Manager
Selection
Always a fine art, volatile times have underlined
the importance of careful manager selection, reports Christopher Andrews
Pension scheme trustees are generally a cautious lot,
and recent market conditions have made them even more so. This is fair
enough, as any sort of sustained good news concerning the investment universe
seems a distant memory. As a case in point, at the beginning of 2009
the OECD published its Private Pensions Outlook 2008 report, which estimated
that losses in private pension assets in the year to December 2008 had
increased to $5.4 trillion, up from $5 trillion in October. The average
pension fund, the report found, had realised a negative rate of return
of 23 per cent over the year.
The findings dovetail with a recent report from the European Fund and
Asset Management Association which found total European investment fund
assets falling by 22 per cent in 2008, or a whopping EUR 1,768 billion.
Pension scheme trustees therefore can be forgiven for adopting a more
cautious attitude generally, and specifically in terms of their selection
of fund managers. Many schemes have been wary of making any major portfolio
changes during this extended period of high market volatility, and have,
understandably, not been overly keen on proceeding with manger selection
undertakings.
However, this initial cautiousness is at last being replaced by action
and pension funds are starting new searches, says Sam Gervaise-Jones,
director of business development at bfinance. "And a key consideration
for trustees has been to ensure that they are reviewing as broad a manager
universe as possible which will allow them to appoint managers most suitable
for the current market circumstances," he says. Although trustees
may be starting new searches, this increased caution remains, which is
resulting in a substantial increase in demand for due diligence to be
undertaken.
While in the past trustees may have been more relaxed about relying on
RFPs and consultants' advice, says Rick Di Mascio, CEO and founder of
Inalytics, they are now looking for increased evidence of the manager's
skill, as well as increased transparency, before agreeing to fund that
manager. "The whole process of due diligence has changed considerably
in the last two years," he says. Generally the level of analysis,
in terms of how trustees, consultants and managers look at performance
numbers, has been on the increase for the last five or six years, according
to Guy Davies, director, portfolio management at FundQuest. However, like
Di Mascio, he believes that there is now an increased emphasis on operational
due diligence, looking qualitatively at the management team and the processes
it has in place and that these make sense within an overall investment
strategy. "It's about making sure that a manager stacks up from a
due diligence perspective. So looking at operations, the stability of
the organisation, the stability from a financial perspective and so on."
In addition, Gervaise-Jones says that he has observed trustees paying
greater attention to the alignment of interests between managers and the
pension fund. This includes checking whether fund managers have their
own net worth invested in their funds, and paying more attention to the
stability of the manager's organisation and that of its parent company.
The Madoff question
Calls for more transparency are nothing new, but arguably in the past
if a fund was making money they became somewhat muted. Bernard Madoff,
and his alleged international pyramid scam, is a good example of why this
isn't the best approach, and trustees can no longer afford to remain silent
– not that they ever should have. Questions need to be asked. "I
think that two years ago if trustees were getting the returns they were
more than happy, says Di Mascio. "People now really do want to know
what their managers are doing with their money and all the skills that
they have. Proper due diligence and transparency would have prevented
people from investing with Madoff."
Davies agrees that there will continue to be a greater emphasis on transparency,
in terms of the investment manager, as well as on processes, the overall
investment team and the portfolio itself. He believes it necessary to
go through a rigorous qualitative, quantitative and due diligence assessment
before choosing a manager, and that there should be very clear responsibilities
and undertakings at each point of the process, providing a clear audit
trail.
Once the selection is made, says Davies, managers and portfolios must
then be monitored. "Combinations have to be monitored relative to
established guidelines and objectives, in isolation and within an overall
structure. This is an area that has been focused on and will continue
to be focused on.”
This is probably not something that the average trustee board would be
able to carry out on its own, according to Michelle McGrade, chief investment
officer at Investment Solutions, who suggests some boards lacks both the
time and potentially the expertise to do so. "I don't think transparency
is what people really need anyway," she adds, as the average trustee
isn't necessarily going to be able to work out if there is fraud taking
place in a portfolio by getting copies of the portfolio. As such, she
believes trustees should be focussed less on transparency and more on
basic disciplines; such as site visits, meeting members of the investment
team, as well as perhaps members of the risk team or upper management.
"And we also like to have an office tour, which may seem like a soft
thing but is not something you would have got with Madoff," she says.
"I think in the heydays when markets were going up, some of these
disciplines were forgotten about. They may be small things but you learn
quite a lot by going on site and just nosing about."
Manager consolidation
Another factor that trustees need to consider is whether their manager
is going to be able to ride out the storm, and how their product offering
is being affected by current market conditions. McGrade points out that
we've already seen some consolidation among companies, and some firms
closing down units and consolidating their products. This, she believes,
is set to increase.
Davies agrees, and says that both product consolidation and firms exiting
the market altogether will increase over the next 18 months. Therefore,
trustees need to consider risk within the investment management firm itself,
and whether or not it could or should be considered an ongoing concern.
"In terms of product offerings," he says, "when we've seen
markets drop by upwards of 50 per cent in certain areas over the last
year, profitability has been squeezed, and as a result product lines will
be rationalised. In a similar vein, there will be new products being launched
as well, and new ways
of using scale to continue to offer a broad range of investment strategies.
I wouldn't be surprised
if the number of guaranteed products or strategies in the market increased
over the next 18 months."
Trustee considerations
While we may see new product offerings coming to market, for trustees
selecting managers now there are a number of areas they should consider
to ensure their choice is the best option and they get the best out of
their manager. Davies says that trustees should take advantage of the
information that a quantitative analysis can provide, and be aware of
what general news flow is providing. He also says to make sure that "the
tyres are kicked" checking that the qualitative aspects stack up,
that the right questions are asked and that the operational due diligence
is there. "And as an overarching theme, make sure that there's a
clear audit trail, so there's clear rationale for decisions that have
been made."
Gervaise-Jones says it is important to have a comprehensive overview of
the manager and
the products in which they invest, reviewing not only the manager's performance,
but also taking account of the organisational structure, the team of managers
who will be looking after funds and the overall financial health of the
firm.
WRITTEN BY CHRISTOPHER ANDREWS,
A FREELANCE
JOURNALIST
