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“Consultants outsourcing is an accident waiting to happen—it’s a very dangerous model.”
These are not the words of an asset manager trying to win over a new client. They were uttered by one of the most prominent figures in European fiduciary management—who is also the CIO of a pension fund—and they go some way to explain the problem the industry faces if it is to reach its much-hyped potential.
Patrick Groenendijk, CIO of the Dutch transport workers’ pension fund Vervoer and the man to whom these words belong, has more experience than most in these matters. In early 2010, after becoming one of the first to embrace investment outsourcing, the €14 billion fund heaved Goldman Sachs Asset Management (GSAM) out of a fiduciary management contract. Vervoer did not dump the idea completely, however: it brought in Robeco to take over the role.
“I think outsourcing is a great idea,” says Groenendijk—but only on certain grounds. His experience with GSAM was one of a problem with the tactics of a specific player, rather than hating the game. And he has more worries for the -evolution of the market.
His main concern is consultants’ lack of experience in the field—observing is only part of the job, he says. You can watch Roger Federer play tennis for 20 years, but it’s fair to say you won’t pick up a racquet and immediately be able to play like him.
He also has a concern about conflicts of interest more widely—consultants are not the only ones who can trip up the system.
Vervoer’s assets are slotted into investment mandates by Robeco, which itself runs money but is not allowed to allocate to its own funds. “This means that if we miss out on stellar performance as Robeco is the best European high-yield manager—which it is by the way—then so be it,” he says. It keeps them honest.
There is still too much muddy water for some, however.
“How can you be acting in one client’s interest when you have to release information to all your clients at the same time?” says Stefan Dunatov, CIO of the Coal Pension Trustees Investment. “This assumes that all clients’ interests are identical, which can’t be right.”
Dunatov oversees one of the UK’s largest pension asset pools, a similar post to Groenendijk’s, but their views are diametrically opposed. And to build a business of any size, the outsourcing industry in the UK will have to reach out and convince these non-believing investors of their worth.
“There’s a great interest in larger mandates and tenders from providers, but it’s not really what we see happening,” says KPMG’s Head of Manager Research Alex Koriath. “We’re seeing these funds separating out the advisory and investment management to more specialist firms to implement a certain part of the portfolio—it’s looking less likely that fiduciary managers will see a way in to this end of the scale. There needs to be change for this to reverse.”
Groenendijk believes that in the Netherlands, where asset managers are the predominant providers of this service, the sector has moved on and learnt from its initial mistakes.
“Investors can now take a modular approach to fiduciary management,” he says. “If, for example, they want a risk management module from BlackRock, they can go and just take that. It used to be all or nothing, but things have now changed.”
And the proof may be already visible in the numbers. In the Netherlands, most fiduciary management mandates are run by asset managers—and it seems to be working. Even in 2011, MN Services, a provider of a range of outsourced solutions, published data showing Dutch pension funds had committed more than €790 billion to the approach.
In the UK, which has similar assets under management to the Dutch system, the number is just £58 billion—less than 10% of the Netherlands’ total—according to figures from KPMG.
In order to really crack the market, there are mountains to scale. Since 2007, outsourced assets in the UK experienced an uptick of 34%, KPMG’s figures show. But despite this increase, the exposure the industry gets, and arguably the marketing budget, less than 3% of the UK’s pension pots are managed in this way.
There are plenty of asset managers offering outsourcing arrangements in the UK, but the allocations remain stubbornly low. Therefore, looking beyond the battle lines drawn between fund houses and consultants, there are issues that both sides must address in order to gain any ground at all.
For one, there is a serious lack of standardisation across the industry. Far from just confusing investors with a range of names (implemented consulting, fiduciary management, outsourcing), the products that lie behind the labels are an eclectic range of different approaches and delegation levels.
“The market is growing rapidly,” says Koriath. “As this market matures, it will have to become more transparent and there will have to be more standardisation.” The array of products on offer ranges from basic advice on investment navigation all the way through to taking over the map, wheel, and accelerator—and it depends on who you ask, and how much they ask to be paid, as to where you fit in on the scale.
Within this mishmash of approaches lies another problem: Can a provider offer a fund bespoke solutions if it has lumped its assets in with countless others?
“Some concerns trustees have centre on how the money is run and reported, for example, from an environmental, social, and governance [ESG] perspective. BT trustees are no exception,” says Sunil Krishnan, head of market strategy at the British Telecom Pension Scheme Management (BTPS). “Therefore, it suits them to have tailored investing and reporting so there is no nasty aftertaste when they have to ask a certain manager: ‘Can we change our investment approach to X?’ If the idea makes investment sense, there is no compromise needed. If I was a fiduciary manager, I’d want to concentrate on how closely I can replicate that.”
