The Irish landscape
Written by European Pensions team
Chair: Jerry Moriarty - CEO and Director of Policy, Irish Association of Pension Funds
Kevin Coughlan - Vice President, J.P. Morgan Asset Management
Dominic Croft - Client Relationship Manager, Profund Solutions
Martin Leech - Vice President, Irish Institute of Pensions Management
Carol Leonard - Business Development Manager, Irish Life Investment Managers
James McConville - Partner and Head of Pensions Unit, McDowell Purcell Solicitors
Joe Mottley - Principal, Clarus Investment Solutions and Director, Verus Advisory Limited
Frank O’Riordan - Pension Trustee and Consultant
Colin Doyle - Associate Director, EMEA, Russell Investments
Phil Rixon - Senior Reward Manager, Ladbrokes
Chair: How are we feeling about the recent regulatory/legislative changes, such as the temporary 0.6 per cent levy and the advent of sovereign annuities? How will these things affect pensions going forward?
Coughlan: If the current regulations remain in place they will drive asset allocation decisions that will potentially lead to poor outcomes for many members. The feedback from a lot of trustees is that they feel they are being forced to go in a certain direction. Sovereign annuities may have provided a partial solution but implementation was too slow and the investment opportunity has passed.
Doyle: I echo that sentiment. There are some reasonably good ideas out there but the timing and the circumstances in which to try to apply them are inopportune, to say the least. For example, sovereign annuities - is the opportunity over? Quite possibly it is.
Mottley: The levy has been terribly damaging because of the uncertainty it has caused and the sense it has created that there is no coherent policy framework underneath. Are private sector pensions a source of riches to be raided for the Exchequer for the short-term, or are they a solution to the problem of excessive burden of retirement provision that might fall on the state in the future?
It doesn’t seem like anyone at the government level has actually thought through the answer to that question.
On the topic of sovereign annuities, what has happened is that Irish bond yields fell so rapidly that we have gone very quickly from a point where Irish bonds were perceived as far too risky to even consider to them now appearing so expensive that the opportunity isn’t really there. There was only a window of a few months when the pricing was at a sweet spot to make sovereign annuities potentially a winner.
McConville: I think the introduction of a risk reserve long term and certainly the fact that the Pensions Board seem now to be sticking to a 30 June date for funding proposals is focusing the minds of an awful lot of employers. Pensions wise, we are seeing an increasing number of scheme wind-ups under way or preparing to commence. But for trustees that creates a number of problems. It creates problems in relation to whether or not they can get any more funding from the employer and then they are also going to have to consider just how the assets are to be treated. Do they go for sovereign annuities if the yield gap is narrowing all the time? Are they a realistic option anymore?
Beyond that, is there a temptation to try and hang on to see just what will be available from future legislation in relation to the order of priorities and how that might impact on actives and deferreds? But then you are getting into an active and deferreds versus pensions argument. Trustees probably don’t want to go there. So, from that perspective, the fact that there is this firm deadline of 30 June and the fact that we don’t have a degree of clarity around these various matters is creating a large degree of uncertainty, not just for the trustees but also for members and for advisers as well.
Rixon: We are receiving a lot of feedback from our colleagues who are not members of the scheme and who claim that the levy is a good justification for not joining at all. This combined with the other charges that are associated with pensions is really knocking confidence. My worry is that it almost doesn’t matter that the levy is going to disappear quite soon – what really matters is an uncertainty and lack of trust in pensions generally – and this is really concerning. What we don’t need are further knocks in the confidence of the pensions industry.
Leonard: From an investment management point of view, it is really the asset allocation call that we would be concerned about. As Kevin [Coughlan] said, is legislation driving people down the bond route and, if so, are you potentially forcing those less mature schemes, the ones that still need growth to meet their future pension obligations, into a potential wind-up or sovereign buyout situation? Pension funds need to be diversified and balanced and we feel that to a large extent the growth side has been completely ignored or more-so that pension schemes can’t actually afford to take it into account because of the burden of the risk reserve.
O’Riordan: Many fund managers are saying that equities are a good investment at this point in the cycle and AAA sovereign bonds are not - that is somewhat pure and simplistic view - yet the regulator is pushing schemes down the bond route, so there is a real tension there. But going back to Joe [Mottley]’s point on this, pensions can be seen as a “pain” from a sponsor’s point of view, from the government’s point of view they can be seen as low hanging fruit. The reality is that pensions represent the real money savings of their members and as a pool of investments looking for long term sustainable opportunities in both public, private and public/private offerings. However, the push for pensions to so called de risk is driving these monies into long term German bonds at negative real yields.
