Why we can’t dissolve fund management like monasteries



If you had to pay for advice – would you pay for judgement or luck?

Con Keating makes an important point in response to my blog, in denial and in disgust

it is required by statute to retain an investment advisor. It is not so much that clients want to work with consultants but that they have to work with one or another. This needs to be changed.

Michael Johnson has today called for 80% of the fund management industry to be considered redundant. I do not disagree with his argument. But it ignores Con Keating’s point. You cannot simultaneously make 80% of investment consultants redundant without putting yourself the wrong side of the law.

This seems the single strongest argument for referring investment consultants to the competition and markets authority. Johnson may not know of the requirement on pension scheme trustees which might explain his comment

“It is not clear how (a referral to the CMA) would help”.

One alternative to a referral is to change the law and give trustees the freedom to take decisions by themselves with regulatory and commercial impunity. But the FCA report paints no more optimistic picture of trustee competence than the OFT did of employer’s capabilities with workplace pensions.

Experts are needed to advise on and help deliver diversification and ensure liquidity (as Johnson points out), but these experts are not embedded in most occupational pension schemes or other fiduciary structures in the UK.

Another alternative is to follow the PLSA’s recommendation to collapse occupational schemes into large pools which can be managed with the interests of all in mind. This is what Johnson wants too and he spends much of his paper praising the Department of Communities and Local Government for its leadership in bringing Local Government Pension Schemes in just such structures.

The difficulty of extending the LGPS pooling model to private schemes is inherent in the terms “public and private”. Public pensions are heterogenous in benefit structure and in sponsor (we the tax-payer pick up a general tab). Private schemes have different benefit promises and each sponsor is different both in its capacity to support the future promises of the pension scheme.

The logical argument for Michael Johnson , would be to nationalise pensions and place the burden for private defined benefits in one great pool (under the management of Government agents such as the PPF). This may be a step too far for a right leaning think-tank like the Centre for Policy Studies, but there are some sane experts calling for a “living PPF”.

Evolution not dissolution.

Johnson argues for the dissolution of the fund management industry with 80% of its structure being dismantled and the remaining 20% targeting genuinely valuable activities.

But we don’t have to treat asset managers and investment consultants like medieval monasteries!

There is an opportunity, with a referral to the Competition and Markets Authority, to clip the wings of the fund managers and investment consultants so that they focus on the jobs that Johnson properly wants them to do.

Licenses to manage money actively, or manage managers within funds or fiduciary management agreements , can currently be obtained with virtually no regard to the value for money offered to the consumer. The CMA has powers to link the performance of those in asset management (including consultants) to results, thereby asking asset managers to underwrite their activities.

The evolution of fund managers into risk sharers suggests that they may well return to where they came from – the insurance industry.

Ironically, insurance companies initially managed funds for policyholders as a risk management activity, in the purest sense, the guaranteed endowment or annuity is a fully insured fund management activity. We now have insurance companies that take no investment risk at all and fund managers who will point to insurers (they use for distribution) as the risk takers.


Payment by judgement rather than luck

It may be that the answer that the CMA comes up with, if investment consultants are referred to them, is to make investment consultants pay linked to the outcomes of the advice they offer (or for their activities to be limited as Johnson suggests). I would support such a proposal.

I do not mean by this an “ad valorem’ approach; this means that the quantum of the reward is based on market performance with the majority of the fee payable in any market condition (a beta approach). I mean a fee based on the “alpha” of investment consultants, payable only where it can be shown that the consultants added value by judgement rather than luck.

I suspect that few asset managers or investment consultants would back themselves to consistently get paid on that basis.

do ya feel lucky?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in actuaries, pensions and tagged , , , , , , . Bookmark the permalink.

15 Responses to Why we can’t dissolve fund management like monasteries

  1. Colin Meech says:

    You make a bad error with trust based schemes. There is no requirement to merge or pool liabilities. Just create an inhouse managed fund on an industry basis. The scale and reduction in costs would provide a massive boost to scheme cash flows.

  2. Con Keating says:

    There is a genuine problem with consolidation (of which asset pooling is a part): to be practical it needs both the terms of pension award and the pension benefits to be,broadly speaking, homogenous. This means that industry-wide arrangements, such as we see in Holland, are feasible; that there are not too many conflicts among the various sponsor schemes and members. Unions have played a significant role as a standard setter in this regard. It also means that the LGPS is the prime candidate for this treatment here. However, the diversity of UK schemes, which is of course a strength of the system, makes this unlikely to prove beneficial for most.
    Let us also forget that there are diseconomies of scale associated with fund management – the star performing fund often underperforms precisely because it has attracted more money.

