Are we where we need to be on governance?

 

There is no doubt the UK pensions industry has made huge strides forward when it comes to improving areas such as governance and asset allocation. However, a recent paper published by the 300 Club questions whether these improvements go far enough and says a major cultural and behavioural shift is needed to bring lasting improvements.

According to Governance practices: Bridging the gap between rhetoric and reality, without "this behavioural shift we risk merely re-spraying an old car when, in reality, a new model is needed."

It is worth pointing out that improvements have been made. In terms of investment, pension plans are switching to areas such as absolute return investing and smart beta. These approaches contrast with old style static strategic asset allocation models based on assumptions about risk and return over the long term.

In addition we are seeing increased investment expertise on trustee boards, authority is delegated to professionals where needed, and we have seen big changes to how risk is managed.

According to the 2014 Amundi Asset Management/CREATE Research Survey, just under 90% of pension plans have refined their asset allocation approaches to a large or medium extent while just under 85% have upgraded governance to a large or medium extent.

Long way to go
However, there is still much to be done. According to the paper, as funding ratios have been hit by falling discount rates this has led to a culture of micro-management becoming evident. The challenge for trustees is how to delegate authority to investment professionals without losing control. This control needs to move to a strategic level which requires a different mindset.

However, full time executives have a challenge in balancing personal accountability and career risk. The responsibility of being able to pay out pensions over the long term, often with less support from the sponsoring employer, is a heavy responsibility to bear. As a result, blame culture could potentially lead to executives putting their own interests above those of the plan as they seek to avoid failure. This in turn leads to a risk adverse approach to decision making.

Avida International senior adviser and report co-author Sally Bridgeland says the situation has built up gradually.

"I think the situation has partly arisen due to the regulatory environment," she says. "It has built up over time and I liken it to the experiment of putting a frog in cold water and then increasing the temperature gradually – it won't notice the increased temperature until it becomes really hot."

According to Bridgeland, trustees need to adopt a new approach to pensions and approach them as you would run a business.

"I have experience of being a chief executive of a large pension scheme and you have to think of it like running a business," she says. "You have to look at managing cost as well as risk effectively. The challenge is that pensions have been under resourced over the years but as schemes mature then you need to think about how you are going to manage. To do this we have to really take the time out to consider what we need to do rather than focusing on performance on a quarterly basis."

Increasing confidence
However, developing a more confident way of making decisions does present its challenges, according to report co-author and chief executive of CREATE-Research Professor Amin Rajan.

"Implementing desirable governance changes is one thing, getting the best out of them quite another," he says. "The requisite mind-set shifts are hard in an environment of maximum uncertainty that we face today. Seemingly good ideas can come unstuck for irrational reasons."

One option the paper mentions is to enable trustees to take greater risk with a defined part of the assets where the part not only depends on risk appetite but also the skills the organisation needs to take those risks. This will enable the scheme to build on its existing capabilities while also exploring where new skills are needed.

The paper says such an approach might play particularly well to the skill set of lay trustees, especially those with experience of running divisions or teams and so have been responsible for areas such as strategy, resourcing and external contracting.

"I think this is where lay trustees can really add something different," says Bridgeland. "No matter how good the specialists are they will not have their finger on the pulse of that business in the way a lay trustee does."

So while big changes have been made, it is clear that more needs to be done if we are to see enduring improvements to how pension schemes are run. However, according to Bridgeland we are not so far from adopting this approach.

"I think we are closer than we think to being able to operate in this way," she says. "The problem is we don't stop and think about what we need to do – it is more about reacting to events. A more open and opportunistic frame of mind will certainly do more to trigger more creative thinking and that is what we really need to see in the pensions area right now."

 

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