The definition of reserves has been under debate for some months now - we are three months away from the 30 June deadline to get your funding programmes in and there are vague indications of a change in the classification of risk reserves which would clearly have an impact on funding plans.
Croft: I agree that the levy is showing a lack of cohesiveness, and the fact that it is only going to be around for three years shows that the powers that be haven’t really got a grip on what is going on. They are clearly not comfortable with what they are doing. Also, those that are saving into pension schemes have to pay the levy; those that aren’t do not. That is not a positive message to encourage saving. From the point of view of a pension software provider, we have found that a lot of our clients have got to provide a SORP statement and have got to take the 0.6 per cent into consideration. It is added complexity and additional information that they have to put on the statement – things are already confusing enough for members, without all of this on top; and by the time many software providers have managed to implement it for a lot of their clients, because it is so complicated when integrated with other legislative and bespoke requirements, 30th June 2014 will be gone!
Leech: First of all, on sovereign annuities, I have heard anecdotally that while the delay in confirming the funding standard has slowed down the process of trustees going into sovereign annuities, now that they are nearly there, there are some trustees who are finding it attractive; even though the gap has narrowed, and so the saving is smaller, the risk has narrowed by considerably more, so they feel more comfortable going into a sovereign annuity than perhaps a year ago. Time will tell whether that view is correct or not.
The other point I would like to make is that pensions and tax don’t and shouldn’t mix. Pensions are long-term – there to provide financial security for people in their retirement years. Taxes are short-term - about the running of the country day-to-day. I think we have to be very aware that we are in an industry that is long-term but we are going to be heavily influenced by a government looking at things from a short-term point of view - that is something we have got to deal with, but it can be very painful at times.
DB challenges – funding
Chair: Moving on to the issue of funding – do DB schemes needs to re-focus on growth assets and, if so, how? And how can pension funds meet the MFS?
Leonard: Growth assets are very important in terms of the longevity, viability and sustainability of these schemes going forward, but there is a catch 22 situation here, because I am not sure whether the 80 per cent of schemes that are failing the funding standard are really in a position to handle an extra 15 per cent on top of their liabilities. It is really hard for pension schemes to try to navigate that while continuing to grow. Of course there are numerous growth strategies available, it is not just about diversification, for example there is volatility management and other tools that can be looked at, but I don’t think a lot of them will be options for many pension schemes because they won’t be able to afford the 15 per cent risk reserve in the first place.
Mottley: My view is that whatever proportion of total assets that schemes can afford to allocate to growth assets they probably need to work harder to optimise the portfolio in terms of diversification and broadening the opportunity set that they are utilising. Larger schemes have probably done a fair bit of work in that regard but smaller schemes, certainly some of the schemes we come across, have a long way to go in terms of getting their investment assets up to modern standards. They are hampered obviously by a lack of expertise, a lack of resources and a lack of accessibility to alternative assets, in the form of easily accessible pooled funds.
McConville: I don’t think there is any doubt that the burden of the risk reserve requirement is playing very heavily on the minds of sponsoring employers. When you are advising trustees in a potential wind-up situation or the trustees receive a notice to terminate contributions, very often one of the key reasons for it is the fact that the company doesn’t think it will be in a position to sustain funding for a DB scheme when the risk reserve requirement comes in, so they see now as the time to walk away. That is a very strong argument from an employer’s point of view. Because we don’t have the equivalent of the UK’s section 75 which places a statutory debt on the employer, the employer is entitled to walk away and the trustees are then faced with a situation of trying to see if there is any more money, but ultimately can do very little once the employer has decided enough is enough. Therefore, I suspect the risk reserve requirement is probably going to force the hand of a number of employers this year and that we will see an increasing number of scheme wind-ups over the coming months.
O’Riordan: There are three observations I would make here. First, is this inherent tension in the MFS target and the long-term fund requirements in terms of the on-going valuation. The 80 per cent or so funds which are below the MFS are the ones that are being been ‘forced’ into bonds with little or no prospect of generating real returns and thereby increasing the costs to the sponsor. The few guys that are already in surplus are the ones that can take, if I may call it, a strategic investment view as opposed to a strategy dictated by a regulatory mindset.
