DESPITE an increasing prevalence of professional trustees, retirement fund trustees are now often part-timers who aren't remunerated. They're generally elected by their peers or nominated by their employers and therefore don't necessarily have specialist trustee or investment skills. To further exacerbate that, the retirement fund sector has become more complex over the years, with new legislation being promulgated and new - often more complex - investment alternatives being introduced.
The publication of PF Circular 130 in 2007 by the Financial Services Board (FSB) highlighted the need for better governance of retirement funds. Since its introduction, many trustees have endeavoured to understand their roles and responsibilities better. All of these circumstances have led to an evolution in the way retirement funds are managed and operated. More specifically, there have been significant changes in the areas of investment strategies, investment service providers and investment decision making by trustees over the past few years.
The evolution of retirement fund investments is inextricably linked to the evolution of two different types of service provider: namely, asset managers and consultants. Initially, large public and private retirement funds had dedicated staff who managed both the operations of the fund as well as the investment of its assets. The status quo remained for many years due to the relatively restrictive requirements to hold prescribed assets from around the Forties until the establishment of the FSB in 1990. However, over that period smaller private funds were formed, where size didn't justify having dedicated investment professionals and even large funds realised the merits of outsourcing the investment of the assets to dedicated and skilled teams of investment professionals. The asset management industry - led by the life companies - was the main beneficiary of this initial outsourcing of investments.
That process gathered steam during the Eighties and Nineties as more asset managers opened their doors in response to the introduction of Regulation 28 of the Pension Funds Act, which meant funds were no longer required to hold a substantial portion of their assets in prescribed assets. To help trustees make sense of the plethora of asset managers available, and to help analyse liabilities and design the investment strategy, asset consultants sprang out of the employee benefits consulting industry. These asset consultants were initially the preserve of only the largest funds, with the trustees retaining the responsibility for making the final investment decisions. As a trustee respondent in a recent European survey of the retirement industry by Spence Johnson put it: "Consultants used to drive you to the edge of a cliff, watch you jump off then stroll back to their car."
Multi-managers then arose to address the difficulty of sorting luck from skill in the asset management industry. Multi-managers could package investment products that could be used by funds further down the size spectrum and pooling led to greater economies of scale and lower fees. The advent of multi-managers led to a move away from balanced portfolios towards specialist asset class portfolios. The debate still rages as to whether so-called single managers or multi-managers are best suited to making asset allocation - especially tactical asset allocation decisions - and recent years have seen some reversion to balanced portfolios.
The consulting side of the industry then evolved further, leading to the concept of implemented consulting. This approach was designed to introduce efficiencies, especially faster implementation of investment decisions and pooling, into the development and management of the investment strategy process. It was also designed to improve transparency and accountability for key investment decisions. The result - similar to the advent of multi-managers - was that smaller funds were able to access the type of consulting advice previously only available to large funds.
The competition intensified, and asset managers, specifically multi-managers, responded to the implemented consulted approach with a focus on fiduciary management. Although a convenient, simple and consistently applied definition of fiduciary management doesn't exist, it's very similar to implemented consulting in that it's also an outsourcing of the design, implementation and oversight of the investment aspects of a fund.
The fiduciary management concept is hard to define, because the solution differs from client to client. To add to the confusion, it goes by a variety of names depending on the market where it evolved: investment outsourcing in the United States, fiduciary management in the Netherlands and implemented consulting in Britain and other consultancy-led markets.
In this article we'll use implemented consulting and fiduciary management interchangeably. All of these slightly different business models have common themes of partnering with trustees and fiduciaries in an investment advisory capacity, with varying degrees of accountability to make and execute decisions on behalf of the retirement fund. The aim is to improve accountability for investment decisions, increase the speed of implementation of investment decisions and move the focus away from a product pushing mentality to a comprehensive, client-centric solution. The diagram below attempts to illustrate a typical implemented consulting or fiduciary management model.
