Generally speaking fiduciary management involves outsourcing of the day-to-day management of a pension scheme to a lead manager with a high degree of transparency so that the manager's decisions can be easily scrutinised and overall control is retained by the trustee board.
This enables trustees to focus attention on the key strategic issues that affect the pension scheme and ensure its long-term goals are met. Effectively, implemented fiduciary management offers a pension scheme the potential for improving its governance and, ultimately, its funding ratio. In practice, fiduciary management can take many forms - from the outsourcing of a specialist segment of the portfolio, e.g. alternatives or distressed debt opportunities, to a full strategic partnership with a fiduciary manager.
This flexibility is also reflected in the terminology. While fiduciary management is generally accepted as the industry term, some providers use alternative terms such as solvency management or variations on the term implemented or delegated consulting.
Why now?
Fiduciary management was pioneered in the Netherlands, one of the world's
most sophisticated pension markets, at the start of the decade, with the first significant fiduciary management arrangements being set up from 2001-2002 onwards. Since then, fiduciary management has completely transformed the Dutch pension industry and is now increasingly being exported to other defined benefit markets. Specifically, in the wake of the recent market dislocation, we are now seeing UK pension schemes re-assess their management and governance model. In many cases, this is leading schemes to move towards fiduciary management.
How can fiduciary management help schemes?
So what are the most common reasons schemes give for adopting a fiduciary management approach?
- Need to improve the timeliness of the implementation of investment strategy;
- Lack of resources to deal with the increasing complexity of investment strategies;
- Need for a higher level of diversification and commensurate risk analytics;
- Governance and compliance have become more challenging accompanied by more demanding regulations and reporting requirements;
- Heightened awareness that strategic asset allocation cannot be divorced from prevailing market valuations and that, on an ongoing basis, the strategic mix may need to be altered to reflect medium term opportunities; and
- Need for increased help with manager selection, particularly in the area of alternatives where dispersion of returns can be significant.
Fiduciary management can address each of these different challenges as the fiduciary manager can act as the scheme's in-house manager without any of the limitations in terms of resource and expertise. In reality, the extent to which this is achieved will depend on the capabilities of the specific fiduciary manager. We believe, however, that there is a growing consensus that effective fiduciary management arrangements should have the following key characteristics:
- holistic, looking at the entire scheme rather than trying to fix individual components;
- customised, reflecting the specific challenges of the scheme;
- flexible, catering for the changing requirements of the pension fund;
- based on a partnership approach, between board, provider and independent advisers; and
- unbiased, potential conflict of interests have to be identified from the outset and effectively managed, preferably with the help of a genuinely independent adviser.
Implementing fiduciary management
Scope
As a first step, trustees need to be clear on what they want to achieve and adopt the most suitable approach taking into account factors such as:
- Role of external consultants and other advisers;
- Level of sophistication of investment committee and the wider trustee board;
- Amount of time that the investment committee and the board wish to spend on the strategy process;
- The expectations of the role of fiduciary manager, including the level of educational support, advice and analysis that is required; and
- Level of day-to-day control the scheme wants to retain, for example trustees may want to be able to veto a manager selection.
2) In-depth analysis
An effective fiduciary programme should capture all the interdependencies involved with managing a pension and be really tailored to the scheme's specific needs as highlighted by the diagram below. The cornerstone of the programme should be an in-depth analysis of the scheme's specific circumstances and objectives, undertaken in close consultation with the scheme's board and advisers, on which the other essential building blocks such as asset allocation, risk management and portfolio implementation can be built. As the scheme's objectives and the regulatory and market environment will naturally evolve over time, it is also essential that the chosen approach is flexible in nature.
3) Risk management
We believe it is important to single out risk management as a separate component. After all, improved risk management is at the heart of the fiduciary proposition. The recent credit crisis has served as a cruel reminder of how vital good risk management is. Having the appropriate risk management capabilities has evolved from a ‘nice to have' via ‘a must have' to a ‘must have the best' feature. Indeed, having comprehensive and in-depth risk management is one of the key attractions of fiduciary management for both schemes and sponsors. Consequently, any successful fiduciary management assignment should involve the provision of holistic and timely risk management information with a clear rationale for each risk position. In essence, trustees want to ensure that all risk positions are deliberate, diversified and appropriately scaled within the total portfolio context and subject to regular monitoring.
4) Due diligence
As well as the above mentioned risk management capabilities, Trustees and their advisers need to ensure that the chosen fiduciary manager has the necessary breadth of the skill, including the ability to:
- advise on strategic decisions, including benchmark, based on in-depth understanding of scheme's objective and liabilities;
- proven capital markets and asset allocation expertise; and
- take full responsibility for day-to-day management and overall performance of the scheme, including selection and monitoring of external managers and
- genuinely tailor the fiduciary arrangement to changing needs.
5) Monitoring
Schemes that set up a fiduciary arrangement should also ensure that the provider can offer comprehensive and integrated reporting so that the investment committee is at all times fully apprised of the scheme's strategy. However, to ensure appropriate control and monitoring, schemes may also want to consider the use of a genuinely independent third-party adviser.
6) Managing conflicts of interest
As ultimately the trustee board retains responsibility for the overall strategy and performance of the scheme, we believe it is good practice to establish clear guidelines from the outset that identify respective duties and potential areas of conflict. One area of particular concern is the selection of external managers. The best practice in this area we believe is the open managed architecture pioneered by some of the largest and most sophisticated institutional investors in the world. It basically ensures that a pension scheme achieves the most cost-effective blend of manager skill. However, we believe that to be effective this process has to be highly transparent and based on pre-agreed guidelines and alignment of interest
7) Costs
Having a single party accountable for the design, implementation and oversight of the scheme's investment activities not only improves overall quality of the governance, but also means the board spends most of their time on the long-term, strategic objectives. In effect, fiduciary management means a more professionally run pension scheme where the day to-day investment business is managed on a holistic basis by investment professionals, overseen by the board and their independent advisers. While a more professional approach may entail greater costs, these should be outweighed by a significant improvement in the risk-adjusted performance on a net of fees basis.
8) Measuring results
So how do schemes know their chosen fiduciary management approach is yielding results? Implementing a fiduciary approach is a long-term strategic decision and therefore benefits will take time to materialize. However, a number of criteria can be met in a relatively short timeframe and serve as a touchstone for the ultimate success of the fiduciary management programme. They include improvements such as:
- Time and cost efficiency gains
- More focused asset allocation
- Better risk controls
- Greater transparency and accountability
- More educated and knowledgeable pension board
- More supportive sponsors.
Ultimately, effective fiduciary management is about delivering good risk-adjusted performance net of all fees in line with the scheme's objectives and risk tolerance. In practice, performance should be derived from multiple sources including strategic asset allocation, tactical market and style allocation, manager structure and the use of risk analytics.
Contact
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Data and views as at 15.02.10. Issued by BlackRock Investment Management (UK) Limited (authorised and regulated by the Financial Services Authority). Registered office: 33 King William Street, London, EC4R 9AS. Registered in England No. 2020394. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. BlackRock is a trading name of BlackRock Investment Management (UK) Limited. This material is for distribution to Professional Clients and should not be relied upon by any other persons. Any research in this document has been procured and may have been acted on by BlackRock for its own purpose. The results of such research are being made available only incidentally. The views expressed do not constitute investment or any other advice and are subject to change. They do not necessarily reflect the views of any company in the BlackRock Group or any part thereof and no assurances are made as to their accuracy.