Second, there are ranges out there of different real assets – it’s not just about equities, bonds and property any more. Things like infrastructure, absolute return funds, unconstrained equity funds have become of interest. But then you come back to the point that currently all these are classified as risk assets, every bit as much as your conventional equities.
The third issue is that, even if it is the best investment in the world, trustees have to bear in mind, because of the long term uncertainty of the future of the pension fund, they are mindful about buying into those sorts of investments in the event of a wind-up situation if they are illiquid and you can’t get out of them quickly.
Coughlan: German bund yields post war peaked about 40 years ago and the direction of travel has been pretty much one way since, to the point where yields are negative in real terms. So rationally, if you could operate outside the existing regulations, why would you invest in bonds at these levels? Every other category of investor is seeking additional yield and income from other categories of fixed income or other asset classes. Pension funds are being prevented from taking a long-term view. That ability to take a put a long-term investment strategy in place ought to be a key strength. Regulation is preventing them from doing the rational thing and that is the basic conundrum that we are all wrestling with.
Doyle: Well, there are bolder schemes in different jurisdictions even selling down bond assets at the moment to take advantage of some of the long-term opportunities. Should schemes be focusing on growth assets? Yes, now more than ever, because the additional return from growth assets is an important weapon in tackling deficits in a zero-rate environment. But that it is completely conflicted with the regulatory environment that schemes find themselves in at the moment.
Coughlan: There are alternative approaches that would allow DB schemes to reach a more natural end in the next decade or so. I don’t think that many of us think that DB schemes in their current form will exist 20 years from now, they probably won’t, but being forced into an unnecessary wind-up is going to lead to unfair outcomes for a lot of members.
Chair: On that point, I have heard someone from the Society of Actuaries describe DB as pretty much dead but that it would be good to give it a decent burial. So, if DB is dead, it is a good time to move the discussion to DC. Can the current DC system deliver a reasonable pension for somebody in retirement? And are there sufficient investment choices and designs out there at the moment?
Leech: There is quite a good suite of investment choices and lifestyle strategies available, but investors need to be paying enough into their pensions from early enough. What is lacking at the moment is awareness of this and I think it should fall on the regulators, the Pension Board, to try and raise this awareness.
Everyone knows what their salary is, but they don’t know what their pension is going to be, and by the time they do know, it will be too late for them to do anything about it. But that awareness has to be driven by someone who doesn’t have a vested interest. So the regulators would probably be most appropriate in my opinion. This leads to education.
Rixon: Education here is absolutely critical and you can educate in different ways with big ticket items, but also on a day to day level - scheme members need constant reminding in a user-friendly way of what their benefits are likely to be in retirement. By user-friendly, one place to consider is annual benefit statements. Why not start again with something new. Surely it is not beyond the realm of all of us to come up with just a one page summary (with detail behind as appropriate) which puts things into real terms so that members can really understand.
Mottley: When we are talking about getting through to those people who aren’t currently members of any scheme, there is an onus on the industry collectively to get through to those people via the media. You talk to people who are sceptical of pensions and they say the markets are too volatile, the tax system can change at the drop of a hat and the charges are too high, but while there are a lot of negative perceptions about pensions out there, and some of them are partly justified, some of them at least we can try to counteract.
Croft: Quite clearly the communication message just isn’t getting across - maybe we are starting too late with these individuals; trying to get a message across when the horse has already bolted. There should perhaps be a greater emphasis on financial education in schools, it should be part of the curriculum, so that people grow up knowing how important it is to save and that, quite frankly if they don’t put enough aside, they are going to have to work later, and later, or they are going to be totally scuppered!
I also think there is a lot of emphasis these days on enhanced annuities for those in poor health, sometimes due quite frankly to their own chosen life styles. This can be to the detriment of those that have looked after their bodies whose annuity rates are less generous. So they have to sometimes work longer as a reward for looking after themselves just to end up with the same benefit! For these people, I believe flexible or capped income drawdown will be the way forward as at least you are actually drawing on your own funds without necessarily relying on unfavourable annuity rates.
Rixon: I agree the merits of this type of arrangement are compelling. But if a lot of people are retiring on relatively small pots, then the opportunity to do things like income drawdown won’t be there, simply because the insurance companies are unlikely to handle fairly complicated transactions on relatively small funds; the charges for doing so will be too high for members - and the increased level of knowledge and understanding required for members to be comfortable with these types of ideas are considerable. We might consider the need to widen the conversation to one about long term savings. Pensions has a really crucial part to play in this not least because of the tax relief, however the conversation should be about ‘savings’ and there are other ways of saving for your retirement.
