Managing expectations

Choosing investments is hard; choosing fund managers is probably harder still - no wonder some trustee boards look to “experts” to take these decisions for them says Ken Willis, partner in the LCP Investment Consulting practice

Ken Willis
Ken Willis

Many people ask whether there is a difference between fiduciary investment management and implemented consulting. I would say not really, they are both forms of asset management. The two names have arisen because of the different providers in the market. Whilst traditional fund management firms tend to refer to themselves as fiduciary managers, investment consultants tend to refer to what they offer as implemented consulting. The two names have perhaps led to some confusion about what is involved. It is tempting to think of “implemented consulting” as taking a traditional investment consultant but allowing them a bit of power to actually turn their advice into action. The “consulting” makes it sound like a two-way process with the decisions still being taken by the trustees. In reality, “fiduciary investment management” perhaps better fits the bill as the manager actually takes control of these assets and the trustees rely on the manager meeting their expectations.

So what is fiduciary investment management? It involves pension scheme trustees outsourcing the majority of investment decisions, including the choice of asset classes and the selection of fund managers. The main argument for this is that it allows more tactical decision making, outside of the traditional trustee governance process.

Trustees who do appoint a fiduciary investment manager are delegating a lot of decisions, but still retaining the ultimate responsibility, along with the sponsor, for the performance of the investments. Essentially the trustees’ decisions are just moved one layer back, but it is a crucial layer: How do they select the right provider? How do they gain comfort that any investments are being managed in the long-term interests of the beneficiaries? What controls do they wish to put in place? How is investment performance to be monitored? And by whom?

But I believe that most importantly, how is risk encapsulated by this approach? Unless a scheme is fully funded on a no-risk basis, the trustees, and importantly the sponsor, need to understand that there will always be a risk of underperformance compared to the funding plan. Typically, trustees and sponsors therefore still retain this hardest, and most important, of decisions – the high-level strategic decision as to the balance of risk and the level of investment return to target. Herein lies the inescapable truth: fiduciary management is not a magic bullet. The path to securing liabilities in full involves taking on risk to generate the required returns. It is not for the fiduciary manager to decide how much return is needed, nor how much risk is appropriate; that is down to the trustees, and the sponsor, in conjunction with their traditional investment consultant and their actuary, and nowadays their covenant adviser.

Although being benchmarked against the scheme’s liabilities sound good, there may be other factors to consider. Conflicts of interest could arise, for example. Fiduciary investment managers might be paid performance fees based on short-term performance, meaning that they will be focused on adding value in the short term and may be less inclined to take longer-term “thematic” positions.

Unless a scheme is fully funded on a norisk basis, the trustees, and importantly the ponsor, needto understand that there will always be a risk of underperformance compared to the funding plan

Many fiduciary investment managers also have very limited past track records in this area, so the approach they adopt may not generate the hoped for performance. Indeed, only a very small handful of traditional managers have demonstrated the ability to consistently deliver 2 to 3 per cent pa over their benchmark for a sustained period, so trustees should decide how much confidence they have in the fiduciary managers being able to achieve it.

Where fiduciary investment management is appropriate, it does throw up the difficulty of monitoring. Typically, due to the balance of risk taken and the more complex nature of many fiduciary mandates, it is often difficult to assess how successful a fiduciary manager has been. Therefore, increasingly, schemes that use fiduciary managers need to appoint additional specialists to monitor and advise them on this aspect, adding additional costs and another layer of advisers.

But I believe that the benefits that fiduciary investment management may offer could perhaps be incorporated into a pension scheme’s investment arrangements by other cheaper and simpler ways. Helping trustees and sponsors make better, more timely and efficient investment decisions doesn’t necessarily mean outsourcing everything. A decent investment sub-committee with proper delegated powers and direct and plain English advice might achieve the same results.