Fiduciary management (“FM”) is acknowledged by some as being an efficient way to run a pension scheme’s investment strategy, especially one constrained by limited governance and administrative resources. FM is widespread, with around 900 UK defined benefit pension schemes representing £172 billion1 of assets using fiduciary managers.
What if there was an alternative, cost-efficient solution through which Trustees could retain the same feeling of transparency and control over their investment strategy as the “traditional” consulting model but with a lower governance burden? Maybe not a “new”, but instead a different, “best of both worlds” perhaps?
Whilst FM may be a good solution for some schemes, there can be conflicts of interest inherent in the model. One such example is that fiduciary managers may earn higher fees from the investment of client money in their own funds rather than third-party funds. So, what is the alternative, you ask?
One such route we have found can work very well, especially for governance-constrained pension schemes, is that of traditional advisory plus an implementation manager (“IM”). An IM provides the operational benefit of a FM (mainly through managing asset transitions, hedge rebalancing as well as managing and implementing pre-determined triggers) whilst strategic asset allocation and manager selection decisions remain with the Trustee.
A comparison summary can be seen in the table below:
Utilising the traditional advisory route plus an implementation manager enables the Trustees to have greater control over the detail of their investment strategy and of manager selection, whilst minimising the governance burden by delegating asset transactions to the implementation manager. For example, the implementation manager can undertake asset rebalancing, manage transitions, and monitor and implement triggers using instructions set out in their Investment Management Agreement (“IMA”). The implementation manager is often also the Scheme’s LDI manager to maximise operational efficiency.
Making the switch can be more efficient than you think
We were recently appointed by the Trustees of a pension scheme who approved our proposal to unwind their existing FM mandate in favour of this “new” best of both worlds approach by combining our investment advice with the services of an implementation manager.
Our remit over the course of last year was to:
- Work with the Trustee to help articulate objectives and constraints – to help frame investment decisions. The Trustees agreed a new long-term investment objective.
- Agree the appropriate asset allocation changes and advise on the selection on an implementation manager and third-party managers to implement these changes.
- Set up the implementation manager mandate, including the asset allocation, hedging, rebalancing, monitoring and de-risking trigger instructions. Oversee the unwinding of the FM mandate and transition to the implementation manager structure (including the transition to a new custodian to support this structure).
These substantial changes were completed in a relatively short time frame (8 months). The key investment milestones of the transition are listed below.
In order to meet the new long-term investment objective and stay within risk limits, the new strategic asset allocation involved turning over 93% of the portfolio. Key points of this strategy include:
- Increased interest rate and inflation hedging to bring hedge ratios in line with the Scheme’s funding ratio. Since the increase in the Scheme’s hedging, long-term interest and inflation rates have fallen by c.70bps2 (July 2019 to March 2020) which would have caused significant funding level deterioration had the Scheme maintained its previous materially underhedged position.
- Reduction in the Scheme’s equity exposure from c.37% of assets to c.18% to reduce the concentration of equity risk. Global equity markets fell by c.20%3 in Q1 2020: this would have caused a c.7% funding level drag from equity holdings alone had the Scheme maintained the same passive equity exposure. Instead, our initial analysis suggests that the Scheme only suffered a c.3% funding level fall in Q1 2020.
- Reduction in the number of asset manager mandates from 15 to 7, reducing the governance burden on the Trustees.
- Overall reduction in fees paid by the Scheme when comparing FM with IM plus traditional advisory, with a c.35% increase in expected return targeted by the new investment strategy.
- Implementation of a more diversified strategy to reduce investment risk to a level that stakeholders were more comfortable with. The stark improvement in the investment strategy’s risk/return efficiency can be seen in the funding ratio-at-risk charts below4. The new strategy has increased expected returns meaningfully, from Gilts + 2.1% to Gilts + 2.8%.
Redington has helped us to make a complete overhaul of our investment set-up and strategy. Redington managed a multi-layered process with efficiency and we are extremely pleased with the shape that our investment strategy is in. The move from Fiduciary Management back to a “traditional” advisory model plus Implementation Manager has given us greater clarity over the investment strategy and ensures that we are still focused on what matters.
Chair, Investment Sub-Committee
Can this work for your scheme?
We have had many clients that use an implementation manager, or elements of the implementation manager service. These schemes are typically the smaller or medium-sized, resource-constrained schemes (<£500m AUM), and who often therefore benefit the most from this set-up. However, this approach also works well with larger, multi-billion pound schemes. For this reason, we have a “preferred list” which provides suitable managers across the spectrum of scheme size.
We believe there is a clear opportunity for schemes across the board, whether they employ a fiduciary manager or are currently working with the traditional advisory model, to consider the use of this “best of both worlds” approach to helping the Trustee most efficiently achieve their long-term objectives. Should you have any questions or wish to discuss this further, please do not hesitate to contact your dedicated Redington consulting team or myself.
1 Annual 2019 KPMG U.K. fiduciary management survey
2 Source: Reuters
3 Source: Reuters
4 1 year, 95th percentile funding ratio at risk. Charts show contribution of investment risks to overall scheme risk, expressed as the impact on scheme funding ratio in a downside scenario.