Croft: It is crazy that people don’t see the benefits, because for every euro you contribute, you get tax relief, and you normally get a corresponding contribution from the employer; so there is a massive benefit even if the return is zero, so it has got to be a positive thing. Why we can’t get that message across, I just don’t know.
McConville: I think the timing is wrong. If we were having this conversation 10 years ago, we would be in a better position. Today, the kind of people that we, as an industry, are trying to target are the people who see that Waterford Crystal has collapsed, see that SR Technics has walked away leaving a deficit behind it, see that the government is actually reducing the value of reliefs and essentially saying that it is going to do no more. Minister Noonan has made it absolutely clear that, from here on in, the industry is on its own. The government believes that it has given certainty to the tax position, and is now saying to the industry that it is up to you to come up with the solutions to ensure adequacy into the future. That is a huge burden, a huge responsibility, given the timing.
I also think we missed the opportunity 10 to 15 years ago to go the Australian route and look at a compulsory system. While that could have been done as part of a social partnership then, it can’t be done now. I don’t think there is any doubt that the compulsory system in Australia does encourage greater engagement, but I think the only way that we can improve engagement here in a way that is manageable is to start at the very beginning.
I am going to draw an analogy here. In Tasmania, there is a proposal to prohibit anyone who was born after the year 2000 from purchasing tobacco. Essentially, what they are saying is, ‘we are drawing this line, anybody born after 2000 will be effectively prohibited from smoking’. Maybe in Ireland we need to say, similarly, that everybody born after a given date, say 2000, is going to have a degree of compulsion upon them to save for their retirement. For those people who are much further on in their careers, we will have to continue to encourage them by way of education and perhaps auto-enrolment.
O’Riordan: I don’t think choice is the primary issue. There is far more choice available today, there is far more bespoking available. A key challenge may bet the ‘glazed eye syndrome’. I agree there was probably an issue of choice in the past, but I think today things are falling down at a much earlier stage than choice. A practical issue may be the choice between putting money into a DC fund or buying a first time apartment or house.
Mottley: There is also a lot of empirical evidence to suggest that too much choice is counter-productive anyway, and that people switch off and/or end up picking an option that is either too low risk for them, or they just go into the default and give it no further thought. What is important though is that the choice is presented and framed in terms of outcomes rather than what goes on at the back end. For example, the ins and outs of an emerging markets fund is of no interest to the member; we should be presenting things in terms of the risk versus reward.
Croft: The question is, how can you make people save? Perhaps the adverts on TV should be more hard hitting. Maybe if they show more clearly that if you don’t save, the state is not going to bail you out, then the message might get across. These days every other advert on Sky promotes gambling. If half of these promoted the virtues of saving, it might be a start. If you can afford to gamble you can afford to save.
Leonard: But who does the responsibility for communication actually fall to? We know that 75 per cent of people in Ireland choose the default fund, and that is because they are not engaged. So is compulsion or auto-enrolment the way to improve that engagement? The UK Nest scheme is a start, but 4 per cent isn’t going to guarantee anyone a sufficient pension when they retire at 65. Australia has gone a step further not only with a 9 per cent contribution rate but also with the creation of industry-wide pension funds. This gives the funds greater buying power to deliver high quality, low cost and efficient outcomes for their members. It also means they have a bigger spend available for marketing and communication. In Australia, there is a very creative approach to pension fund engagement through TV, radio, newsprint ads, iphone apps and other online tools. It is in their interest to actually get people engaged because they are competing for members. That is why people are so in-tune with their pension arrangements in Australia. Also, they see their funds growing because 9 per cent of their salary is going in there every year.
Rixon: Having gone through pensions auto-enrolment in the UK, despite some of the complexities and other issues, on the face of it, it actually ticks a number of the boxes that we have pushed and pulled around today. I agree the contribution levels right now are very unlikely to result in a meaningful retirement, but by the same token it is not going to hurt individuals which means they are less likely to ‘opt out’. It will get people into the scheme, engaged in the pension system in one way or another, even if it is passively. And as the contributions nudge up, as they will in a few years, suddenly a more meaningful pension will be on more horizons.
