William Parry looks at the challenges pension schemes face before appointing a fiduciary manager and recommends what schemes can do to get the answers and information they need
- Fiduciary management is growing increasingly popular but concerns remain whether schemes are getting value for money
- Making the wrong decision can cause big governance problems in future
- Comparing the different offerings available in the market can prove difficult
Fiduciary management's benefits are proven, but whether pension schemes are genuinely getting value for money remains up for discussion. The issues of performance and fees remain notoriously opaque, and with the industry being held increasingly accountable fiduciary managers should be no exception.
Appointing a fiduciary manager is a responsibility that pension scheme trustees should not underestimate. Delegating day-to-day responsibility does not absolve trustees from their responsibilities to members as set out in the Pensions Act.
Appointing a fiduciary manager can increase the efficiency of the ongoing scheme management and the investment strategy. However, if the wrong decision is made at outset, this can cause huge governance issues further down the line, which can be a considerable distraction for trustees. Unwinding and transferring a fiduciary solution can also result in significant costs.
When selecting a fiduciary manager, trustees have to be certain they're making the right decision. The correct due diligence involves someone that has the necessary research expertise and market breadth. Although historically this has only been in a minority of cases, it is becoming increasingly common that a third party firm is used for selections and evaluations (especially if the fiduciary manager was not appointed via a competitive tender).
What are the key problems?
The rationale for third-party involvement comes down to the complexity and heterogeneity of the offerings. This makes them seem opaque to parties who have spent less time researching and understanding the various offerings in detail. It is also difficult for parties who have less direct experience working with different fiduciary managers.
The complexity of fiduciary arrangements leads to two main problems:
i) Understanding and measuring the success of the strategy for the scheme in question.
ii) Comparing the different offerings and knowing which one is the most suitable.
Understanding and measuring the success of your current arrangement
Within fiduciary management, in almost all cases, investments are allocated via funds of funds to third party managers. This added layer of delegation means that trustees are at least one, highly customised layer away from the movements of the underlying managers.
Being further away from the underlying managers makes it much harder for trustees to see what is going on 'under the bonnet'. As a result, for many trustees this can become very confusing.
Even more concerning is trustees sometimes believe they are in possession of all the facts but fail to notice certain nuances of the relationship. Spending enough time to fully assess the arrangement is important.
Looking at performance, this can be evaluated by breaking it down into portions that can then be assessed properly against targets. For instance, looking at the performance of the growth assets against the strategic target (say, the premium over gilts). Or the contribution to performance of the decision to be over-hedged or under-hedged relative to the target hedging ratio. Even these have to take place in light of the input from the trustees; fiduciary managers should neither be rewarded nor penalised by decisions that were not ultimately theirs.
Comparing your fiduciary manager to the marketplace
Without the correct knowledge and involvement it becomes very difficult to draw comparisons between managers. This makes it hard for trustees to know which solution fits them best. To highlight this difficulty, what appear to be the hardest comparisons to draw are those that are typically easiest within the traditional asset management space.
For instance, advancements in traditional, single-mandate asset management make comparing fees (both AMCs and additional costs) and performance easily comparable - a well-documented problem for fiduciary mandates.
Addressing this is difficult and relies on understanding how the fiduciary managers work. For instance, finding out about fees can come down to wording the question in the correct manner from a technical perspective.
In what is still a relatively embryonic space, perhaps it is to be expected that the various stakeholders are still working on ways to disclose all aspects of the relationship clearly. This includes the inconsistencies surrounding fees and performance, as well as the less advertised hidden complexities about the structure of the underlying investments.
The hidden complexities within the arrangement are much more complicated. These range from the efficiency of the instruments being bought within the LDI portfolio; to whether the manager research is adding value. When assessed in a forward-looking manner, these can have a much greater impact than fees.
Only trustees with considerable expertise and governance budget will be able to satisfactorily conduct these exercises themselves. Even then, maintaining independence is critical.
William Parry is an investment consultant at Xerox HR Services
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