BTPS offers a similar model to the one targeted by many outsourcing providers—but to just one client: the biggest pension fund in the UK.
Koriath also believes there are problems brewing here. “If you go to someone and say: ‘I want ESG, or this type of investment only’, it will cause huge problems for many of these fiduciary managers. Many of their models are based on model portfolios, which are then scaled and implemented in different ways for each client, but most are based on a basic model portfolio,” he says.
“By name, it’s supposed to be a tailored solution, but there may well be limits. You have to realise them at the point of selection, rather than engage someone and then spring the news on them that you need all these specialisms.”
One of the most important issues is how to measure a fiduciary manager’s activity, and as of yet, partially due to the lack of standardisation in the sector, no one has satisfactorily achieved this.
“How do you keep the checks and balances of fiduciary responsibility?” demands Koriath. “How do you keep grasp of how well things are going? Do you rely on the reporting from the fiduciary manager that tells you they are doing a good job? Do you ask a custodian? How do you verify the reporting and do independent checks? That is a question.”
Members of KMPG’s investment consulting practice appointed themselves as key gamekeepers of this space in 2009 with the creation of a new department. They have been brought on board by several UK pension funds to oversee how their fiduciary manager is doing, hence the production of an annual survey. In the Netherlands, Ortec Finance carries out a similar job as there are also muddy waters across the North Sea.
“Metrics for assessing success would, ideally, be quantitative in order to ensure objectivity,” says Ralph Frank, an independent solution provider who previously worked at Anglo-Dutch fiduciary manager Cardano, and suggests a range of quantitative methods. These could include solvency ratios for those promising improved funding and asset class achievements for those just selecting managers. “Metrics would help assess success objectively. Different providers would also be more easily compared using relevant reference points.”
Krishnan at BTPS says there are soft and hard measurements of success. “The value for money has to be clear, and costs have to be transparent.”
Cardano is the only provider operating in the UK to offer year-by-year figures on its clients’ solvency. But without competition the numbers, although applauded, are pretty meaningless in a wider context. Providers will soon run out of excuses as to why they cannot provide firm figures—and claiming that each client and their service is different may soon turn out to be a curse.
KPMG has decided that a balanced scorecard is the best option. “You need to see the overall performance against a funding level with a high-level objective that everyone needs to approve,” Koriath says. “But then you have to dig a little deeper and look at how this result came about. Is it just risk being taken? What kind of market risk? And how did they add value? Were they successful in asset allocation or selecting managers that really deliver alpha? Did they change how they hedged the liability profile? Or the LDI strategy?”
And then there’s the qualitative angle—how the fiduciary manager works with the internal team and trustee board. The list goes on and on.
Groenendijk at Vervoer has two basic metrics for measuring how well his outsourced provider is doing. “I look at how well the managers they chose have performed after fees to measure their selection success,” he says. And for the general fit of the relationship and if they are fulfilling the mandate? “We go on how satisfied we are. It is completely subjective. We look at the working relationship we have and assess that.”
This working relationship is what might be the undoing of the whole industry if it is not managed properly. “People who outsource their investments need to realise that it’s not just a way of getting rid of a pension fund problem,” says Groenendijk. “It can never become someone else’s problem—and the regulator needs to know that you still understand all that is going on.”
To illustrate, Groenendijk’s team has grown from two to seven since appointing a fiduciary manager. The team beefed up risk controls and other functions they had never needed before just to better oversee the new processes being brought in to their investment strategy.
“Fiduciary management won’t cut down the time you spend on your investments, or the time budget you have allocated to them,” says Koriath. “You just spend the time differently, and usually more closely with a fiduciary manager, getting to understand what they do to add value for you. In most cases, strategies are more complex than the investor might have had previously.”
Understanding liquidity profiles, risk premia, and volatility may be outside a pension fund’s previous remit, and some might be disappointed to find they have to spend more time on investments rather than less. Was this the fault of providers failing to let their potential clients know what they were in for?
“I don’t know whether consultants and asset managers really knew what it meant in terms of how the working relationship would develop,” says Koriath. But it is certain that they are going to have to inform them in future. So if the providers iron out all of these issues, will they end up with the golden goose—the really large pension funds across Europe?
“Fiduciary management is an abrogation of responsibility,” says Dunatov. “By exercising their authority to use a fiduciary, they are giving away their authority. If you don’t know what you’re meant to be doing, how can you measure what someone else is doing for you?”
It might be a tougher climb than they think.