The Nest investment model of providing capital certainty for the first few years again takes the away the fear factor for those individuals who are scared they might lose everything by having their money in risky assets. So there is some interesting thinking underpinning behind auto-enrolment, and if it were properly structured, learning from some of the UK challenges that have emerged, then a fantastic system could be the shot in the arm that may be needed.
Croft: In Australia contributions are going up to 12 per cent now, and everyone in the workplace is used to that culture, so they don’t complain about it.
O’Riordan: I take on board everything you say, but bear in mind also that conditions in Australia are far different than they are here at present. Even if you look at the UK, yes 1 per cent is neither here nor there, but here it could well be portrayed as another tax. I am not saying that we just throw in the towel, but one has to be fairly sensitive to the environment we are in.
Leech: The OECD is carrying out a very comprehensive review of pensions in Ireland at the moment, which is very wide ranging, and I think that report when it is published should and probably will inform us on how we should proceed. It will give us all the context that is lacking at the moment.
Investment strategies/asset allocation
Chair: What are the most popular investment trends and asset allocation choices being made by Irish pension funds today and why?
Mottley: I would again highlight the fact that the restrictions imposed by the funding standard, and now by the reserve requirements, are pushing schemes too far in the direction of low return assets, namely bonds, which are potentially high risk as well. That is not good.
O’Riordan: There is a big push towards bonds, and clearly you are seeing a big move into corporates. People are very aware of sovereign risk on the bond side. We have also seen a big move into absolute bond type strategies as a way of meeting the monetary requirement in the hope that the manager can generate positive returns in the event of a back- up in sovereign bond yields in the knowledge that you are getting practically nothing in cash.
Mottley: Probably what a lot of trustees don’t realise until it is pointed out to them is that investment grade corporate bonds in aggregate are lower risk than medium dated sovereigns.
Leonard: What we have seen from an investment point of view is that pension schemes do not want to experience another 2008. They recognise that the traditional benefits of diversification were eroded as all asset class correlations converged to one.
The discussion has been two-fold with schemes exploring other asset classes as part of a diversification strategy, but also a growing number looking to identify what hedges and tools can be put in place to actually manage the overall volatility of the performance outcome. There has been increased interest incorporate bonds, emerging market debt and equities, and absolute return strategies. Volatility management tools, whether through physicals or synthetics are also gaining traction as pension funds are looking for solutions that help to minimise drawdown in times of market stress.
Doyle: Similarly I would say that there has been, not quite a trend, but certainly a renewed desire to look at outcome oriented portfolios for exactly that reason – funds are asking themselves, ‘what is our ultimate outcome and what are the available instruments to achieve that outcome?’ Effectively they are trying to put together the most efficient portfolio from an overall asset allocation perspective to deliver the desired outcome.
Coughlan: It also very much depends on the individual circumstances of the scheme. We have schemes that are struggling with the standard. Contrast that with a scheme we are working with which is fully funded and has a very strong sponsor covenant.
They can reflect long-term views around in their investment strategy and take a nuanced approach to some of their hedging strategies, for example. That is the perfect place to be. Where schemes can they have been looking to generate greater income and yield from their portfolio. The allocation to alternatives is probably still below levels in other DB markets.
Absolute return funds
Chair: Absolute return funds – what are the risks versus the rewards?
Coughlan: The reward, in theory, is reduced volatility, less drawdown and a smoother ride for investors. A basic risk is around complexity. Many of the investment techniques have their origin in the hedge fund sector. With some modification and compromise these strategies can be made available in liquid regulated vehicles. The skill set required is very different to the long only space. Proper due diligence need’s to take place. Expectations also need to be managed in a strong market environment. In a market rally the degree of upside capture may disappoint some.
Doyle: Ultimately these funds have a role to play, and given the likelihood of them reducing volatility they can form an important component in a broader overall asset allocation. The risk is that they are seen as some kind of a panacea which is certainly not the case and we will know all about that if and when markets take off again. But it is encouraging to see a lot of trustees evaluate them from that perspective and hopefully include them alongside other vehicles and instruments that have complementary characteristics from a risk return basis.
Mottley: I agree absolute return funds do have a role, but it is vital that trustees understand that when they invest in a properly constituted absolute return fund, they are investing purely in alpha, in manager skill. They need to understand that the relative importance of manager risk is so much greater than if they were investing in long only funds, and manager skill is probably harder to find that a lot of people believe. Those caveats being said, they do have a role to play, but ideally if a scheme is large enough and has the resources to do its homework you probably want to spread your exposure over more than one fund so that your manager risk is diversified.
