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What to expect from your fiduciary manager?

Written by Michael Marks
October 2011

Michael Marks suggests how a simple framework can help trustees achieve clarity around the role of their fiduciary manager

Widespread in the Netherlands, the concept of fiduciary management is now increasingly embraced in other European markets such as the UK, albeit under different guises and names. Despite this growing demand for fiduciary management type arrangements, there remains confusion around what exactly it entails. Specifically, many trustee boards find it hard to determine what expectations to set their fiduciary manager.

Fiduciary management is by its very nature bespoke. Nevertheless, managers should be able to deliver added value across a number of common areas. By putting in place clear criteria for each of these areas it is possible to build a simple but effective framework that can help trustee boards decide what falls within and - equally importantly - outside the remit of their fiduciary manager's role regardless of the specifics of the fiduciary management arrangement. This in turn enables trustees to maintain control, manage expectations of the other stakeholders and ensure maximum transparency in relation to the sponsor around the respective roles and responsibilities of the fiduciary manager, investment committee and the wider board.

Capital markets expertise and resource

One of the principal reasons that pension funds adopt fiduciary management is the need to bolster the pension fund's internal capital markets and investment expertise in order to enhance both the quality of investment decisions and governance. Access to the insights and risk management skills of hands-on practitioners may be particularly beneficial in a volatile market environment such as we are currently witnessing.

Clearly, putting in place a fiduciary management arrangement does not mean that a pension fund should expect to be totally shielded from market volatility or will be able to capture every opportunity. Nevertheless, trustees are entitled to demand that the fiduciary manager offers an improvement in outcomes.

So what should the investment committee and the wider pension fund board expect in practice? A true fiduciary management partner should in effect be able to act as
an in-house investment manager, providing expert insight and advice based on an intimate knowledge of the pension fund's specific circumstances. Specifically it means that the trustees should receive asset allocation recommendations which are appropriate for the fund's risk budget and agreed long-term goals taking into account the impact on both the liabilities and assets.

In relation to acute market volatility, the fiduciary manager should be able to outline to the board what, if any, approaches may be available to protect the portfolio from extreme market shocks. This includes providing the trustees with a clear understanding of associated cost and potential downsides. The outcome of the discussion may be that the trustees do not implement a strategy, but the important point is here that this action can be justified on the basis of an informed and deliberate debate.

Transparency of framework and interests
Trustees worry that fiduciary management may mean the decision process becomes less transparent. However, the reality is that a sound fiduciary manager should enhance transparency both in terms of the decision-making process and the overall framework in which these decisions are taken. Risk management is key here as fiduciary managers should have the tools and expertise to provide the trustees transparency regarding the risk the fund takes versus its liabilities. In practical terms, this means that the manager needs to analyse the pension fund's risk positions in detail and, even more importantly, be able to distil and articulate this into useable information for the trustee board so they can fully exercise their governance duties.

Open communications

Excellent communication is an essential ingredient of an effective fiduciary management partnership. While trustees should expect a fiduciary manager to undertake day-to-day management of the portfolio, the board or, at least, the investment committee needs to remain fully apprised of the fund's day-to-day strategy. This requires not only that reporting is of the highest quality being both comprehensive and easily digestible, but also that the fiduciary manager is able to communicate frequently and openly with key individuals, the investment committee and/or the wider board to ensure appropriate debate. This is particularly crucial in challenging market conditions, where the board needs not only to be fully aware of the actions that are taken to mitigate threats and exploit opportunities but also of the rationale underpinning each of those actions.

Pro-active idea generation
Trustees cannot and should not expect the fiduciary manager to take decisions that go beyond the day-to-day management without their input and approval. However, the trustees should rightly expect a fiduciary manager to be supportive and provide them with the tools and information necessary to take informed and timely decisions. It is incumbent on the fiduciary manager to propose ideas pro-actively to the pension fund and clearly, it is up to the trustees to ensure they have an appropriate ability to take decisions in a timely manner based upon the proposals of the manager. The quality of idea generation is another key aspect trustees need to consider. They should not settle for one-size-fits-all responses. Rather the fiduciary manager should be delivering recommendations that meet the specific pension fund's circumstances and goals. It is
also important that the fiduciary manager challenges the status quo by providing fresh thinking. For instance, since the crisis started in 2008 we have at various times seen significant opportunities to add material value in credit, certain alternatives and more recently selective eurozone government bonds. As part of the fiduciary partnership the pension fund board or investment committee should be presented with such value-adding ideas as soon as they arise but again framed within the fund's specific context. Pro-active idea generation should also include running the board through regular 'what if scenarios'. Over the last few years many long-held beliefs have been severely tested and fiduciary managers should be able to guide trustees through the consequences of potential further market dislocations and recommend, where appropriate, defensive action.

Effective control
Ensuring good governance and effective control is core to the pension fund trusteeship. Fiduciary management does not equate relinquishing that control. On the contrary, the litmus test of best practice fiduciary management is that it enhances the quality of governance in terms of management information, timeliness and expertise. Moreover, fiduciary management provides a holistic approach to the management of the pension fund. Trustees should be able to rely on the fiduciary manager to demonstrate at all times how risk is taken in relation to the pension fund's liabilities and how this relates to the trustees' risk budget. Furthermore, they should expect the manager to provide assurance that where risk is taken it is done in a deliberate, diversified and appropriately scaled manner.

In summary, while each arrangement will by its very nature be different, we believe that by carefully assessing the role of the fiduciary manager against the framework outlined above, trustees can ensure they build a genuine fiduciary management partnership with clearly defined responsibilities and expectations. Only then can fiduciary management truly deliver for pension funds by providing them with a greater control of outcomes and, ultimately, a clear roadmap towards their goals.

Written by Michael Marks, chief operating officer of the fiduciary mandate investment team at BlackRock



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