Seeking a common definition of Fiduciary Management (“FM”) is like finding the end of a rainbow. You think you can picture it, but as you get closer its definition fades and then finally disappears. This is because FM offerings can range from a simple service where Trustees remove the need to directly deal with several underlying investment managers, all the way to the Trustees fully delegating management of assets relative to scheme liabilities.
The FM sector has been increasingly topical since the FCA released its final report highlighting the need for the investment management industry to be, amongst other things, more transparent in their dealings and management of Pension Scheme funds. The reason is, by definition, FM involves Trustees delegating at least some of their decision power; therefore, the transparency of FM contracts and the clauses that Trustees agree to are particularly important.
In this note we aim to highlight some of the key issues Trustees should be aware of when reviewing a FM provider, and potential questions that Trustees may wish to ask.
The all important, what will it cost?
Often the first question we are asked about FM is “how much will it cost?” In reality the cost is dependent on which of a wide range of services are included in the contract. As such, when thinking about fees, we believe it is better to separate into the following components:
- FM provider fees – this is the fee paid to the FM provider for the services they provide and removes the need to directly deal with several underlying investment managers. Trustees should make sure they understand what this service involves and that they are happy the fee reflects the level of delegation the Trustees are handing over.
- Underlying investment manager fees – this is the fee paid directly to each of the underlying investment managers. FM creates aggregation benefits for investment managers as most see exposure to one ‘client’ not several. Because of this, investment managers often discount their fees for FM providers compared to direct investors. Some FM providers pass on this fee discount but others do not. If this is not made clear, Trustees should pose the question to their FM provider.
- Investment consultancy fees – this is the fee in relation to a wide range of services such as investment strategy reviews, investment reporting, meeting attendance and trigger monitoring. Are all of the services that the Trustees require included? If not, the FM service that appeared to be ‘good value’ can become increasingly expensive due to additional fees.
- Asset transfer costs – How will the FM provider move the assets from the current investment managers to their Funds? Some organisations may sell existing holdings for cash to purchase their own internal funds, incurring significant transaction costs. Also, managing the asset transition is time consuming and can result in significant one off fees. Are these included in the stated FM charge?
- Other fees – this may include administration costs for instance. It is worth Trustees asking for the aggregate total expense ratio for the investment managers with the FM provider compared to investing directly.
In addition to the above, performance fees can also exist. Some FM providers believe a performance related approach can directly align the interests of Trustees and the FM provider. However, other FM providers believe a performance fee can create a conflict of interest, such that the FM provider is incentivised to target short-term performance. Trustees should be clear whether a performance fee is charged, and if so, is it reasonable?
The primary objective for Trustees when selecting a FM provider is to delegate some of the decision making, freeing up time to deal with other important strategic decisions. Trustees must therefore decide if the time saving is worth the cost and whether they are comfortable with the level of control being given to a FM provider. If not, then perhaps the Trustees should not be considering FM.
Performance and how this is measured
Performance can be measured in many different ways, although success for a pension scheme is likely to be defined as a long term improvement in the funding level and/or a reduction in funding level volatility. Trustees should ensure this change in funding level is considered in line with the agreed scheme specific objectives and any reporting should clearly show performance relative to the agreed benchmark.
Care should be taken when Trustees are selecting a FM provider. The performance information provided during a FM provider selection is often of little value in helping Trustees understand how the FM provider will add value for their scheme. This is because there are many variations between FM providers, meaning data cannot be directly compared. Despite these variations, Trustees often place undue bias on performance data, meaning FM providers may be selected for the wrong reasons.
To provide better transparency and allow effective performance comparisons, a group of industry leaders, not linked to FM providers, have been working with IC Select1 to introduce an industry performance reporting standard for FM providers. We expect to see FM providers quoting performance according to this standard in 2018, however, as of now, this area is limited and performance comparisons are extremely difficult. When selecting a FM provider it is important that Trustees do their utmost to ensure the data provided is on a consistent basis and consider whether they are placing too much weight on performance during the selection process.
The relationship with a FM
As described previously, the relationship with a FM provider can vary greatly, depending on the services selected by the Trustees. The more services selected, the more potential conflicts of interest need to be considered by the Trustees. There are many conflicts, some highlighted earlier in this note, but some key ones include:
- Appropriate use of active and passive management.
- Asset ‘churning’ or excessively switching funds to generate fees through ‘initial fund’ charges.
- Hidden lock in periods either explicit or through the crystallisation of a performance fees.
- Model portfolios rather than portfolios bespoke to the scheme’s requirements.
- Difficulty in novating holdings back to a direct relationship, effectively another ‘locking in’ mechanism.
It should be remembered that, although the Trustees have delegated the day to day management to a FM provider, the Trustees retain legally liability for the pension scheme. This means that Trustees are responsible for reviewing the appropriateness of the FM provider alongside the scheme’s other advisers.
As you can see, there are lots of issues for Trustees to be aware of when looking at FM and this note is just the tip of the iceberg. We cannot emphasise enough the importance of Trustees asking FM providers questions, until they are absolutely clear on the service that is being offered.
If you have found this note insightful, we will be further exploring the role of FM providers in our webinar on 2 November 2017.
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