Rixon: I like these funds enormously also for the DC sector where they can act as some sort of replacement or complement to the traditional lifestyle type of approach. Take something like the Standard Life GARS arrangement which has gone through massive economic turmoil, gone through significant change in its leadership team and has come out well. I think it has proved its worth. Of course you should diversify the fund itself.
Leech: I also agree that absolute return funds are a very valuable tool, but in the context of defined contribution, I think communication is critically important because investors need to understand that ‘absolute’ can be negative as well as positive, and we could be storing a lot of trouble for ourselves in an industry that is already discredited, fairly or unfairly, in other people’s eyes.
Leonard: I think fees are also a key consideration because absolute return/hedge funds command a higher fee it is really important that investors are paying for the alpha rather than a beta call.
Coughlan: As with long only funds, cheaper alternatives emerge over time. Strategies that were regarded as exotic have become replicable where you can identify the risk premia and access them cheaply. Delivering that beta can be a valuable tool for clients. The fees drop accordingly.
O’Riordan: But it is a crowded space now, and you always get worried in crowded spaces that you get a tail wagging the dog syndrome. The issue of fees and performance analysis particularly in down markets needs to be examined.
Chair: Moving on to smart indexation - should funds be matching investor requirements with alternative benchmarks?
Mottley: I am very attracted to the idea of smart indexation and in my mind what we are talking about here is using indices that are anything other than market cap indices, and we all know the inherent flaws of market cap indices; whereas the smart approaches such as, for example, fundamental weighted indices in the case of equities or GDP weighted indices in the case of sovereign bonds all have theoretical and intuitive attractions. Just a couple of caveats - mathematically, the whole world can’t move to alternative indices because somebody has to have the other side of the position.
Also, I think simplicity is important. Some of the overly complex smart indices that you see being produced by providers which have fantastic back-tested records are drastically over-fitted. We can all construct a strategy that worked perfectly for the last however many years but don’t be deluded by that - if it is too complicated then I would say the golden rule is to forget it.
Leonard: They can certainly form part of your equity or bond allocation - it is an alternative approach to picking your stocks; but you need to be cognisant of some of the biases that you are introducing into your portfolios. So you need to go in with your eyes open – be aware that you are still getting equity beta risk, it is just a different subset of stocks.
McConville: In all of this you have to look at the mentality of the trustees. What are they thinking? What are their priorities? That is an absolutely crucial point. If you have a group of trustees who are looking over their shoulders thinking ‘the employer is about to wind the scheme up; we have been in a funding proposal for a couple of years and we have had a few years going off track’, they are going to ask themselves whether they take the risk of trying to do something that is different or do they just go ultra-conservative, see if they can survive the coming year and then see what happens next? Trustees are only human; quite often they are volunteers and not professionals and you are asking them to make big decisions as the prudent man investing on behalf of others.
Rixon: Absolutely, and we mustn’t forget that a lot of trustees are lay; they have day jobs that they are very good at. Given the specialist and increasingly complicated nature of some of these investment products it is almost impossible to suggest they can be trained sufficiently so that they have their eyes wide open to all the risks and all the rewards of such investments.
Doyle: Back in the day trustees used to manage stocks and then that became too hard, so effectively trustees took a step up the governance chain and appointed investment managers and delegated the security selection to those investment managers. But that space is becoming extremely crowded. There are all kinds of investment managers, asset classes and investment strategies, so what the fiduciary management type framework is doing is effectively facilitating the trustees taking one more step up the governance chain and delegating to the fiduciary manager the appointment of the investment managers, asset classes and strategies, subject to pre-agreed investment guidelines. That allows the trustees to have greater amounts of time to concentrate on the really important issues that trustees need to tackle – such as: what is the strategic target end-game? What is the appropriate level of benefits? What risk must we take in order to achieve our target funding level? So, within the type of framework that is emerging, it does allow schemes of any size, of any degree of sophistication, even if they do not have all the in-house resources that some of the very large schemes have, to avail themselves of all available investment technology, because assuming that the fiduciary manager is fit for purpose and can be independently audited, and there is somebody around the table to do that, it is the role of the fiduciary manager to make sure that all appropriate investment strategies are brought to the table and can be put at the disposal of the trustees.