  3. henry tapper says:

    I don’t think you’ve read my blog correctly Colin, Con is saying that there is a statutory obligation on trustees to take advice, not to pool assets. I totally agree with your point (out of context!)

    I should acknowledge the work that you and Chris Siers have done to make pooling beneficial to us council tax-payers and to ensure the future viability of LGPS as a means to pay proper pensions!

  4. Con Keating says:

    spot the missing not in my earlier comment

  5. henry tapper says:

    The “not spot” is a rather interesting exercise in abstract speculation Con.

  6. Mark Meldon says:

    Well, it seems to me, as a rather “provincial” IFA, that we know many things, but not enough of those things are put into practice! We “know” that something like 90% of any given portfolios return comes from asset allocation. We “know” that most financial assets have an index and that, where there is an index, there is an index fund (whether ETF/OEIC, it doesn’t matter). We “know” that once an asset has been chosen (equities, bonds, or whatever) we should try an capture as much of the return of that asset as possible. We “know” that is likely best achieved by buying an index fund.

    We “know” that no-one can predict the future returns from financial assets, but we do “know” what the cost of “matching” those assets costs – we can measure that pretty accurately.

    Why try too hard to “second guess” the future? Why not just “Buy, Hold & Rebalance” your pool of indexed assets? Maybe along the lines of Harry Browne’s so-called “Permanent Portfolio”? It seems to work for my client’s and I don’t cost them very much in fees.

    Confession time: I do purchase “active” funds from time-to-time, but these are closed-end investment companies that have been quietly plodding away throwing off dividends for decades at low cost; you know, Scottish Mortgage, Temple Bar, Personal Assets Trust, etc. I don’t know if they will be any good in the future, but the nature of their construction does appeal emotionally, if not objectively. I just can’t help using them – they seem to work, very well, too. And they are cheap to keep.

    In my 27-year time as an IFA, I have had one very simple rule with investment ideas that has saved my and my clients bacon dozens of times; the glossier the brochure, the further I threw it across the office.

    Mentioning offices, it seems to me that most of the “asset gatherers” out there fail my somewhat cynical “office test” – the swisher the office then the higher the cost to their clients!

    Anyway, enough of that, but, maybe, just maybe, we can start to do something to let the truth and therefore the trust in!


    • George Kirrin says:

      Mark, I think if you re-read the late 1980s/early 1990s research by Gary Brinson and others you will find that around 90% of the “variability” of US mutual fund returns is explained by their assumed asset allocations. This is not the same as saying that the “absolute level” of returns is to be explained by asset mix.

      If you make this mistake, how many other investment consultants make similar mistakes?

      • Mark Meldon says:

        To be clear, what I was driving at was really the point that asset allocation is clearly one of the major decisions when looking at investing in “real assets”. Setting aside, for the moment, things like attitude to risk, etc. I think I’m right in saying that the choice of which assets to hold and in what proportion is the main determinant of portfolio returns. But, of course, that is only the case in hindsight! I just don’t know, apart from so-called “educated guesses” whether equities will outperform bonds next year or whether small-caps will outperform large-caps. I might like to think that the “experts” have the opportunity of making a better informed guess than me, but I no longer believe that is the case.

        I might think that buying some shares in, say, a small-cap investment trust at a 15% discount to NAV is an attractive proposition right now, but I don’t actually “know” that as that, of course, means polishing my crystal ball. I might think that gilts are a one-way ticket to long-term financial ruin, but I don’t “know” that, do I?

        I do know, however, that the UK economy might experience prosperity next year or recession; it might be subject to inflation or deflation – but I have no idea, apart from “hunches” as to which “economic condition” or combination thereof will prevail. I can’t steer a ship by looking at the wake, so why should I try?

        Some say, surely the majority, that simply trying to hedge your bets by buying assets that approximately “match” those economic conditions is just plain stupid; maybe they are right, but I don’t know that.

        In the real world of advising clients about what to do with their SIPP/ISA/whatever portfolios is a difficult responsibility. I might think that “equities are the way to go” (and, actually, I probably do), but I don’t know that.

