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Is it time to change your pension fund manager? Back  
Today's pension fund trustees are better educated and better informed about their pension funds than in years gone by, but are fund managers providing the services that trustees need? Finance asked trustees, fund managers and consultants to outline the obstacles to perfect pension fund management.
March has been a difficult month particularly for fund managers who have seen the value of some portfolios slashed. And it has been a no less difficult time for pension fund trustees who have had to deal with fund members worried that the value of their pension is dropping. The nosedive of the NASDAQ has heralded the dreaded bear market and truly banished the bull for the time being.

Finance asked pension fund trustees, fund mangers and pension consultants whether they thought it was time for Irish pension fund trustees to change their pension fund managers and if so why? The answers proved through provoking.

Bill Riley chairman if the trustees of Intel Ireland summed up the role succinctly ‘It is our job to manage the performance of the fund mangers.’

While today’s pension fund trustees are better educated and better informed than their predecessors there is still a culture of loyalty surrounding the industry. But trustees are demanding more from their mangers: more specialist management and more regular information updates as they wake up to the fact that they are legally responsible for any mismanagement.

Pension fund trustees have a tough job. They have to decide on the investment objectives of a fund, weighing up the desire for growth with the need for stability, choose the investment fund and the appropriate investment manager for the fund. They have to keep members of the fund informed and deal with the day to day membership issues of contributions and payments, and often times delegate the administration and management for the fund to third parties, but nevertheless remaining legally responsible for any mismanagement by the third parties. A thankless task and one for which they are not paid - by law.

However all this could be about to change. The recent Myners Report in the UK heralds radical changes in the industry - and recommends that pension fund trustees should be paid for their work. The controversially report also makes other recommendations and for a more in depth report see the article on page 9.

When faced with a poorly performing pension fund manger what should today’s Irish pension fund trustees do? Gone are the days of happily handing over the cash of the fund and seeing no more from the manager until the annual meeting. However the plethora of fund value statistics shows that overall Irish managed pension fund performances have been less than startling over the last 12 months? Given this what are the options for trustees - should pension fund trustees change their pension fund manager?

Bill Riley chairman of the pension fund trustees at Intel Ireland believes that fund managers should only be appointed for the long term. ‘Our approach is to set out a clear view of our expectations for performance of the funds over a 2 - 10 year period. Clearly there are differences between fund managers performance and that difference can be significant and has to be taken into account when looking at the fund.’ Riley believes that there is a mandate for switching fund mangers if there are clear criteria for the change but warns against swapping in response to a downturn in the market.

According to Brendan Johnson director of pensions at Eagle Star Life Assurance ‘Pension fund trustees should always keep the performance of their managers under review. However the recent past, which will feed into the statistics, has been very volatile in general terms and particularly in the technology and communication stocks.

‘Also property investment has performed particularly well over the last couple of years and one could question whether enhanced short term performance based on a high element of property should be given much weight moving forward.

‘A final point is the spectacular performance of Elan which grew by over 60 per cent in 2000 and constitutes over 20 per cent of the Irish index. A manager with a high weighting would have benefited but should a trustee really be happy with the stock specific risk if more than say 3 per cent of their portfolio was invested in any stock. With the recent past being an uncertain measure of return the trustees may be better looking to managers that have a stable team and good long term good performance.’

Peter Griffin of PricewaterhouseCoopers said that pension fund trustees should only consider changing their fund manager in 2001 ‘if the fund manager has under-performed on a consistent basis or the underlying strategy adopted by the fund manager is inconsistent with the investment objectives of the trustees or scheme members.’

According to Gavin Cauldwell chief executive of KBC Asset Management trustees should be looking at whether they are satisfied with the services of fund managers rather than at the recent performance. ‘Another issue is how settled the management team are. It is important that key people stay within the business and that they are motivated to run the business well.’

