PP’s expert panel discusses key considerations for trustees tendering for a fiduciary manager
Head of investment solutions
The Competition and Markets Authority's review into fiduciary management is having a wide-reaching impact on the industry - with its requirement for trustees to carry out a competitive tender before awarding a fiduciary mandate heralding a busy period for schemes and managers alike.
This Q&A - conducted in partnership with Aon, Mercer and Schroders - looks at the key considerations for trustees going through a tender and ask how they can design the most effective process for selecting fiduciaries.
What are the key considerations for trustees going through a fiduciary manager tender process?
Tim Banks: In entering a tender process the trustees will need to be clear where they are on their journey, and what they have in place today and why. Understanding what is included in the current providers offering is crucial in establishing a baseline of what will be required.
Strength of the existing relationship is critical, as for our clients we become an extension of the team, focused on delivering the scheme's objectives.
A clear vision of where the scheme is headed, (buy-out or self-sufficiency), and reconfirmation of the trustees' investment beliefs and preferences will inform the process.
For a fully delegated offering most trustees will require a partner that can offer a true end to end solution, designed to get them to their chosen destination as quickly and efficiently as possible. Whether the current provider has the resource, expertise and capabilities to partner with them for the next stage of the journey will be a key consideration.
Value for money is crucial, and understanding where fees are paid, ensuring that both the fiduciary fee and the underlying manager fees represent good value will always form part of the process. Understanding what you are paying for in both elements of the fees is important. For example an illiquid private market allocation will add material benefit to the portfolio but command higher fees.
Tony Baily: All trustees are aiming to secure their members' benefits. Fiduciary management can help trustees to achieve this by delivering more efficient investment solutions.
Trustees will want the tender process to identify the fiduciary manager who is best placed to work with them to achieve their funding goals. Most are looking for a partner, focused on them, who will:
• Hold the trustees' hands, providing guidance and training as needed.
• Take the necessary time to discover the trustees' own beliefs and objectives.
• Work with the trustees to develop a long-term funding plan to meet their objectives.
• Implement a portfolio optimised uniquely for them (rather than being the fiduciary manager's model portfolio).
• Ultimately, deliver strong and stable returns to secure their members' benefits.
Neil Walton: Fiduciary management is both a sophisticated investment service and a governance solution. In our experience, the best approach to a tender process is to invest significant time up front to consider both of these elements, and to understand the most important elements of the investment strategy and the governance approach.
It is important to understand the full range of solutions that are available, and to investigate the merits of different provider types before narrowing down your options.
This up-front investment of time bears fruit by bringing clarity over which parts of the investment decision-making process you wish to delegate. There are a range of approaches available, and trustees should be clear over their key criteria before they begin to select a fiduciary manager. It is vital to have a clear picture of the working relationship you are looking for, before you can choose the right provider.
What do you see as the key differences between fiduciary managers? Are there different models trustees can choose from? What are the key things that set different providers apart?
Tim Banks: At Mercer we believe a full fiduciary relationship is a service rather than solely an investment product. We ensure that we leverage all of Mercer's intellectual capital for the benefit of our clients.
As schemes evolve towards a lower risk destination, trustees will require a different set of capabilities from their fiduciary partner. Expertise will need to be demonstrated, that a provider can be a complete partner, for the trustees, on the journey to securing member benefits. Having taken 15 of our clients through to completing their journey we have needed to pioneer, and develop capabilities as schemes near their end-game destination.
Key strengths in cash-flow driven investing (CDI), implementing dynamic discounts rates, income generating solutions and providing ‘live transactable' pricing for insurance solutions are all required in assisting trustees in completing that journey.
Finally we have tried to think about all of the slightly less obvious things that make trustees' lives easier, so that from a governance perspective the group can focus on first order strategic issues. For example having no need for separate custody agreements or investment manager contracts removes a lot of the day to day noise.
Over the next ten years we are unlikely to see the same investment environment as the past ten years, so some of the ‘norms' we have come to rely on will need to be challenged. For example going forwards real diversification may well become increasingly important.
Tony Baily: Delivering strong and stable funding improvements isn't just about growing the assets, it's also about managing the scheme's liability risks. Therefore, trustees may want to choose a fiduciary manager who has expertise across both investment and actuarial matters. Such a fiduciary manager is well placed to provide a holistic view around scheme funding, drawn from a deeper understanding of the interplay between the assets and liabilities. This is where providers with a consulting heritage have an edge.
When considering fiduciary managers, it's important to understand who is delivering each aspect of the solution. To deliver a market-leading solution, there are a range of components that the provider needs to assemble (e.g. strategy advice, asset allocation, liability-driven investment, manager and stock selection). The extent to which these are delivered in-house or externally varies across providers. This has a significant impact on the solution provided.
Some fiduciary managers carry out many of these activities themselves. The benefit is an integrated approach. However, it holds the risk that trustees get a standardised solution based on that fiduciary manager's capabilities rather than accessing the full market.
Other fiduciary managers offer an open architecture model, which accesses best-in-class ideas for each investment component. Accessing the full range of ideas needs significant capabilities and resources. To deliver this, without seeing an increase in costs, requires the fiduciary manager to have significant scale and negotiating strength.
Trustees looking to secure their members' benefits with an insurance company should consider a partner who can provide advice on all aspects of the journey to buy-out, rather than just the investment elements alone. For some schemes, the endgame may be closer than they think after considering current market pricing and the impact of potential liability management options. This should be reflected in the assets held, both to move more closely in-line with the buy-out premium and to minimise the transition costs.
Ultimately, trustees are looking for a long-term partner in their fiduciary manager, and so it's important that the provider continues to innovate and develop. In response to pension schemes' needs, we are working with our clients to deliver new and enhanced solutions across different areas including impact investing, real assets, and transparency of costs and performance.
Neil Walton: The range of fiduciary managers in the UK varies significantly. We see three broad groups: firms that have expanded their consulting activities into implementation and portfolio management; firms that have grown from multi-manager platforms; and firms that have expanded their investment management skills into a full fiduciary management service.
Alongside these different business models, there are several areas in which providers differentiate themselves: their approach to risk management; their investment philosophy; the cost structure of their approach; and their relationships with clients.
Managing risk is absolutely key to all aspects of investment management. A fiduciary manager should be able to demonstrate a strong balance sheet and the resources to continually invest in their systems.
From a wider investment perspective, there are a number of differentiators. Some key examples of this are: whether the fiduciary manager adjusts portfolios dynamically over time; their philosophy on managing liability risks; their use of active, passive or systematic exposures; and the role of alternatives in the portfolio.
Another important differentiator is the cost structure of the solution, how effectively the ‘fee budget' is allocated across different asset classes, and the mix of internal and externally managed strategies.
Finally, but equally as important, fiduciary management is at its heart a partnership, and it is important to understand how each fiduciary manager approaches that relationship.
To what extent can a trustee board conduct a fiduciary manager tender on its own? How can third-party evaluators or advisers help?
Tim Banks: Obviously this is an individual choice, with the base requirement to get three quotes on a best endeavours basis, and we are aware of a number of schemes that plan to do this themselves. It may be that they are happy with the existing relationship, or that a professional trustee on the board can lend assistance.
Appointing a fiduciary manger is a complex exercise, and in our experience a third-party evaluator (TPE)/adviser with specialist knowledge of the fiduciary market is well placed to shine a light on the issues that really matter for each trustee group. Ensuring that the service is future proofed to your changing requirements.
One of the issues we come across frequently is comparing ‘apples with apples', whether that be fees, or market return assumptions or risk numbers. TPE/advisers work hard to understand the different components of the various providers and provide a true and fair comparison for trustee consideration.
Tony Baily: Deciding whether to use a TPE is very much a scheme-specific decision. It really depends on whether the trustees and sponsors of a scheme have the resources to be able to run a selection process themselves and if they feel confident in doing so.
We are increasingly seeing TPE being used to support all or part of the fiduciary provider selection process across schemes of different sizes. This ranges from providing an independent, professional view on solutions being considered by trustees, to conducting governance reviews at the outset to establish clients' requirements and determining which providers might be best placed to meet these. In instances where there is a professional trustee on the scheme, we sometimes see them carry out this role or run the selection process.
Neil Walton: A fiduciary management tender involves delegating a significant portion, potentially all, of the scheme's investments to a provider who, if chosen well, could be your partner throughout your journey to self-sufficiency or buy-out. Therefore, clearly, choosing the right fiduciary manager is a very important decision, and not something to be taken lightly.
We think that in most cases trustees can benefit from the help of a well-informed adviser who understands the market and has experience in running tender exercises. An adviser can help you to run a clear and well-governed selection process, including the up-front work to consider the most important issues. Whilst there is a cost associated with seeking this help, trustees should consider the magnitude of the long-term benefits of selecting the right provider.
What are your top tips for a successful tender process?
Tim Banks: This is a question probably better answered by third-party evaluators!
From our point of view, being clear about the next phase of your journey, and understanding what capabilities and expertise you're looking for from a partner is the key. Trustees will need a partner that can build, react and innovate as your strategy evolves.
Tony Baily: If you want a fiduciary manager to create a unique solution that is tailored to your needs and objectives, the more guidance you can provide at the outset, the better. For example, providing background information on the scheme; your desired endgame and timeframe for achieving this; your beliefs and tolerances for different assets and the level of service that you would like. Whether or not you use a TPE, we would still encourage trustees to remain fully involved throughout the tender process.
Neil Walton: Be clear about your selection criteria from the outset. This will help managers to provide you with the most relevant information, and will make your decision-making process easier.
Provide as much information about your arrangements as possible. No two schemes are completely alike, and the more information you provide, the easier it is for providers to tailor their solution to your needs.
Keep an open mind, and be prepared to challenge your beliefs. For example, trustees who are used to a traditional investment consulting model may have a tendency to focus on manager selection as a key criteria in choosing a fiduciary manager, whereas at Schroders we believe that total scheme risk management and a focus on asset allocation are more important to the overall outcomes for our fiduciary clients.
Really get to know your shortlisted fiduciary managers before making your final choice. Ensure that you meet the people that you will be working with. We find it helpful to invite trustees to our office to see the environment in which we work and to meet more of the team: this helps the trustees to really get a feel for our culture and working practices.