        But I do know that “cash is king” in a recession; that shares (and bonds, too) tend to do well in times of prosperity, fixed-income should do well in inflationary times and things like commodities, real estate and “alternatives” should do well enough in inflationary times.

        Arguably, then, just split a fund into four roughly equal-sized pots holding “matches” (that’s a whole separate matter, of course) in those “pots” and stop trying to second-guess the future too much – this does seem to offer a decent “hedge”. Adjustments need to be made in many circumstances (seeking yield, time-horizon, etc.) but the basic idea is, I think, sound.

      • George Kirrin says:

        There’s a lot of your investment beliefs innthat reply, Mark.

        The point about “variability” is that many of the consultants seem to equate volatility with risk, or pseudoscience as Henry referred to it.

        I fear “matching” and “de-risking” are born of similar misconceptions.

  7. George Kirrin says:

    The legal requirements on pension trustees are set out in section 36 of the Pensions Act 1995 “Choosing investments”:

    …. Before investing in any manner (other than [permitted by] the Trustee Investments Act 1961) the trustees must obtain and consider proper advice on the question whether the investment is satisfactory having regard to [the Occupational Pension Schemes (Investment) Regulations 2005], so far as relating to the suitability of investments and [the trustees’ own statement of investment principles; although to the extent the investment consultants draft it rather than the trustees it’s yet another example of agent tautology].

    The word “suitability” does not appear in those 2005 regulations.

    I think the relevant parts are to be found in section 4, “Investment by trustees” from sub-section (2):

    (2) The assets must be invested—
    (a) in the best interests of members and beneficiaries; and
    (b) in the case of a potential conflict of interest, in the sole interest of members and
    (3) The powers of investment, or the discretion, must be exercised in a manner calculated to
    ensure the security, quality, liquidity and profitability of the portfolio as a whole.
    (4) Assets held to cover the scheme’s technical provisions must also be invested in a manner
    appropriate to the nature and duration of the expected future retirement benefits payable under the
    (5) The assets of the scheme must consist predominantly of investments admitted to trading on
    regulated markets.
    (6) Investment in assets which are not admitted to trading on such markets must in any event be
    kept to a prudent level.
    (7) The assets of the scheme must be properly diversified in such a way as to avoid excessive
    reliance on any particular asset, issuer or group of undertakings and so as to avoid accumulations
    of risk in the portfolio as a whole. Investments in assets issued by the same issuer or by issuers
    belonging to the same group must not expose the scheme to excessive risk concentration.
    (8) Investment in derivative instruments may be made only in so far as they—
    (a) contribute to a reduction of risks; or
    (b) facilitate efficient portfolio management (including the reduction of cost or the generation
    of additional capital or income with an acceptable level of risk),
    and any such investment must be made and managed so as to avoid excessive risk exposure to a
    single counterparty and to other derivative operations.

    In my second-hand experience, I’m not sure that many trustees have ever read these regulations? And while their consultants are employed to ensure the trustees comply, I’m not sure many of the consultants are that familiar with the exact details of the regulations either – for instance, “security, quality, liquidity and profitability …. as a whole”.

  8. Has it really taken fifty long and often painful years to come to the realisation that the life assurance and pensions industry, insurance companies, provide the most appropriate mechanism to provide long term and diverse pension planning benefits, with attendant guarantees, to the general public?
    Unit linking, fund management ‘expertise’; imported first from Israel, then South Africa and now dominated by American fund management companies in the UK, have all been held as a panacea for the individual’s right to choose their own funds and that ‘right” morphed into the pension trustee domain whilst eschewing the provision of underlying guarantees such as those provided by with profits or fixed benefit insured funds.
    It is refreshing to read the current analysis yet frightening to behold the suggestion of state control or nationalisation as even a possibility to redress the balance of responsibility for effective fund management.

  9. henry tapper says:

    That’s very clear George; thanks for posting. There is no judgement call on the suitability of an investment call in these regulations. But trustees also have the DC code which is very much concerned with suitable investments –