As in nature, this evolutionary path won't produce only one perfect end result. Retirement funds have unique needs, membership and liability profiles and each fund's investment strategy needs to take its circumstances into account. Some trustees may feel they also have little control over crucial decisions, so fiduciary management isn't suitable for them. As fiduciary management is a solution rather than a product, such concerns can be overcome. However, it's likely some funds will adopt this approach while others may follow a different evolutionary path. For example, in the Netherlands - home to one of the world's most developed retirement systems where fiduciary management is widespread - there's already a move towards unbundling the services to provide more flexibility for trustees to delegate some of the investment function and retain other elements where they have the skills. The graph above shows the range of delegation possibilities.
The focus on short-term investment performance is a serious shortcoming in the retirement fund industry. Fiduciary management has the potential to address that as accountability is centralised and the goals of the fund and its stakeholders are shifted to more appropriate 15- to 20-year time horizons. For this reason it may be useful for the industry's evolutionary process to slow down for a while to allow quality implemented consultants to deliver on their strategy. Of course, this assumes implemented consultants have the skills required and take advantage of the leeway provided on the measurement criteria and time horizons to deliver real benefits for members.
It's clear that, over time, investment strategies have evolved and will continue doing so. As risk has shifted to the member and the responsibilities of trustees increase, the review of investment strategy, valuation of scheme designs and the overall management of retirement funds will come under the spotlight. The traditional model of retirement fund management may come to an end with a move towards a new model that provides support to trustee boards and strengthens governance structures for the benefit of members.
The evolution of the retirement fund industry has led to a convergence of investment solution providers and it seems consultants and asset managers may now, more than ever, be in direct competition. This will necessitate adjustments on both sides. Asset managers will need to improve their consulting skills to enable them to analyse and better understand the needs of the retirement funds and their members. On the consulting side, investment skills will be required. That's likely to result in resources moving between the two parts of the industry and will inevitably lead to an intense debate about where the best skills lie for each aspect of the investment process.
Interestingly, while the trend in Europe has followed a slightly different evolutionary path from SA there have been similar developments resulting in an overlap between asset managers and consultants. Respondents to a fiduciary management survey by Spence Johnson predicted asset managers will in future win a bruising confrontation in European markets, particularly in the Netherlands and Britain.
In SA the fiduciary management industry is certainly not as well established and the predominance of defined contribution schemes introduces different challenges. Key advantages of this new service include a focus on client needs and the ability to take accountability for investment decision making. If this can be combined with a long-term outlook to match the liabilities of the fund or those of the average member and the implemented consulting provider can demonstrate that they have the required breadth of skills and can win the trust of the fund's board - thus buying them time to allow superior decisions to bear fruit - then retirement funds and their members are likely to enjoy a period of relative prosperity.
If not, then the merry-go-round will continue, with the associated drag on net returns. Either way, it seems clear the evolution of investment strategy and investment solution providers is reaching a crossroads that could have significant implications for the way retirement funds manage their assets in the future.
References
* The Evolution of Fiduciary Management, Spence Johnson, 2009.
* The Asset Management Industry in 2010, McKinsey & Company, 2006.
* The New Gatekeepers: Winning Business Models for Investments Outsourcing, Casey Quirk, 2008.
* SEI Global Institutional Solutions: A Market Gone Bad: How are pensions around the world responding? 2009.
* Investment Policy for North American Pension Plans, Keith P Ambachsteer, 1994.
* Insurance legislation and the demise of the industry, Dr Brian Benfield, 1999.
* European Pension Fund Management - Outsource or In-House?, JP Morgan, 2009.
ROB MACMAHON
acsis
MACMAHON is business development manager at acsis and holds a BCom in business finance and economics and a number of British-based industry qualifications, including an investment manager's certificate. He also holds a postgraduate diploma in financial planning. His work experience includes positions with Legal & General Investment Management and AVIVA in Britain and at Liberty Life SA.
ANDREW DAVISON
acsis
DAVISON is head of Institutional Asset Consulting at acsis. He holds a BSc (Hons) from Wits and is a fellow of the Faculty of Actuaries. He has 14 years' experience in financial services, ranging from developing investment products for both life companies and asset managers to consulting on all aspects of investment strategy to retirement funds and other institutions, including medical aids, trusts and charities.