However Cauldwell said there were legitimate reasons to change your fund manager. ‘If your fund manager is performing badly over a 3 - 5 year period it is reasonable to ask why, and the concern should be that there is either too much change or too little change within the organisation.’

He believes that the continuity of the people within the business is one of the most important issues for trustees. But he did underline the changes taking place within the industry saying that ‘trustees need a greater choice of investment product’ and that they were demanding more regular fund value information. ‘Providing more performance data is important.’

From the trustee perspective Oliver Egan of FAS said ‘we will be reviewing our fund managers in 2001. The review is part of an ongoing program whereby managers are formally reviewed at regular intervals (on average every three years). These formal reviews are part of an ongoing review process that sets performance parameter and compares performance with other fund managers.’

Back at Eagle Star, Johnson believes that the most important criteria for trustees when choosing a fund manager is the long term performance achieved at a level of risk that is acceptable to the trustees.

According to Alan Flynn of BDO Simpson Xavier ‘the role of the Trustees in relation to investment is to invest the money wisely and get the best possible return. But this must be achieved with a level of risk that the Trustees are prepared to accept. So for example if you were to consider changing your investment manager on what basis would you be making this decision?
‘The problem with making a decision of this nature is that trustees may only consider moving when the fund manager is under-performing. And if they move at this stage they may only consolidate the losses that their previous manager made. It is therefore extremely important that trustees develop an investment strategy before they even consider who the fund manager(s) should be. The trustees should therefore ask themselves the following type of questions in formulating their strategy;
• What real rate of return (i.e. rate of return over inflation) would they ideally like to achieve?
• What level of guarantees would they like to apply to their fund?
• What asset classes would they like to invest in and what per cent should apply to each class?
• How often should the performance of the fund be reviewed and is relative position important if the fund is achieving it’s objectives?
• How long should an under-performing manager or asset class be given to correct its position before a decision to change is undertaken?
• Are there likely to be any penalties on changing?
• Should different age groups have different strategies? (Money Purchase schemes only).

Flynn continued by saying that although no two pension schemes will have the same answers but the factors likely to influence the answers are; the number of members, the average age of members and different age categories, the size of the fund, and the attitude to risk.

‘Financial institutions are becoming ever more sophisticated in providing solutions for Trustees and probably the one that has caught most attention is the introduction of ‘consensus fund management’. This is a method of investing money where the collective decisions of the fund managers in a market are copied and therefore the return in the fund is the average of that market. This is particularly popular with trustees of schemes with large numbers of members.

‘Trustees can also choose to have different fund managers managing different portions of the same fund, new contributions can be redirected to new managers, guarantees can be applied, different equity markets can be selected, and individual members can choose their own strategy. Compared to even a couple of years ago the amount of investment choice at the disposal of trustees is overwhelming. But we still all want the same result, the challenge remains the same to achieve the best possible return in the circumstances.’

According to Griffin of PWC the most important criteria when choosing a pension fund manager is the ability of the fund manager to demonstrate a consistent approach in deciding upon asset allocation and stock selection decisions backed up by a consistent return on investments.

Alternatively Bill Riley of Intel says that the clarity and consistency of the fund mangers are the two key criteria for trustees. ‘Fund managers need to have clarity and consistency and a clear sense of what they can and what they expect to achieve.’ He added that it is also important that fund managers and trustees to understand the criteria under which the fund manager’s performance will be judged.

Pramit Ghose pension fund manger at Hibernian Investment Managers takes a more pragmatic approach to trustee requirements and says the trustees should make sure they are happy with the international capabilities of the chosen fund manager so that they can deal with the increasing requirements to invest internationally.

He said ‘we’re seeing more of a focus on the type of mandate that people are being given.’ He explained that while trustees used to want the manager to manage a balanced fund that now trustees they want specific fund mangers to manage specific parts of the fund - foreign exchange, fixed income and international equities as an example all going to different fund management houses.

