The third paper ’Selecting Fund Managers and Consultants - What Do Trustees Look For?’ puts the relationships between trustees and their fund managers and investment consultants under the spotlight and gives insights into the interactions which are fundamental to the investment processes of pension schemes.
The wide-ranging research, led by Dr. Iain Clacher, Associate Professor in Accounting and Finance at Leeds University Business School, is based on 197 mainly defined benefit (DB) trustees and scheme managers in the UK, representing schemes ranging from those with less than £15m under management, up to those with more than £5bn, with 60% having assets under management of between £100m and £2.5bn.
This paper is in two parts; the first examines what trustees look for in their fund managers and aspects of fund manager selection, while the second looks at trustees and investment consultants.
Key insights
- Trustees focus on risk-adjusted performance and most retain a longer-term view
- Large scheme trustees place greater emphasis on investment philosophy, decision-making and risk management
- Small scheme trustees focus more on past performance, costs and fees, fund size, firm size and volatility
- 64% of trustees review investment strategy annually and 57% review their investment managers annually.
- What trustees value in investment consultants varies – especially by size of scheme
- Irrespective of scheme size, trustees look to consultants for clear advice, understanding of the scheme and its goals, and risk management advice
- Trustee/consultant interactions are complex and often scheme specific
John Belgrove, senior partner at Aon Hewitt, said: “This, the third of our research papers with LUBS, is no less revealing than the first two. One clear insight is around the impact of scheme size on how a trustee views their task. In this context, size brings power and the ability to be selective – which is not present with smaller schemes. This can allow the larger scheme to use the asset management industry in a more solution-focused as opposed to product-focused way.
“However while all trustees naturally expect investment performance delivery from their fund managers, the key tasks of their consultants are more varied.”
John Belgrove continued: “We found that trustees of different sized schemes look for very different things from their consultants, meaning it is hard to pin down a generalised statement of ’what trustees look for in their investment consultants’. A larger scheme may use its consultant for, effectively, a compliance check, or as a sounding board or as a bringer of new ideas. With a smaller scheme the relationship is different, with a greater reliance to be led or guided – reflecting their lesser resources.
“There were also interesting comments on the trustee/consultant relationship and the way consultants can be seen as ‘tailoring’ advice to scheme’s trustees. This is surely a key part of how they can work together; trustees value consultants who really understand their goals, so investment consultants are more likely to give their advice or offer suggestions which they believe fit with those goals and the known attitudes of the trustee board. One unintended consequence of such mutual understanding is that tailored advice is less likely to be challenged.”
Dr Iain Clacher, Associate Professor at LUBS said: “One of the most informative parts of the research was talking to trustees. When asked ‘How would you describe value in the fund management process – what is it you pay for?’ they succinctly summed it up as, ‘we pay for alpha, not beta’. However, in seeking the best performance, trustees made it clear that it is also about governance and the balancing of risk and return as well as the monitoring of these two factors. It is not enough to produce alpha by excessive risk-taking, as this does not fit with trustees’ focus on investment strategy.
“In examining why trustees change their fund manager, the key drivers stated were changing investment strategy and de-risking, followed by past performance. This was not as predicted, as past performance was expected to dominate decision-making. As well as this, most trustees said that when past performance was being considered, just under half of the sample (48%) said they looked at the past three years of performance. Trustees are, therefore, willing to give fund managers a reasonable time-period to start to generate performance - which shows trustees recognise that a fund’s investment strategy is not something that generates returns overnight.”
Iain Clacher continued: “In looking at the relationship between trustees and investment consultants, the research demonstrated that smaller schemes are more reliant on their investment consultant than larger schemes, which is understandable given the resource constraints they face. However, in the case of the small proportion of schemes - of all sizes - who say they are totally reliant on their investment consultant, this is a real concern.”
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