMENT Gaining strength
There are several good reasons why fiduciary management is growing in popularity, explains Pieter Steyn, Willis Towers Watson
- for schemes that do not have in-house capabilities, the fiduciary management model is a means of filling the gap between the resources required to run efficient investment strategies and the typically constrained governance budget of a pension scheme
- the fiduciary manager implements an investment strategy within boundaries set by the trustees, allowing high level decision-makers more time to focus on key strategic issues and long-term scheme goals
- the concept is fairly simple, but the implementation can be less easy to visualise; for this reason, it is worth reviewing a few good reasons why one should look closely at fiduciary management.
The use of fiduciary management by resource constrained UK trustees has increased over the past decade, despite fiduciary managers being in the firing line of many industry figures, perhaps because the case for fiduciary management to the objective bystander may seem rather obvious.
Fiduciary managers are investment specialists. Trustees are well-intentioned, prudent people, primarily chosen to represent stakeholders, routinely considering packed agendas at their (typically) quarterly meetings. Fiduciary managers are investment professionals without such constraints on time or resource. Trustee agendas are also getting more complex. Consider the sheer number of investment decisions required to cover just the main investment risks which schemes are exposed to and it is no wonder that the average scheme is struggling. The fiduciary management industry evolved to offer a better solution and outcome for schemes. Trustees can access professional investment decision making and implementation support from a selection of organisations with the requisite skills and resources, which then alleviates their busy agenda to keep trustee investment focus suitably strategic – the level at which trustees, professional and amateur, can add real value. Conceptually, therefore, it is a much stronger model. Outcomes for schemes with fiduciary managers also appear very strong versus the average scheme.
The trouble is that system change is hard and, if decision making is the issue in the first place, it is no surprise that the uptake of fiduciary management has been slower than perhaps it should have been. One might also suspect there is more to it. The current fragmented model allows for lots of separate fees (consulting and legal) and spheres of influence, both of which are extremely difficult things to let go of. The case for greater collaboration in the Local Government Pension Scheme was a complete no-brainer, but the government still faced opposition in pushing it through. The question is whether the recent disastrous falls in funding levels warrant the consideration of a more robust approach, for the sake of all stakeholders. Fiduciary management is the means by which schemes without the scale to build a first class team can improve investment governance.
The concept is fairly simple, but the implementation can be less easy to visualise. For this reason, it is worth reviewing a few good reasons why one should look closely at fiduciary management.
It is not very expensive
It is understandable that some consider it expensive. After all, schemes are asked to spend more money on a service that was previously a relatively small part of the annual budget. However, in aggregate across the scheme, employing a fiduciary manager does not mean that costs rise, and they often fall. Why is that? It is because a fiduciary manager commands the scale and has developed the partnerships to source investment management and other services more cheaply than schemes can do alone. In addition – and most importantly – outcomes for scheme sponsors and members often improve as a result of professional risk and return management.
It is not simply a matter of luck
Outcomes experienced by pension schemes that have hired fiduciary managers have been markedly better than those for the average UK scheme. Comparative data over the past seven-year period shows funding outcomes of fiduciary management schemes in the UK very substantially outperforming the average scheme and also displaying much lower funding level volatility. Some pensions industry participants argue that fiduciary managers got lucky because they hedged liabilities – principally, interest rate risk – just as yields slumped. As a result, the growth portfolio has served to improve their funding levels, rather than offset losses in hedging portfolios. Is this really luck? Certainly, fiduciary managers hedged liabilities at just the right time, but they also considered a range of risks that schemes face across their life cycles and interest rate risk was just one of them. The fiduciary management schemes underwent a professional risk management process and identified interest rate risk as one of many risks that needed addressing. It is interesting to note that while liability hedging techniques, such as swaps or specialist liability driven investment funds, have been widely available for a number of years, many schemes have yet to adopt them.
It can work for a variety of sizes
If only smaller schemes used fiduciary management, not as many multi-billion dollar schemes in the UK and US would have a fiduciary manager. The model is less about size and more about how feasible it is to build sustainable in-house resources to cope with the considerable demands of institutional portfolio management. Sometimes resource is allocated from the sponsor’s finance function. Although this can appear a natural fit at first glance, many corporates have discovered that finance professionals are not always best suited to assessing risks within an investment environment. Also, finance functions today are often shared services, so allocating individuals to the pension scheme can leave the function short of resources. Of course, the very largest schemes have the option of developing an in-house team and some have exercised this option. But for most other schemes, fiduciary management is likely to improve their investment governance.
It is becoming more mainstream
A multi-asset approach to managing pension scheme portfolios is nothing new. However, across the industry the multi-asset approach is often implemented through a range of specialist mandates. This is unwieldy, as it requires a high level of governance on the part of the scheme. In the outsourced model, governance is considerably strengthened and mandates can be reallocated in good time to take advantage of changing market opportunities. In the UK and the Netherlands, fiduciary management has been a feature of the pensions landscape for more than a decade, and outcomes have been demonstrably strong.
It is an aligned model
Critics argue that fiduciary managers are conflicted because they profit from their position as both adviser and investment implementer, but there is surely a distinction to be made between incentives and skewed incentives. A good service will always command a fee. In the fiduciary management model, schemes may pay a service fee and, perhaps, a performance fee too. Fiduciary managers will only retain these mandates if they perform, so schemes can be fairly confident that fiduciary managers will try their best to deliver the desired outcome for the scheme and its members. If the perception of a conflict persists, this is not necessarily a reason to jettison a service that is potentially highly beneficial to the scheme – this turns a win-win situation into a lose-lose one. In the case of the fiduciary management model, there are a number of intermediaries – professional services firms and individuals with the specialist skills to understand the products, the incentives and the potential conflicts – that can help with assessment and benchmarking.
It leads to greater control
Some fear that if you hand some of your decision making to a specialist, you are no longer in control of your scheme and of investment outcomes. Delegating investment does not mean giving up. Trustees still control the objectives and the constraints within which the delegate operates, such as which asset classes are selected, and potentially the hedge ratio, cost budgets and liquidity. In fact, because the fiduciary manager has greater resource and expertise, trustees can instruct fiduciary managers to do things trustees may not have been able to do within existing decision structures.
If circumstances or needs change, trustees and scheme sponsors still have the power to change the objectives and the constraints to which the delegate is working. In addition, the trustee or scheme sponsor is fully responsible for the oversight of investment activities. Importantly, the time freed up allows focus on what really matters: funding, overall risk, stakeholder equity, conflict management and all the other activities that help to keep members happy.