For many people familiar with the problems besetting the trustees of defined benefit occupational schemes it is a no brainer that they should manage assets against their liabilities. For the experts, the debate is now over who should be responsible for the complex decisions that are needed to use “liability driven investment” and who should be accountable if things go wrong.
Most people are not experts and in this article I put the debate in a short historical context to answer the question “how did we get here?” .
It might be helpful to start by making a disinction between Wealth Management and Fiduciary Management. Wealth Management is what asset managers have historically been asked to do for pension schemes. The view given to trustees by their advisers was that the liabilities of a pension scheme were long-term and that provided the pension fund generated sufficient wealth, they would be taken care of. In the second part of the last century trustees concentrated on building up large surpluses and improving benefits for members. They were succesful as long as they “rode the wave” of the great equity Tsunami.
Trustees today are taking a different view, they see pension scheme liabilities as very pressing and are being advised that they are in an “End Game” which will see their residual liabilities being bought out by an insurance company- (if they get it right) or off-loaded to the Pension Protection Fund – (if they don’t).
The reason for this shift in view are well known- the imposition of mark to market valuations on scheme liabilities by the accountancy profession, the imposition of taxation on equity assets by the Government, the failure of equity markets to deliver anticipated returns over the past ten years and the seemingly endless improvement in member’s life expectancy.
All of these factors have led to a worsening in scheme funding positions and distress to employers, members and regulators alike. The days of trustees worrying how to distribute surpluses are over.
While trustees used to monitor the performance of their pension funds using a consistent benchmark- the average performance of similar funds or the index of a market, they are now having to use a more specific measure- the performance of their assets against a very volatile set of liabilities. They now are being required to adopt a liability driven investment strategy which targets the scheme’s funding position on a mark to market basis.
Experts are now debating who should be managing the liability driven investment programs . It is a big issue because of lack of market capacity. Trustees do not have the time to understand, and manage their liabilities on a day-to-day basis. There are insufficient advisers who have the time to help trustees, especially trustees with small advisory budgets, to properly manage a liability driven investment approach. Most fund managers have yet to adapt to the new model and continue to offer services based on the old Wealth Management approach.
Wealth Management allows trustees to set their strategy and watch it develop over time on a “set and go” basis. The biggest demand on the trustees is to check the performance of their fund managers on an occasional basis and change managers from time to time.
Liability driven investment requires much more involvement, more training, more meetings, more decisions and in particular more timely decisions. Trustee boards and their advisers have found it difficult to adapt to these new demands.
The attraction of handing over responsibility for the day-to-day management of liability driven investment to a third party- an adviser, a fund manager or to an investment subcommittee is obvious. In response to this need some advisers and fund managers have put themselves forward as Fiduciary Managers who, subject to a formal instruction (an investment management agreement), will offer this outsourced solution to trustees.
However, trustees know full well that they are accountable for the outcomes of such outsourcing.
Which is why, in a recent debate on this issue, one expert pointed out “there had better be an independent arbiter to make sure the benchmark is correct and to give an impartial view on performance and risk levels being taken”.
This is spot-on. There will always be potential for Fiduciary Managers to revert to the Wealth Management model and worse to some self-serving model where their internal benchmark is the revenue that can be generated from the mandate.
Talking of a pension scheme as a ship holed below the water-line is not a bad analogy. At such a time the advice is “all men to the pumps”. Trustees, advisers and fund managers need to be working to a common purpose and working closely together. Especially at a time of crisis, strong leadership is needed, a stricken boat needs its captain. The members of defined benefit pension schemes need strong and determined leadership from their trustees; advisers must continue to oversee the salvage work ; Fiduciary Managers should expect to pump very hard!