Mottley: My sense is that the adoption of fiduciary models so far in this market has been mainly in the DB space because it tends to go hand-in-hand with the implementation of a dynamic de-risking programme. But I think there is a huge opportunity there to bring fiduciary models to the DC space and greatly enhance the investment offering in doing so. This is because the fiduciary model lends itself beautifully to the implementation of a white labelling framework and the provision of a simple and logical set of investment choices to the members which are outcome orientated. In an ideal DC investment choice you might have three default portfolios of low, medium and high risk, and what happens under the bonnet in those portfolios in terms of the allocation across different asset classes and managers is looked after by the fiduciary manager and doesn’t have to be a matter of concern to the member; they just pick the thing based on the outcome orientated label. That is the way the DC world should go, the marketplace is crying out for it and somebody is going to do it.
Leonard: I think where fiduciary management is very beneficial on the DB side is if you have another situation like 2007 when many schemes were solvent and in surplus, Fiduciary managers can play an important role in terms of the de-risking and timing decision of capitalising on market opportunities, because I do think it is very difficult to expect a trustee group to know when to react and when to time certain decisions.
Fiduciary management will also play an increasing role on the DC side where bespoke member lifestyling arrangements that take into account the members risk profile and how they want to take their benefits will be required.
Coughlan: I can see the attraction for trustees wanting to implement such a model. The decision-making process can be much improved and the traditional model for interaction with investment managers has its limitations. There can be great efficiencies for trustees on implementation. The engagement between manager and the fiduciary is between professionals. That is a good thing. A concern I have is that it places an enormous amount of trust in the fiduciary and so that part of the relationship is very important. There may need to be some mechanism in place to have some oversight of that as well.
Chair: There are some quite different models of fiduciary management and some lend themselves to accusations of conflicts of interest. How do you deal with that?
Doyle: It is correct to say that it is a very trust based relationship and the way to deal with that is transparency and complete objectivity; and in order to ensure that the outcome is as effective as it should be, everybody needs to buy into it, from the trustees to the sponsor to the provider and preferably to an independent adviser who is a ‘fit for purpose’ observer. In every relationship there will be conflicts, but it is a matter of how you manage those, and declare them, and as long as there is complete transparency as to who is doing what, it can be managed.
A corollary of that is accountability. At the moment, under the traditional model, trustees and advisers and indeed sponsors are never quite sure who is responsible for which decision and there is a lot of finger pointing when it goes wrong. So a powerful component of this approach is to be very clear from the outset who is responsible for precisely which decision; understand what are the terms of engagement, and make sure the investment guidelines are agreed upfront.
The trustees must own the strategy, and they get all the expert advice they need to formulate that strategy, and it has to be presumably agreed with the sponsor. The fiduciary manager then is responsible for implementing that strategy, all components of it, and most importantly they are responsible for delivering the overall strategic objectives of the scheme, for example, a pre-determined return above the scheme’s liabilities in order to achieve a target level of funding by a set date in the future.
On a quarterly basis, then, the conversation becomes based around questions such as: ‘what was our funding level last quarter? What is it this quarter? Why, and what did we/are we doing about it? And how does it compare to where we expected to be at this point in time?
Mottley: My own company Verus Advisory supplies a service to trustees to help them monitor the delivery of fiduciary management by providers. When we introduce our service to trustees and make the point about conflicts of interest, some of them say they are concerned about it and want to find a way to make sure it is properly addressed, whereas others are completely relaxed as they trust their adviser completely and don’t see the need for third-party monitoring. So yes there are potential conflicts, but as long as there is transparency, then the danger of this can be minimised.
Chair: How important is dedicated pension software for ease of administration and why is selecting the right software provider so key?
Croft: It is really important to have the right software and to have things automated. I am amazed at how many companies still do things on spreadsheets - it is so inefficient, there will be manual error, and so on. In terms of picking the right provider, I am also convinced that trustees do not always ask the correct questions; sometimes a system might be selected which is not necessarily a robust or appropriate one for them, but just has very good sales people selling it. The sorts of things you should be looking at when choosing a software provider are which other clients do they have? Do they have a portfolio of similar sized clients to you? Do they have the right experience amongst their staff for your scheme? How compliant is the system? How well does that provider keep up with the pace of change? These are the sorts of questions I would be asking.
McConville: The importance of a good software model cannot be understated, particularly where that model is conducive to better member communication. That is an absolute key. When you can keep members engaged either by way of online access or via email, that is great, because these types of communication allow you to respond to queries almost immediately.