While he said that the bigger funds should get a better return from this type of specialist management approach he warned smaller funds against adopting this investment method.

Ghose said ‘Trustees hate poor fund performance that can’t be explained in a logical manner.’ But the length of time that trustees look at varies - some considering 6 months as long term while it is generally accepted that 3 - 10 years is a more appropriate length of time for performance measurement.

Tom Finlay of Bank of Ireland Asset Management believes the onus is on the trustee to understand the four ‘p’s’ of the fund manager - the process, the philosophy, the performance and the people.

Meanwhile Egan of FAS believes that past performance, projected performance, the strength of the management team in terms of the skills mix and the experience and range of services on offer are crucial in choosing a fund manager. He also pointed to the importance of the fund manger’s track record in terms of gaining or loosing business and would want to know what the scale of these and the impact they had on the investment team. Egan also suggests that trustees look at the reporting systems of any potential fund manger their security systems and not least of all, the fee.

Griffin highlights the importance of asset liability modeling as a key service to pension fund trustees. ‘As a pension consultant the most important services we provide to scheme trustees is asset liability modeling. This means matching the scheme’s investment strategy with its liabilities (for defined benefit arrangements) and defined contribution schemes we assist the trustees in selecting a fund manager to invest the scheme assets on behalf of the members offering a range of funds consistent with the risk profile of the scheme members. In general terms it is important that Trustees of both defined benefit and defined contributions are properly educated to what their role is and the extent of their duties and responsibilities are.’

Trustee of the FAS pension fund scheme Oliver Egan said the most important service on offer is the quality of the return and the investment mix, but he also highlighted that the reporting and communication from the fund manager needed to be of a high quality.

According to Johnston of Eagle Star Life ‘The main challenge for 2001 will be to maximize the advantage that we can from the opportunities that will arise as a result of changing legislation.’
Eagan of Fas said the main challenge is to secure a return in excess of wage inflation.

Main pension challenge in 2001
Griffin of PWC sees 2001 as a crucial year for pension reform. ‘There are probably two significant areas that will be pension challenges in 2001. Firstly the proposed Pensions Bill, which is likely to introduce personal retirement savings accounts (PRSAs) and other changes to existing pensions legislation. The other is the method of reporting pension cost to company accounts.

‘The current reporting method SSAP24 - Standard Statement of Accounting Practice 24 is being replaced on a phased basis by FRS17 or Financial Reporting Standard 17. The new reporting standard effectively treats your pension scheme as if it were a subsidiary of the sponsoring employer.

‘For accounting periods ending on or after 22nd June this year, the net worth of the pension scheme has to be assessed and entered into the company’s balance sheet as an asset - if the scheme is in surplus or as a liability if it is in deficit subject to certain restrictions.

‘The method of working out the net worth of the scheme is highly prescriptive (the scheme actuary has no discretion) and lays down the base line for measuring the performance of the Pension Scheme for the trading year to come.

In valuing the scheme’s assets and liabilities a market-based approach is adopted and this is radically different to the method most commonly used up until now.
The finance cost of the scheme is the difference between what the scheme expects to earn by way of investment return and the cost of interest on the scheme’s liabilities. The interest based on the yield available on corporate bonds at the beginning of the trading year.

‘Costs are entered in the company’s profit and loss account, the finance cost is usually negative since the return of the fund is expected to be higher than the cost of interest on the liabilities.

‘In the past where benefit improvements have been given the cost of providing these benefits have been spread over the lifetime of the scheme. Under the FRS17 standard where a benefit improvement has been given the actual cost must be shown in the profit and loss account in the year in which the improvement has been granted. This cost is reported in the statement of recognised gains and losses (STRGL) and these figures can be huge.

‘The difficulty facing trustees wishing to improve scheme benefits, for instance provide post retirement indexation, is that where in the past the true cost of granting such increases has been more easily digested by the sponsoring employer the new reporting method may make employers think twice.

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