 By Paul Francis, Director, JLT Employee Benefits
You never quite know what questions you will be asked as an investment specialist during a Trustee meeting, but lately there appears to be three queries which repeatedly arise, all of which concern the use of fiduciary management and all of which seem to be points of vexation for many Trustees. The first of these queries is simply, ‘What exactly is fiduciary management?’ As an industry, we are guilty of causing confusion here.
We ascribe a plethora of different names to fiduciary management, including Implemented Consulting, Delegated Consulting, Solvency Management or Managed Solutions; however there are some profound differences between each service provider’s approach.
Put in its most simple form, fiduciary management is when a service provider (an investment consultant or fund manager) is given discretionary control of some, or all, of a pension fund’s assets. But this, as good a definition as it is, is less than half the picture. If we look more closely at this definition, then a house that structures a multi-manager equity fund qualifies; so one could argue that fiduciary management differs little from a normal fund management mandate. However, ‘proper’ fiduciary managers manages the fund’s assets relative to the fund’s long term investment funding objective, following a flight plan to self sufficiency which is pre-agreed at the outset by the plan sponsor and the Trustees. Therefore, the terms ‘solvency management’ or ‘dynamic asset allocation’, to me, seems particularly poignant. Furthermore, the far more significant driver of pension scheme funding needs to be considered – the volatility of the fund’s liabilities to changes in bond yields and inflation expectations.
One common misconception is that fiduciary management entails the Trustee outsourcing the decision-making for an investment strategy to the fiduciary manager. While a delegated approach makes for the most efficient and robust implementation framework, many Trustees understandably prefer to have the final say over changes to the asset allocation of their plan’s assets. This approach calls for more on-going interaction between the adviser and the Trustee. I like to think of it as a proactive advisory approach, sometimes called Implemented Consulting. Interestingly, some pension funds that started using such an approach a while ago have since moved to delegate their investment strategy decisions, within an agreed framework, as they become more comfortable with the idea of outsourcing investment decision-making to a trusted third party. Confidence in the investment consultant is needed to make this move because, as Trustees know all too well, decisions themselves may be delegated but the responsibility for the decision cannot.
The second query from Trustees is usually along the lines of, ‘why should we go to the effort of formulating a derisking flight plan and paying to use sophisticated tracking tools of a plan’s funding level, when the consensus appears to be lower bond yields for longer, therefore less chance of a material improvement in the funding level for the foreseeable future and little chance of a major derisking opportunity?’ For one, the framework for derisking can take a while to put into place, and it is wise to ensure it is in place comfortably in advance of when it is needed. This includes the signing of the investment management agreement and moving the pension plan’s assets onto an investment platform. An investment platform that has been designed for institutional pension plans can significantly lower the fund management costs for each pension plan (via bulk-purchasing power gained through amalgamation of client assets) whilst providing efficient transition management. Also, it is not outside the bounds of possibility that a shock to the financial markets could push long dated bond yields lower and, for those Trustees with the stomach for the increased risk budget, this could provide a window of opportunity to increase risk by tilting the asset allocation towards return seeking assets.
The last of the three queries is, ‘given the above, what should we - as Trustees and sponsors - do to the plan now?’ If a framework for spotting investment/derisking opportunities and implementing them in an efficient manner is not in place, then should it be put in place? Most often the answer to this question is yes. Waiting for bond yields to rise materially, or inflation expectations to fall significantly, and thereby eradicating a significant part if not all of the average scheme’s funding deficit, is not, in my view, a credible position in the medium term. Yields are unlikely to go up quickly but, when and if they do, high levels of demand can be expected to act as a natural cap to the yields level. Trustees should manage their asset as hard and as efficiently as possible to help close the funding gap – and this is where fiduciary management can really add value.
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