Making fiduciary management work for you

A sponsored article by Tim Banks, Mercer Global Investments

Mercer’s Pensions Risk Survey data shows the accounting deficit of defined benefit (DB) pension schemes for the UK’s 350 largest listed companies was an eye-watering £152bn as at 30 September 2016. This highlights the scale of the funding challenge facing DB scheme trustees, deficits near an all-time high, compounded by the time horizons for securing benefits continuing to fall.

Against this backdrop it’s hardly surprising that fiduciary management services continue to be in demand, helping trustees to deliver on the pension promises made. Clearly each scheme’s circumstances differ dependent on the current funding levels, sponsor covenant and the scheme demographics. Trustees need to carefully consider all of the issues against the backdrop of their own circumstances, and set out their key strategic objectives to meet the liabilities. These will reflect both their investment beliefs and the sponsors’ commitment. It is important to firstly understand the ‘end-game’ as this will influence the investment strategy implemented. Our fiduciary management business assists trustees in setting out the most efficient journey plan, the optimal investment strategy and short terms targets (for example de-risking triggers). Having set out a realistic journey plan, with the trustees and employer on the same page, it is then important to understand how the journey plan will be executed and how short term risks can be managed. Trustees need to manage an increasing number of short-terms factors along the journey. With a sharp fall, and subsequent rebound in bond yields over 2016, market volatility and generous equity valuations, governance models need to be able to cope with the ever faster changing environment. Added to this schemes are increasingly becoming cash-flow negative, bringing with it an increasing focus on funding level volatility. Against this backdrop we helped clients significantly improve their funding levels against the average FTSE 350 pension scheme.Solving the investment puzzle A great investment structure is like a jigsaw puzzle, it consists of a number of pieces that need to be joined together in the right order to provide the complete picture. We believe there are six key pieces in building a robust structure. Using a traditional governance structure trustees have often focused on one piece of the puzzle at a time rather than considering them as a complete picture, and how they interact with each other. Given decisions on investment strategy, hedging and asset allocation need to be much more dynamically managed than was previously the case, the answer for an increasing number of trustees is to delegate decisions they previously made themselves to a fiduciary manager.Flexible governance model Fiduciary Management has evolved a considerable amount since its inception, the way in which the various elements (see below) can be used, and the extent to which decisions can be delegated has changed. As providers achieve scale, new technology and capabilities allow each element of the service to be tailored to the schemes specific circumstances and governance requirements. Rather than a ‘loss of control’, this is a service to complement and implement the strategic decisions reached by the trustees. As well as bringing all pieces of the jigsaw together in a more efficient way, fiduciary management can also bring benefits to each individual jigsaw piece as well. The benefit of fiduciary management is you don’t need to buy the whole jigsaw, trustees can just employ the fiduciary manager for the bits that are missing, or need enhancing in their current arrangements. Many schemes now utilise a few of the services, configured to their specific needs. Sometimes creating and managing a bespoke growth portfolio, or a de-risking portfolio, sometimes solely using the investment infrastructure to release the legal and operational burden, and access the platforms considerable economies of scale. This flexible approach to managing investment governance has helped increase the use of fiduciary management within the UK.Building a better picture The early adopters of Fiduciary Management now have meaningful track records of 5 years+ which can provide evidence of whether a fiduciary management approach has made a difference to the outcome for pension schemes.The chart above shows Mercer’s first full fiduciary client in the UK to highlight how their journey has evolved over the last 6 years:• When the client switched to a fiduciary approach their 60% allocation to growth assets was retained, however their interest rate hedging was significantly increased, thus reducing the overall risk in the portfolio.• We had agreed funding level triggers with the client. The funding level was monitored daily and when a trigger was reached, assets were switched from the growth portfolio and invested in matching assets to further lower the funding level volatility. Since inception the client has seen growth assets reduce from around 60% down to 20%. • During their fiduciary journey the scheme has experienced a 75% reduction in risk.• The client is now working with us to consider buy-out, and finish the journey they started. Final thoughts The continued time and governance challenges faced by trustees, coupled with the increased uncertainty of future events means fiduciary management is increasingly likely to be considered as a way of helping trustees manage their journey to securing the benefits.