Easing pension pain

Tuesday, 01 December 2009
How a fiduciary management approach can ease pension pain for family-owned businesses.

Over the last 18 months, global markets have experienced unprecedented volatility. As a result, companies have experienced massive job cuts, ballooning pension deficits and have had to make tough decisions including diverting cash, originally intended for reinvestment in the business, to the pension scheme. Earlier this year, for example, the BBC announced that it was cutting its programming budget in order to fill a GBP2 billion hole in the pension scheme (Guardian, July 2009). Pension deficits are a problem facing companies of all sizes across the industry, including family-owned businesses. In July, it was reported in research by Lane, Clarke and Peacock that the combined pension deficit of the companies that make up the FTSE 100 had doubled to GBP300 billion.

The unprecedented market volatility is not the only challenge facing company pension schemes; rising deficits have combined with other factors, such as: changing legislation, increased focus on governance and rising complexity of investment products, to create a perfect storm for pension fund trustees. Trustee concerns are demonstrated in a recent survey amongst pension scheme decision-makers, where one third of those surveyed reported that they were concerned about the required resources necessary to properly manage the pension scheme.

Although the market volatility of recent months may be dissipating, pressure on company pension funds is not going to go away and it may be time to look for a different decision-making process that allows trustees to delegate the day-to-day management of the pension scheme in order to focus on strategic objectives, such as the scheme’s asset allocation. A new concept for the UK pensions market that fulfils these objectives is fiduciary management.

Defining fiduciary management

Fiduciary management can be defined as an approach to pension scheme management which focuses on achieving long-term funding goals by providing both day-to-day investment management and investment advice that links both assets and liabilities.

The approach enhances pension governance and may increase the likelihood of achieving funding goals by delegating the risk management, investment advice, implementation and oversight of the scheme to one provider, the fiduciary manager.

The concept of combining investment strategy, advice and implementation from one provider has been in existence in the US for many years under the label of pensions outsourcing. Multiple US firms, including many family-owned businesses, have already embraced the approach, recognising the benefits of a process that allows them to focus on strategic objectives while outsourcing the day-to-day management of the pension fund to a team of experts.

The first country in Europe to embrace fiduciary management was the Netherlands, where it is estimated that over 72 per cent of pension fund assets are now managed on a fiduciary management basis (Bureau Bosh, 13th annual review of the Dutch fund management industry, 2008).

So why is fiduciary management becoming popular in the UK now? We have already identified at the beginning of this article how multiple factors, from markets to legislation, have come together to create the perfect storm for pension funds, but overlying this challenging environment are the shortcomings of the current decision-making process. The critics of the current system, including many trustees themselves, would say that modern pension scheme investment in the UK has outgrown the capabilities of a board of lay trustees, who are expected to manage millions of pounds in assets on the basis of quarterly meetings, the advice of an investment consultant and perhaps an investment sub-committee. It is recognised that a more proactive and accountable approach is required and it is against this background that fiduciary management is now emerging as an approach that can offer a more robust model for investment decision-making.

What are the benefits?

A fiduciary management approach has four key benefits when compared to the traditional consultant model. In the traditional model, the pension fund has to engage with multiple advisors managing and interpreting different and sometimes conflicting advice and implementation. When advised by a fiduciary manager, the trustees have a single point of contact for managing strategic advice, transition management, manager oversight and monitoring, all the way to performance reporting. This single contact point can help to integrate the specialist advice given to trustees. Fiduciary management can also prove to be both time and cost effective, allowing the board to focus on longer term, strategic issues that directly impact the outcome of the pension fund, such as strategic asset allocation. In a study conducted by Gilbert L Beebower and Gary P Brinson, they discovered that 92 per cent of investment return was driven by asset allocation decisions when analysing pension scheme returns from 82 large pension schemes. (Determinants of Portfolio Performance, Financial Analysts Journal, May-June 1991).

In addition to helping provide focus on achieving goals, trustees benefit from increased transparency and efficiency through the use of one asset-based fee for all services. Using a fiduciary management model allows trustees to be more nimble in their decision-making process from a starting position where investment decisions might only be taken on a quarterly basis to one where they can be taken proactively. Long-term pension scheme goals set by the trustees can be evaluated in light of critical movements in the market and decisions can be made quickly to better align the scheme to meet its goals.

Fiduciary management also provides management of both scheme assets and liabilities that can lead to an improved funding status. This approach ensures that, once the risk budget has been decided by the trustees, the asset allocation and risk management can be designed and implemented with the goal of ensuring that both current and future liabilities are met.

In summary, there are four key benefits to fiduciary management:

  • Simplification and integration: Bringing all the resources together in one place and providing guidance on the way forward
  • Time: Delegation of day to day tasks allowing trustees to focus on strategic issues
  • Cost: Transparent pricing via an integrated fee for advice and implementation
  • Accountability: One partner directly responsible for managing the funding level and manager monitoring and replacement decisions

Some of the UK’s best known brands, such as Habitat and East of England Cooperative Society, have already taken the decision to appoint a fiduciary manager and it is clear that over the next few years this trend is set to continue. For trustees of family-owned firms, fiduciary management could offer a life line, providing the ability to delegate the day-to-day management of the pension fund whilst retaining focus on the long-term goals of the pension fund and its members.

Author block
Patrick Disney

Patrick Disney is Managing Director Institutional EMEA at SEI.

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