One of the forgotten groups is that of the deferred members, and they are the ones who are very difficult to trace. Good software can also help with this.
Croft: The problem is, when it comes to deferred members, who obviously have left the scheme and often the company, does that company really want to spend a lot of money investing in getting everything automated for people who are no longer there? They should do as benefits still need to be calculated accurately. What you also find is that this category of membership tends to be the most complicated one because of all the tranche splits and, often, without the records being set up correctly. Once you fail to automate one legislation change it is very difficult to catch up afterwards and then everything gets done manually. The frailty of the software can sometimes be blamed but, often, it is the fault of the administrator for falling behind the pace of change; or the lack of budget being granted for legacy members. So as you say the deferred members are the forgotten people, yet they are now becoming, certainly for DB, the more predominant membership.
Leech: It is of course vital to have up-to-date records, not only to serve the member, but also to meet all the statutory requirements i.e. issuing information on time to the right people, in the right way, in the right format is essential. If it looks smart - even better, but it also has to be compliant. I think it is good option for trustees, particularly of smaller schemes who may not have a dedicated resource within their sponsoring employer, to outsource to someone who could be a consultant or an insurance company as it gives them great comfort to know that there is a proven track record there.
Mottley: Administration does pose real risks for all of us and for trustees in particular, but at least it is a risk that can be squared away relatively easily by putting the right system in place, and it would be lunacy not to, so that as trustees you can allocate your time and energy into managing the more onerous risks such as inflation and interest rate risk and so on.
Communication and adequacy
Chair: How can communication increase member engagement?
Leech: It is important to note that, when we are talking about using communication to improve member engagement, the same issues apply to both DB and DC schemes. If you are a member of a DB scheme, the information is just as important as if you were a member of a DC one, so I think the mediums we use across both should include things like smart phones, blogs, etc, as long as we get away from these 28 page benefit statements that no-one really understands anyway.
Chair: How can we ensure pension adequacy?
McConville: The short answer would be to make employers and employees pay a set amount but the problem is that there won’t be the political will for that particularly at this point in time. The question should perhaps be: is it the industry’s responsibility to ensure adequacy? I don’t know. I don’t think that this is the time for the government to go off into the sunset and say ‘guys, it is all up to you now’ but that is what they seem to be doing and I don’t see how we can ensure coverage and adequacy without proper government engagement.
O’Riordan: Unemployment in Europe, it is shockingly high, and has to be a primary concern to policy makers. The forthcoming publication of the OECD report may be timely in this regard. I would make the general point that the primary purpose of pension funds to serve their members can be a source of ongoing investment in both public and private low risk sustainable investments which match their needs. So it is interest of all that pension coverage is as wide as possible.
Leech: As an industry we need to engage and work with the regulators and particularly the government. It can be hard because we and our customers are often on the receiving end of additional ‘burdens’, e.g. the pensions levy. But we need get the message across that pensions are great, and that they are an investment rather than a cost – that would help, but we need to engage with government for us to do that.
Chair: The next question on the agenda relates to the IAPF’s Pension Quality Standard and how it has been received. From my perspective - not widely enough. We have had it for two years and maybe only a dozen schemes have applied, despite it being very straightforward to apply for. It is something that we modelled on the UK’s NAPF’s Pension Quality Mark to highlight good quality DC schemes. It is not the biggest barometer in the world, but we require at least a 10 per cent contribution of which the employer pays 6 per cent - that is deliberate so you cut out the ‘standard’ five and five schemes and recognise those that are doing something a bit above the basic standard. But I would welcome any observations that anyone has in terms of how we can get it more out there in the wider market.
Rixon: We have recently been awarded the Pensions Quality Mark in the UK and we are thinking about rolling it out here. One of the key reasons for doing it in the UK was to aid recruitment and retention - it is a valuable tool and we can market ourselves. I wanted to understand the impact here in exactly the same way. Is there any available evidence for example that shows it has helped recruitment and retention?
Chair: Certainly there is some evidence that those who are engaged with it are engaged with it quite strongly and we know it will take time, but we hope it does get to the stage where people ask their employers ‘why don’t you have it?’
I don’t think employers do enough to advertise their total benefits package and that is what we are trying to help them do. Especially in the current economy, being able to say ‘we have a DC scheme and it is a good quality scheme and here is the mark to prove it’, can mean an awful lot.