Articles - Improving Investment Governance & Fiduciary Management

 By Umar Ilyas, Actuary at Investment Solutions
 Governance is one of the most prominent features on the landscape effecting both corporates and financial institutions, alike. With the impending solvency II legislation for insurers, governance requirements are enshrined within the three main pillars underpinning the regulations.

  In the world of pension schemes (particularly DB schemes), trustees are coming to the realisation that the necessary governance needed in order to effectively look after a scheme’s investments, requires an adequate level of resources, time and expertise.  This includes the need for trustees to establish an effective and timely process for implementing changes to the investment portfolios, in order to meet their key objectives.

  In addition, for the majority of DB schemes, they are now well into their journey to the ‘end-game’. In order to better secure the members’ pension benefits the ‘de-risking’ process has to be managed more effectively. Whether this means focusing on a scheme’s technical provision funding basis or a more prudent ‘self-sufficiency’ basis, and eventual buy-out/in of the liabilities, the need for a good governance framework is a must.

  Improving investment governance

  Traditionally, pension schemes (especially small to medium sized schemes) have been limited by their inability to respond quickly to changes in investment markets to capture opportunities on behalf of their members. Therefore, over the past few years, interest has been growing to see how trustees can better meet their key objectives and the high level strategy, by extending their governance resources.

  Two such models (but by no means all), may offer a viable solution to help with governance requirements facing trustees - Implemented Consulting and Fiduciary Management. (Although there are other terminologies used to describe the different guises on offer such as delegated consulting, solvency management etc.). The key issue is to examine what exactly is offered under the ‘bonnet’ and how this helps the trustees.

  The rest of this article looks at some of the key differences between Implemented Consulting and Fiduciary Management.

  Implemented Consulting and Fiduciary Management essentially allow trustees to outsource some parts of the investment decision-making process to either an investment consultant, in which case it tends to be called Implemented (or Delegated Consulting), or to a fund manager, in which case it is more commonly referred to as Fiduciary Management (or Solvency Management).

  Implemented Consulting

  Implemented Consulting tends to be more of an advice based model, and has evolved from the traditional investment consultants.

  Adopting an implemented consulting approach, a trustee board engage with their investment consultant to work in a more directive manner. This means that the consultant will provide clearer, real-time investment recommendations. For example, a consultant may put forward an appropriate fund manager for an asset class, but the ultimate responsibility for the decision remains with the trustees.

  An example of how this structure may work is as follows:

  •    The trustees, together with their actuary and investment consultant, agree the level of investment return that is expected from the scheme’s assets (this may be a liability plus proxy), in order to ensure the scheme’s funding and investment principles are consistent, and in line with risk appetite.
  •    An appropriate investment strategy is recommended by the consultant in order to meet the required level of return, with the aim of maximising investment efficiency (i.e. minimising risk for the return targeted). The trustees may agree the recommendations (or seek clarification/modification). The investment consultant then manages the transition of assets to the new investment structure.
  •    The implemented consultant monitors the scheme’s assets and makes pro-active clear recommendations to the trustees (in some cases this may be in real-time). These recommendations can include: changing the scheme’s strategic asset allocation (to reflect development in the investment return required to meet the actuarial funding assumptions); and firing or hiring fund managers. As the speed of implementation is essential the trustees need to follow an effective and rapid decision-making process.

  Fiduciary Management

 The term fiduciary management was popularised several years ago in response to a growing phenomenon sweeping the Dutch institutional investment landscape. Although there is no standard definition, it is possible to extract some broad principles:

  •    It involves the appointment of an entity which is accountable for implementing the overall investment strategy adopted by the trustees in order to maximise the chances of achieving the scheme’s objectives with regard, typically, to funding level.
  •   It involves the delegation of day-to-day investment decision-making to appropriate professionals, within pre-agreed guidelines, ensuring more dynamic decision-making and the dedication of expert resources to each type of decision. 

 In short, these are principles of good governance.

  An example of how this structure may work is as follows:

  The trustees appoint a fiduciary manager to run its investment portfolio. The trustees outsource or delegate some of the investment decision-making to the fiduciary manager who works within clearly defined parameters as decided by the trustees. It should be noted that the trustees still retains responsibility for the investments, as they are effectively the governing fiduciary. They define the key objectives and the high level strategy for the scheme.

  •    The trustees, together with their actuary and an independent advisor (this may be the investment consultant) agree the level of investment return that is expected from the Scheme’s assets (this may be a liability plus proxy), in order to ensure the scheme’s funding and investment principles are consistent, and in line with risk appetite.
  •    The fiduciary manager determines the investment strategy (this may include the strategic asset allocation) that is required to meet the pension scheme’s investment objectives. The fiduciary manager overlays their tactical views onto the scheme’s strategic asset allocation. The result is the actual investment allocation that the pension scheme will adopt. The fiduciary manager will implement the investment portfolio by investing the pension scheme’s assets in its own, or another provider’s funds.
  •    Over time, the fiduciary manager monitors the investment return required to meet the actuarial funding level assumptions and the scheme’s investment objectives and alters the pension scheme’s investment portfolio accordingly; as well as to reflect its tactical views. Although the fiduciary manager may not consult at each stage with the trustees, adequate disclosure and reporting is still necessary.
  Some pros and cons of each approach
     Implemented Consulting
     Quicker implementation than the traditional model. Therefore able to capitalise on opportunities and hence generates greater value added.
     Trustees need to consider recommendations swiftly.
     An effective decision-making process needs to be established.
     Clearer recommendations
     i.e. appoint manager ‘Y’ rather than hold a time consuming beauty parade.
     Greater reliance on views of consultant. Trustees need to evaluate and accept/reject recommendations.
     Trustees retain control of investment decisions, but are kept up-to-date with developments (in some cases in real-time).
     Additional governance constraints? i.e. time/resources/expertise
     The Trustees still have a requirement for ongoing education.
     Fiduciary Management
     Trustees can focus more time concentrating on non investment related, other governance issues and defining their key objectives. Areas where they can typically add more value.
     Views in the investment portfolio tend to be those of the fiduciary manager.
     Changes to the investment portfolio may be implemented without the trustees’ involvement.
     Trustees need to be comfortable in delegating control.
     Greater value added through real-time implementation.  Real-time tactical overlay allows value to be added from exploiting shorter term market opportunities.
     Implementation reported to trustees after action (no consultation). Trustees need to retain sufficient investment knowledge to evaluate the fiduciary manager’s actions.
  The focus on effective governance is the key challenge facing pension schemes. Not just for the big schemes, but also for the smaller schemes where there is a perhaps a more pressing resource issue (time, expertise etc.). Understanding exactly what is required to meet the key objectives for the various greater clarity as to how much governance is actually required. Of course, no trustee board is the same and the structure proposed has to meet the needs of the scheme.
  Trustees recognising a need for a more advanced level of governance, in order to meet the key objectives of the scheme, can look to adopt a number of different approaches. This may include adopting an implemented consulting approach or delegating their investment decision making powers to a fiduciary manager (as well as in some cases working with a dedicated Chief Investment Officer). Whichever method is chosen will depend on each scheme’s exact requirements.

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