The world is increasingly complex and continues to change at pace. With the growth of technology, information has become instantly accessible. Governments, corporates and individuals are showing increasing acceptance of a more open and accountable profile. One of the many examples where transparency improves our decision-making in everyday life is the food we buy. Specifically, food labels - providing not just the ingredients, but traffic-light style nutritional labels, the origins of the ingredients and information on the production process to help consumers make more informed decisions on what products to buy.
Across the financial sector, there has also been some improvement in the amount and quality of information available - Basel III and Solvency II both have a large impact of the level of reporting that banks and insurance companies respectively must comply with.
Transparency is equally important in fiduciary management. Fiduciary management can undoubtedly be a force for good by enabling trustees to enhance their overall governance resource. Where executed well, we find better strategic decision making, more effective implementation and improved oversight. No wonder we continue to see significant increases in fiduciary management appointments. As with any principal and agent situation however, conflicts of interest need careful consideration and management. One aspect of such management is ensuring there is appropriate transparency of information, particularly in areas where incentives could impact on the information disclosed by the fiduciary manager.
Fiduciary management is often presented for the right reasons as a ‘bundled service’, but this can hide a lot of underlying complexity in areas such as risk management, fees, costs, and performance monitoring. In our view, disclosure and transparency is essential if fiduciary management is to live up to its promises and build long term successful partnerships.
How are your assets being invested?
When appointing a fiduciary manager, one of the key concerns many asset owners have is the perceived loss of control. Our experience has been that there are significant advantages from trustees being able to focus more time on the key strategic considerations without being distracted by the vast number of moving parts inherent in managing a complex institutional portfolio. In order to focus time on strategic considerations though, we don’t think that there should be a lack of transparency in how a scheme’s assets are being invested on behalf of the trustees.
Disclosure should focus on the decisions that have been made and why they are viewed as being appropriate in the context of a client’s particular objectives and risk tolerance. For underlying assets, disclosure of what asset classes are being accessed, which investment management firms are being used and what costs are being incurred doesn’t seem unreasonable, but when internal funds are being used, such details can sometimes be lacking.
What value is your fiduciary manager adding?
Assessing the value added by a fiduciary manager is a vital question that often prompts debate. Establishing a framework for assessing the role on an ongoing basis is however hard and cannot be encapsulated in hard metrics alone.
Despite this, an important metric in assessing the role of any fiduciary manager is, of course, funding level progression relative to expectations, and measurement should be undertaken with an appropriate time horizon in mind. In addition, a consistent format should be used to enable trustees to understand the drivers of funding level change over time.
In addition, trustees should be in a position to understand how the fiduciary manager’s skill in portfolio construction, liability hedging and manager selection contributed overall. A fiduciary manager’s contribution to reduction in risk should also be assessed and there are a number of risk measures that can be used to monitor this. Trustees could also assess the portfolio’s performance against a simple portfolio of equities and bonds to test whether the complexities of a diversified and active portfolio has added value or not. The key point is that no single measure will provide a complete picture of the value that a fiduciary manager has added; a number of different measures should be used to paint the overall picture and to complement qualitative views on the service being provided. In addition to views on the quality of advice that has been provided on strategic matters, the efficiency of the operational infrastructure provided and, importantly, the communication and transparency provided to the trustees is key.
Fees and costs
When considering fees and costs it is vital to ensure that there is complete transparency of all costs that will be incurred in managing the portfolio under a fiduciary arrangement and to ensure that this is being compared on a like-for-like basis across providers. Underlying transaction costs are very difficult to monitor and compare on a consistent basis, but the following elements are under the fiduciary managers’ control:
■ Underlying investment manager base fees
■ Underlying investment manager performance fees
■ If fund of fund products are used, the underlying manager fees in such structures not just the FoF providers fees
■ Expenses embedded in pooled funds used to access underlying investment managers
■ Fiduciary provider base fee
■ Fiduciary provider performance fee
■ Any additional fees from the fiduciary provider for advisory services
■ Custody and administration costs
■ Independent performance measurement costs
■ Disclosure of any other costs or remuneration to the fiduciary provider such as legal costs, transition management fees or commissions, securities lending revenues or commission recapture arrangements.
In non-fiduciary structures a full understanding of all the costs being incurred in managing a fund on an ongoing basis is something we think would be beneficial for all asset owners to be aware of and this would then enable easier comparison with fiduciary structures. Only once cost differences are fully understood can a fair assessment of the value expected from a different governance approach be assessed.
It is vital to understand the fiduciary manager’s business model, why their particular fee structure makes sense for them and what incentives it could create. For example, an all-inclusive fee covering all management of the assets is simple to understand. However, it does not make it easy to see what fees are being paid to underlying investment managers over time and could create an incentive to invest in lower cost managers if the fiduciary provider is being compensated through the difference between the total fixed fee and the underlying manager fees.
Trustees should also consider how fees should vary through time as their scheme evolves. If a fee structure involves paying a higher fee for a higher risk portfolio, this in theory means that fees reduce as a portfolio matures, which may appear appealing, but does it provide an incentive to proactively raise and capitalise on de-risking opportunities?
Performance fees should be structured so as to reward true added value that is consistent with overall objectives.
The complexity in pension scheme risk management makes a delegated approach attractive, as schemes are able to benefit from investment opportunities and risk management techniques that it may not be able to otherwise. Whilst the ‘bundled service’ can bring a large number of benefits, it is easy for a lot of information to be hidden in this bundling process. Trustees need to have comfort that their fiduciary manager shares their beliefs and is aligned to the interests of the ultimate beneficiaries. Provision of clear, relevant information on a timely basis is key to building a trusting relationship. For this to be effective, fiduciary managers should seek to provide ‘unbundled disclosure’ on the positions being taken, results achieved and the costs incurred. Without disclosure, trustees could be picking a product off a supermarket shelf, oblivious to what is really inside.
Mark Davis is Head of Business Strategy, Delegated Investment Services, Towers Watson