Pension scheme relationships with asset managers are becoming more collaborative
Charlotte Moore examines how pension funds are looking to work with asset managers in different ways as the market evolves.
A combination of evolution and consolidation is changing the nature of the relationships between asset managers and owners. Intermediation is being replaced by collaboration.
In the past, regulation ensured the relationship between private sector defined benefit (DB) schemes and managers was controlled by the investment consultant. An asset manager's fortunes lay in whether it would be included in a buy list and how long it would remain there.
But, while there are still around £2trn of assets in DB schemes, it is auto-enrolled workplace and open DB schemes like the Local Government Pension Scheme (LGPS) which will grow the future wealth of current employees.
According to the government, the trust-based defined contribution (DC) market could grow from around £140 billion in 2023 to about £400bn in 2030 in real terms and overall assets in DC workplace schemes could grow to about £800bn.
The Pensions and Lifetime Savings Association estimates the LGPS is expected to grow to over £500bn of assets by 2033.
Becoming like other jurisdictions
This shift, along with increasing scale and consolidation, are now driving the UK to become more like pension schemes in those other countries – adopting a more collaborative approach to management.
Local Pensions Partnership Investments chief investment officer Richard Tomlinson explains: "The evolution of the UK's institutional market might feel new but, in other countries, strategic cooperation between asset managers and owners has existed for a long time."
In the US, Canada and Australia, asset owners have had long-term, deep connections with a handful of managers and built relationships.
"Rather than viewing their portfolio as a selection of funds, they instead think of it as a handful of strategic partnerships which last for an extended period," adds Tomlinson.
Workplace DC schemes are also changing as the larger master trusts reach the scale needed to embark on more sophisticated investment strategies and consider bringing investment in-house.
People's Pension deputy chief investment officer Phil Butler explains: "The growth of assets means larger sums of money can be put to work for scheme members and savers."
Changes are also emerging for contract-based schemes, those operated by insurance companies, where the investment universe is becoming broader as their assets grow, and the LGPS, where assets are also increasing and consolidating.
More flexibility
Automation has also played a role. "A decade ago, the same size of assets would not have bought you the same benefits– technology has lowered the threshold for certain projects," says Butler.
For example, technology allowed asset owners to move to segregated mandates because they can now be cheaper than a pooled vehicle. "These are preferable to a fund because they give the asset owner more control and flexibility," explains Butler.
These strategies allow asset owners to set their own responsible investment policy and their own exclusions – pooled funds cannot satisfy these conditions, adds Butler.
These changes mean the pensions industry is starting to build vertical integration between asset managers and owners. Tomlinson says: "Asset owners are starting to think more strategically with less reliance on external services."
Size also means schemes need to rely less on external advisors to make strategic decisions – many are being brought back in house.
And it also means moving assets in-house rather than have them held by third-party managers.
Butler says: "We now have the majority of our assets in-house which enables us greater control over what we do with them as well as giving us transparency which we can pass onto regulators and members."
Cultural change
The combination of wealth shift from private sector DB schemes to workplace DC and public sector DB combined with advantages given by size and scale mean there is a cultural shift taking place.
That will require a change in attitudes both from investment consultants and asset managers, with a focus on building a different type of relationship.
When most pension wealth was concentrated in private sector DB schemes, investment consultants were the gatekeepers who determined which strategy would be selected for the buy list.
While this meant strategies could be selected based on data and performance, this also encouraged a very transactional relationship because if performance slipped, the relationship ended.
Tomlinson explains: "Not only do investment consultants now have less influence over which asset manager gets selected, but also the quarterly pension fund committee no longer make all the investment decisions. Levels of delegation to staff are increasing."
In the past this could prove an additional layer of frustration for asset managers. Tomlinson notes: "The manager would have worked hard with the executive for six months to get approval only for someone on the board to veto the decision."
But today many of these decisions are now delegated to investment committees which avoids this issue.
DC stewards
DC master trusts want a similar future relationship with asset managers. Butler says: "We have nearly seven million members and we are stewards of their capital – we need to contribute to their financial future."
Now People's Partnership has moved away from pooled to segregated mandates, the bar is higher for asset managers. Butler says: "We are asking asset managers to run our portfolios and we need them to be our voice."
Many asset managers are not yet being vocal enough. "It's changing but it needs to happen faster," adds Butler.
On stewardship, for example, People's Partnership want their asset managers to be voting and making sure company management are listening to the key issues.
"It's about making sure executive boards do what they say they are going to do and if they don't, then raising the issue," says Butler.
There is a misconception this is the job of active managers but passive managers also need to take this role.
"Not only do asset managers need to collaborate with asset owners but also with each other to have the most effective voice," says Butler.
Opportunities as well as challenges
While scale and consolidation mean more asset owners will be taking management in-house, the shift away from an intermediated relationship as well as professionalisation of pension schemes does provide an opportunity for asset managers.
Tomlinson says: "We have deep relationships with many CIOs at asset managers – the lack of intermediation means it is now worth their while to invest in relationships with counter parts at asset owners."
But these deep relationships will not be possible for every asset manager – the very large and the very focused have a better chance.
Pools leading the way
For parts of the LGPS, some of these deep relationships between asset managers and owners are already in place.
Border to Coast head of external management Graham Long says: "The formation of Border to Coast, further developed the relationship between the underlying partner funds and asset managers."
This is not a transactional relationship. Long says: "We are looking for asset managers not to just to manage mandates but to provide full support − which they are more than willing to do."
Yet, the decision to appoint the manager will not be driven just by the service levels asset managers can provide.
Border to Coast head of alternatives Ian Sandiford explains: "When selecting, for example, a private market fund for investment, aspects such as investment strategy, team capability, track record, cost and portfolio fit would feature more highly than additional strategic relationship capabilities offered by the manager."
If, however, a pool is looking for a SMA – a self-managed account or a segregated mandate – a manager which can include some additional resourcing and support could help to win the mandate, explains Sandiford.
"While there are changes happening in the marketplace a move towards a longer, more strategic relationship, it's not going to happen at occur for all types of asset managers or for all strategies," he adds.
Service level expectations will also depend on the size of the manager and the resources they have at their disposal, says Sandiford.
The four asset manager models
Asset managers can be thought of as having four different business models – there are the mega-managers, the muddled-middle, the multi-acquiror and those with marked clarity.
The so-called muddled-middle have often been formed through multiple mergers and lack a coherent culture or vision
Tomlinson explains: "The muddled-middle will struggle to form deep relationships with asset owners as they lack a clear vision they can share."
There are, however, opportunities for the mega-managers. Tomlinson says: "These can become a big strategic partner helping asset owners with the resources to find an expert who can answer any question you might have."
Managers with marked clarity – either boutiques with specialist expertise or those with a clear focus in their approach to investment or sustainability – also have a good chance of forming strong relationships with asset owners.
Tomlinson notes: "Managers with a niche specialisation whether it is specialist knowledge of an asset class or a clearly defined sustainable investment vision will have plenty to offer an asset owner."
For example, if an asset owner wants to help fund UK productive finance by investing in technology venture capital, they are unlikely to hire a team to run direct positions.
"We would be more likely find someone who is specialist in that asset class and build a partnership that could deliver a sizeable investment," says Tomlinson.
Similar niche areas of interest could be impact or nature, he adds.
Multi-acquirors – asset managers that build scale by buying smaller asset managers and offering centralised services – have a less obvious path to building a deep relationship with asset owners.
Tomlinson explains: "I'm not sure how to treat multi-acquirors; who do you have the relationship with – the corporate entity or the individual asset manager?"
Charlotte Moore is a freelance journalist
