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Wednesday 16 October 2019

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Taking the reins

Written by Sandra Haurant
October 2011

Sandra Haurant explores the benefits delegating to a fiduciary manager can provide for trustees

It has been part of the fabric of pensions management in the Netherlands for a decade, but fiduciary management in the UK is just beginning to break through. The nature of this style of management involves something of a leap of faith on the part of the trustees. Used to dealing with different parties for different areas of scheme management, it takes a lot of confidence for trustees to consider placing everything, from actuarial tasks to benchmark setting, from investment management to reporting, in one company's hands. Some feel that it means relinquishing a degree of control.

In fact, argues Ortec Finance managing director Lucas Vermeulen it is more about taking greater control: "Fiduciary management actually gives trustees more control. The main advantage is that the trustees can focus on strategy. It gives them access to an investment management structure that in turn allows them access to all sorts of asset classes they might not otherwise have been able to invest in."

Entrusting the overall running of a pension fund to another organisation can also help support them in navigating today's choppy waters. Pension funds are facing an onslaught of issues: an extremely volatile economic environment, increased interest rate and inflationary risks, widespread closures of defined benefit schemes to newcomers and solvency issues, to name a few. What's more, the world of pension fund investment has become a lot more complicated.

"Fifteen years ago, most allocations were restricted to 70 per cent equities (mostly UK), 20 per cent bonds and 10 per cent property. It was very straightforward. A lot of trustees didn't need help," says Cardano client director Phil Page. "Now, if you are moving away from equities you are looking at absolute returns, private equity, infrastructure funds. There are 20 or 30 boxes you could allocate assets to. Trustees look at that situation and say 'we need somebody who understands all of these different boxes.'"

BlackRock COO fiduciary management Michael Marks, agrees: "I think it is a valid concern of trustees that they should retain overall control, because that is their responsibility," he says. "They have a legal responsibility to understand and know what they are doing. In fact, that is where fiduciary management is of benefit to trustees. Trustees are enhancing their control with fiduciary management - it should always be about strengthening their control." Crucially, using a fiduciary manager in no way absolves trustees of their legal responsibilities to the scheme, which is why it is so important that decisions are fully understood and strategy remains firmly in the hands of the board.

More often than not, of course, the members of the boards of trustees also have day jobs. As F&C's head of fiduciary management at its Amsterdam office Ernst Hagen says: "Typically for trustees, this is not a full time job, although they should be constantly involved, especially under the current markets and changing regulatory environment. But for a fiduciary manager, their job is to manage investments. The fiduciary manager has a whole tool kit available for trustees to use which includes implementation, risk management and reporting."

Balancing a role as a trustee with another full-time occupation - and that may be totally unrelated to investment - can put a lot of pressure on a board of trustees. "Many trustees would find it very hard to understand the relationship between assets and liabilities, and how they are changing at times of volatility. Even if they had the ability to understand all that, would they have the ability to make timely decisions? And even if they did, could they execute those decisions?" Marks says. "It is that capability to implement that is the value added that fiduciary management brings."

The trouble is, though, while it may be about being more nimble to implement decisions and, essentially, simplifying matters for trustees, fiduciary management in itself it
can be something of a confusing concept. "Fiduciary management is one term with different meanings depending on the investment beliefs, needs and governance structure of the client involved," explains Hagen.

While the term is generally understood to mean an organisation takes over complete running of an entire pension fund, Capita Hartshead head of consulting Terry Ritchie says: "You don't have to hand the entire portfolio over. You can split it to give part of it and, over time, transfer more if that is what you want to do."

There are arguments for and against this tactic. On the one hand, trustees may feel they get more time to get used to this way of outsource their scheme. On the other, unsurprisingly, fiduciary managers argue that if they have the whole portfolio in their mandate they are better equipped to understand the bigger picture.

As a one-stop scheme running shop, fiduciary managers do indeed have a lot of tools at their fingertips, and this in itself has raised concerns about them being harder to scrutinise. "Say you are dealing with a firm that provides both actuarial and management," says Inalytics CEO and founder Rick Di Mascio. "In this case independent measurement would address the conflict of interest issue when the fiduciary is effectively creating the benchmark through the measurement of the liabilities and then reporting their performance based on that benchmark." In many ways, then, one could argue fiduciary managers set the exam paper, sit the exam, and then grade their own work at the end of the process. "One of the impediments of the growth of this industry is this governance issue," says Di Mascio.

It is possible to hire an independent consultant to verify the work of the fiduciary manager, but there are also some fundamental steps that can be taken at the outset. Cardano's Page says: "The first thing is to make sure the benchmark is scheme-specific and relates only to that pension fund." Success needs to be measured in terms of solvency, looking at liabilities versus assets, and it is vital to have an alignment of interests, says Page, and fee structures should be performance related, linked to solvency and liability versus assets.

Again, it comes down to a question of control. The fiduciary manager may be there to implement, manage, report, and perhaps even advise, but the trustees' responsibility remains undiluted - which is why it's important to ensure trustees are fully aware and in possession of the right skills to assess the advice, decisions and practices of the manager. This may mean educating the existing trustees, or it may mean appointing a trustee with a financial background to play that key part on the board.

And due diligence is essential. "It's about being in the driving seat," says Muse Advisory director Mark Hodgkinson. "We believe they have to do more due diligence than they are used to. The only way to do that is to spend time with their provider and look into their processes, people and capability." A lot of time needs to be invested upfront, but once the process is complete, in theory, a relationship of trust with the fiduciary manager should be in place.

Finally, it's important to have a plan in place should the board decide that the relationship is not working. "It needs to be written into the contract up front," says Ritchie, "If this relationship goes sour, what is the process."

While in the Netherlands fiduciary mandates are well-established, the UK has not caught the bug in the same way, perhaps at least in part due to a very different regulatory environment and a reticence regarding governance issues. But it is beginning to gather some speed, with large pension schemes such as the Merchant Navy making the move. "At the moment in the UK we are at the exploratory stages. Trustees are beginning to ask; ‘who can we speak to, how do we find out more about this,’” says Marks. "I do believe it will become a very significant part of the UK market."

Written by Sandra Haurant, a freelance journalist



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