In an article titled Changing investment for the better, we discussed how institutional investors can expand their fund governance by outsourcing to a fiduciary manager in order to cope with increased investment complexity. This article continues the discussion, further exploring what a fiduciary manager does, and the benefits and factors to consider in a fiduciary management relationship.
Why the interest in fiduciary management?
Some schemes have, quite rationally, adopted simple passive equity and bond portfolios that require a lower level of specialist knowledge and time to maintain. For many investors, however, this route is not possible – they need to work their assets harder to generate return whilst controlling the level of risk they are taking, for example to close a funding gap in a pension fund.
This necessarily involves a more sophisticated portfolio utilising a number of investment levers – liability risk management, diversification, active management and dynamic asset allocation. As well as investment complexity, these portfolios naturally require a greater level of operational resource to implement effectively.
For those who want to raise their game and adopt a more sophisticated portfolio, there are generally two options available to add to investment governance – build or outsource.
For schemes that cannot build internally, which generally requires very significant scale, outsourcing to a fiduciary manager is a means of addressing the gap that exists between the need for increasingly complex investment strategies with real-time decision making, and the typically constrained governance budget of many trustee boards.
Historically, a ‘manager of manager’ approach may have been used to help bridge this governance gap. However, increasingly institutions are recognising the benefit of broader fiduciary management relationships.
What does a fiduciary management relationship involve?
The extent of delegation under fiduciary management can vary, but in its fullest form it is the combination of strategic advice and implementation. The trustees or board remain in control of the high-level strategy, generally with advice, determining long-term objectives, return requirements and risk tolerance. The fiduciary manager takes on the day-to-day implementation aspects, with the typical functions including:
- Allocation to different asset classes within the constraints of any guidelines set.
- ‘Hiring and firing’ investment managers.
- Negotiating investment manager fees.
- Reviewing legal documentation.
- Executing documentation.
- Managing cash flow.
- Monitoring investments at a detailed and higher level.
- Liaising with the custodian.
The market for fiduciary management has grown significantly over the past few years. In the UK for example, according to the 2014 KPMG UK Fiduciary Management Market Survey, the market stood at more than £72 billion ($110.49 billion) with around 508 pension scheme mandates as at June 30 last year. Compared to just 59 mandates covering £12 billion in assets in 2007, this shows year-on-year growth of about 29% in assets under fiduciary management.
In the US, where fiduciary management is often called the outsourced CIO (OCIO) model, CIO magazine estimates the market has grown by almost 500% from 2007 to 2014, to more than $500 billion. Over the last year we have also started to see interest from a number of new markets globally, including Germany, Japan and Canada, for either whole fund delegation or delegation of a specialist mandate.
What makes for a successful fiduciary management partnership?
Understanding client context
Fiduciary management is a partnership between the client and the provider. It is imperative to understand client needs and build solutions that meet these. One size does not fit all – in our view a fiduciary management offering needs to be flexible for different client requirements.
The fiduciary manager also needs to be able to adapt to the changing needs of the client. Taking a defined benefit pension scheme, for example, the requirements of that scheme change significantly as it matures – risk tolerance will generally reduce, illiquid investments will no longer be appropriate and longevity risk management becomes more important.
By contrast, for a defined contribution plan that has experienced substantial asset growth, the ability to implement multi-manager pools for participants may have increased, calling for a need to revisit the plan’s structure and implementation with the plan sponsor. The fiduciary manager should demonstrate they have the capability and resources to meet these evolving needs.
Investment content and performance
Ultimately, any fiduciary manager has to demonstrate they can add value to their clients’ portfolios, that they can work the client’s assets harder to generate more return for the risk taken. This is not easy. Like all industries, investment is very competitive – by definition not everyone can be successful if adopting active management or diversification strategies, for example.
To be successful requires a combination of idea generation, best-in-class research, robust portfolio management and control of costs.
Execution and risk management
Investment content needs to be married with operational expertise. Clients rightly require confidence that implementation processes are robust and that all risks are carefully managed. This of course entails an appropriately resourced, specialised team with well-defined processes and supporting systems. The fiduciary manager’s overall risk management culture is similarly critical in this regard.
With such a material outsourcing of investment decision making, trust in a fiduciary management relationship is naturally critical to success. The fiduciary manager can help create and maintain this trust with the client by providing a high degree of transparency in their service, for example, how conflicts of interest are managed, particularly with regards to asset allocation decisions and possible revenue implications to the fiduciary manager.
If executed effectively, fiduciary management has the potential to provide material benefit to funds looking to add to their investment decision-making capabilities. Whether it is the right solution for a given fund looking to raise their game will depend on a number of factors, but in our view fiduciary management is now sufficiently developed as a service to warrant proper assessment alongside other options.
Disclaimer: Towers Watson Investment Services Hong Kong Limited (“TWIS HK”) has prepared this material for general information purposes only and it should not be considered a substitute for specific professional advice. In particular, its contents are not intended to be construed as the provision of investment, legal, accounting, tax or other professional advice or recommendations of any kind, or to form the basis of any decision to do or to refrain from doing anything. As such, this material should not be relied upon for investment or other financial decisions and no such decisions should be taken on the basis of its contents without seeking specific advice. Whilst certain of TWIS HK’s global affiliates have the capability to provide fiduciary management services, nothing in this material should be construed as an offer by TWIS HK to provide any discretionary management or fiduciary management services. TWIS HK is licensed by the Securities and Futures Commission in Hong Kong to carry out Type 4 regulated activity (Advising on Securities).