    94.The law requires trustee boards to take certain matters into account when exercising their powers of investment[42]. These requirements will need to be taken into account when setting investment strategies [GUIDE][43].
    95.We expect trustee boards to ensure that the membership data on which investment strategies are based is accurate (see the Administration section for further details).
    96.We expect trustee boards to consider the interests of both active and deferred members as part of the process of setting investment objectives and strategies and, where relevant, members who are in a decumulation phase within the scheme.
    97.When setting investment strategies, we expect trustee boards to take account of risks affecting the long-term financial sustainability of the investments [GUIDE].
    98.We also expect trustee boards to regularly take steps to engage with members [GUIDE] about the date they may wish to take their benefits and any preferences they have about how to take their DC benefits, and to consider any information provided when determining investment options to offer to members and strategies for the scheme. This includes considering matters such as the likelihood of members wishing to gain flexible access to their benefits and preferences for particular approaches to investment (eg sustainable funds).
    99.We recognise that the investment needs of members will vary across the membership profile and over the lifetime of the membership. We expect trustee boards to consider the scheme’s investment strategy as a whole (not just the component funds) and to take into account the characteristics of different segments of members, for example by proximity to retirement or likelihood of selecting a particular retirement option.
    100.Effective member engagement plays an important role in achieving good outcomes for members. We expect trustee boards to ensure that members have access to enough information about the investment options available to make informed decisions about their investment choices and to understand the potential impact of those decisions on their pension savings. See also the section on Communicating and reporting.

    My experience is that investment consultants aren’t fully engaged with this yet, and that until we can find a way to pay their fees (from some allocated budget) that’s the way it’s going to stay. Hence the urgent need to consolidate DC – which I do support.

  10. henry tapper says:

    Terence- risk-sharing, as opposed to risk transference – has been on the agenda for all of the last 50 years. Currently we have polarised solutions – DB and DC. Unsurprisingly, those paid to take on risks (the insurers) are very happy to be paid to take no risk. Those who pay others to take risk for them are less happy that they find themselves responsible for their own risks, and still paying third parties for the privilege.

    Much of what is in the FCA paper is simply about value for money – or the lack of it – if you think you are paying a third party to manage out a problem and that third party is doing no such thing, it is not surprising that you lose confidence in their “solutions”!

  11. That is possibly the most cynical ‘technical’ response that I have had the misfortune to receive, Henry. The ‘professionals” are ‘taking the mick’.
    In 1997 the UK‘s pension provision through insurance companies and, of course, the large independently governed multinational group pension arrangements, was the envy of the world, including the USA. The destruction of those intuitions which was as insidious as it was deliberate brings shame on all those responsible.
    If the current analysis is to achieve anything it must learn from history. The life and pensions providers have a long and for the most part proud history of benefit provision despite successive governments interfering; primarily for their own, the government’s benefit. So called professionals also carry much of the blame protecting and promoting their own space rather than delivering value to the consumer.
    Each hour of every day over £7 million is paid out in benefits by the life and pension insurance company providers (ABI statistics).
    What are my credentials? 31 years on the executive of the Federation of Small Businesses (originally the NFSE) as National Insurance specialist on their Taxation committee, 34 years on the council , and past president, of Lincolnshire Chamber of Commerce and assorted CII, FIMBRA , and BIBA committee posts. The most important credentials comprise my 44 years as a financial adviser, incorporating 17 years of exam taking, advising 2000 private and corporate clients, achieving Chartered Financial Planner status and Fellowship of the Chartered Insurance Institute.
    I have sat across the table with 6 serving pension’s ministers only one of whom knew even the basic fundamentals of pension funding provision.
    I can only hope and pray that someone in this ‘playpen’ moves ahead with a firm reference to history. God knows that I have used my every endeavour and opportunity, including this one, to stem the flow of uncertainty and personal risk back to guarantees and the with profits principal in its widest application in insurance funds properly managed by experienced teams of salaried individuals with a true eye to a 40 year rather than 40 minute time fram that appears to be the order of today.
    There has to be a call for less government interference, an end to the regulatory overseeing by novices and overbearing rules and restrictions, coupled with a ‘playpen’ where throwing the toys of yesteryear out because it is ‘fashionable’ is condemned and common sense prevails.

    • George Kirrin says:

      The particular learning from history I’d recommend may be found in the investment beliefs of Ben Graham and JM Keynes and like-minded others, not just abstract theory but darn good practice.

      When we allow oligopoly among the large service providers, we lose innovation (which in this case, and agreeing with Terence, should really be a simple case of “back-to-the-future”). Among oligopolistic professions, however, the commercial seems to trump the professional.

      But I wouldn’t expect a CMA investigation to make (or even recommend) radical changes, as their evidence tends to come from the usual suspects and prefers more recent practices to more historical, better practices. Some call this “regulatory capture”, which oligopolies are also good at.

Leave a Reply