Nick Wyld asks pension funds to look beyond the name and explore how governance can help with increasingly complex asset allocations

The pension fund investment industry is a fantastic marketplace for service providers to peddle their wares. They invent solutions to problems that trustees never knew existed, they re-engineer products, slap on a new label and double the cost, they trip over each other in the race to offer the next
must-have state-of-the-art service or product. This is perfectly understandable. Pension funds are big business and their advisers, be they investment managers, consultants or any other service provider, are commercial entities and not charities.

Governance is a word increasingly being bandied around in this context and, like hedge funds in the early 1990s, not everyone is sure what it is. It means different things to different people and "experts" are appearing
all over the place. However, it is imperative that trustees do not dismiss governance as another fad designed to relieve their pension
funds or sponsors of cash. There is a risk of getting distracted by the word itself and losing sight of the concept.

Whatever we call it, the issue is the effective running of pension funds and, for investment governance, the robustness of the decision-making platform and implementation process to enable assets to be effectively invested in a risk-controlled manner. Assessing governance only really requires common sense and introspection. However, it is actually very difficult to objectively review one's own decision-making capabilities and, therefore, the use of outside help can be worthwhile. After all, who admits to being a bad driver?

The key to good investment governance is recognising and taking steps to address one's limitations, generally a function of two variables: capacity and capability, i.e. the amount of time, resource, understanding
and expertise that trustees have at their disposal. Any gaps in this governance “budget” should be addressed – surface cracks may simply require existing resources to be more effectively used while serious gaps may necessitate a more radical overhaul. However, time and money spent on this is likely to be repaid many times over through more effective investment strategy formulation, implementation and results.

Governance should regularly appear at the top of trustees’ investment agendas to promote decisive debate and action, not navel-gazing and routine deferral to the next meeting. This discussion relates to the effectiveness of the overall chain of command and a key consideration is whether, which and how investment decisions should be delegated to third parties. In the old days of balanced fund mandates, delegation was very straightforward; appoint a single discretionary investment manager, one that came with its own integrated custodian, and judge success against the WM/CAPS Survey returns. Those were the days – funds were in surplus, contribution holidays were the norm, trustees and sponsors were happy, investment managers and consultants knew where they stood. Because the jigsaw puzzle was so small, it was easy to put together and to spot any missing or damaged pieces.

But was it really straightforward, or did that simplicity actually result in insufficient accountability, inadequate transparency and investment mediocrity? Suffice to say that although the "one stop shop" approach was very convenient for everyone, convenience and compromise often went hand-in- hand. In reality, there was a herd mentality to asset allocation and
many trustees and consultants rarely looked much beyond the UK equity component of their portfolios. And balanced managers were
rarely, if ever, able to display genuine investment expertise across all asset classes. Not exactly a testament to good governance then.
The jigsaw puzzle has expanded in recent years and comprises many more pieces. Trustees increasingly have to contend with a roster of
equity and bond managers, active and passive, alternative strategies, transition managers, overlay managers, LDI managers, custodians and
so on. For many reasons, whether Maxwell, government, stock markets or demographics-related, pension fund investment has become far more sophisticated, specialised and complicated over the years.

This comes at a cost. The problem is monitoring the vast army of advisers and making changes when necessary, to both the strategic asset allocation and the underlying managers – requiring time and specialist knowledge which many trustees and pensions managers simply do not have. This may be addressed by additional resourcing, particularly for the largest pension funds where dedicated in-house CIO roles are becoming increasingly popular.

However, only a small minority of pension funds have that luxury and in recent years a number of "new" service providers have emerged to take over this monitoring and implementation role from trustees. In simplistic terms, two camps have evolved; fiduciary managers, including a number of investment managers who have started to take the lead on strategic investment issues previously driven by the investment consultants, and implemented consultants, where some consultants are increasingly involved in investment implementation that previously would have been exclusively the domain of the investment managers.

This should be a positive development, providing greater scope to make investment changes more effectively when the need arises and
to avoid missed opportunities, for example, in de-risking strategies
via the derivatives market. This is why some managers and consultants are moving centre stage, albeit from opposite sides, and embracing additional roles beyond their traditional remits. However, it does beg somefundamental questions:

- Do either investment managers or consultants have the complete package of skills required by trustees?
- Are there greater conflicts of interest within the new fiduciary management/implemented consulting model?

The answer to the first question is probably not today, but this is likely to change over time. Providing advice and options to trustees has been engrained into the DNA of some investment consultants and, psychologically, having to get off the fence and be the actual trigger puller is a very different game. Investment managers don't have this problem - their DNA allows them to buy and sell investments whenever they consider it appropriate. However, many investment managers only know about assets. They have been benchmarked in the past against market indices and have never really needed to truly understand the liability side of the pension fund equation. This could represent a significant challenge,
given the increasing importance of liability-driven investment, de-risking strategies and endgame management. Naturally both managers and consultants have been addressing their respective weaknesses by recruiting from the other side of the fence and, by implication, it will simply be a matter of time before the two are indistinguishable.

What about conflicts of interest? Well, in any principal-agent relationship conflicts and moral hazards abound, and fiduciary management/ implemented consulting is no exception. The list is endless and includes issues relating to equal treatment of clients, front running and best execution, capacity issues, double-charging, hidden fees and counterparty related issues. Essentially, all of the conflicts arising from traditional investment management plus all of the conflicts arising from traditional investment consulting plus one or two extra in bringing the two models together. Trustees need absolute clarity from the outset about what conflicts exist and should be entirely comfortable with how they
are addressed. The key word here is transparency.

There is a risk that issues relating to good business management, in this case the business of ensuring that pension fund assets are properly invested, get hijacked by jargon and marketing spin. Investment governance is about ensuring there are sufficient resources in place at all times to establish and maintain an appropriate investment strategy and an investment management framework that enables the strategy to be delivered. What is appropriate will vary from one pension fund to another and from one trustee board to another, including the degree of investment outsourcing or delegation. As the infrastructure and number of underlying investment managers grows it is perfectly reasonable that some trustees may wish to outsource its management. However, ultimate responsibility still lies with the trustees. They must ensure that the overall pyramid of delegation is carefully designed in terms of clear mandates and accountability, and properly monitored from the top down.

In conclusion, don’t worry what it's called – fiduciary management, implemented consulting, whatever. Trustees should focus on ensuring that they are getting clear and comprehensive professional investment advice across the range of their advisers, which can be acted upon
in a timely fashion, has no gaps and no material overlaps. If this isn't happening, they need to review the way they operate as a trustee board and their use of professional advisers. This is good investment governance.


Written by Nick Wyld, associate director, Muse Advisory

Share Story: