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Investment managers bid for public pensions business Back  
Irish investment managers have outperformed UK competition since 1984 and are best placed to win contracts for the new public pension fund. But it is yet to be decided who will have the final say in appointing external managers and setting investment strategies.
I rish investment managers are gearing up to win business from the new public pension fund to be set up with the bulk of the ?3.7bn proceeds of the Telecom privatisation. The new public pension fund, expected to be organised under the NTMA, could start next year at about ?4 billion after the first annual contribution of 1 per cent of GNP is made.

A special IAIM Conference on Funding Public Sector Pension Funds in September heard Dr Michael Somers say that the NTMA ‘had no desire to build up a large investment team and would appoint professional fund management teams to manage the assets’.
Montgomery Oppenheim Investment Managers also devoted their annual conference on 30 September to pensions business.

According to Finance Minister, Charlie McCreevy, the Government has not finally committed itself to having the funds managed by the NTMA, but its Chief Executive Dr Michael Somers clearly expects that the NTMA will have a role which he described as that of a ‘ringmaster’.
Irish investment managers accept that no matter how the pension is organised, contracts for particular mandates will be subject to public tender under EU Public Procurement rules. This will mean that the competition cannot be limited to local investment managers.

At the press briefing before the conference, outgoing IAIM Chairman, Gavin Caldwell of Ulster Bank Investment Managers, said it would be unlikely that the members of the IAIM who were not affiliated with or part of international groups would feel the need to seek alliances with international fund managers to bid for NTMA pension business.

Caldwell presented the investment performance and experience of Irish investment managers with international equity mandates. The median performance of Irish funds with non-UK mandates had been 13.6 per cent over the years 1984 to 1993, while it was 12.4 per cent for UK managers, he said. Irish managers had performed better than UK managers over each of one year, three years and five years to December 31, 1998, he claimed.

One analyst said that this measure of median performance rather than average means that the bottom of the second quartile among Irish fund managers is being compared with the bottom of the second quartile among UK fund managers in international equities.

A reason advanced by Caldwell for this outperformance was the greater international orientation of Irish investment managers, who diversified proportionately more into international equities. A UK source commented that one of the major factors making UK international performance relatively poor was UK funds having been relatively underweight in US equities for the last number of years. If Irish investment managers had been even a little less bearish about the US equity market, this could have accounted for a significant part of their exceeding UK returns.

Irish investment managers will seek investment mandates on the basis of their international, rather than purely Irish, equity management track records. In seeking business, each house will compete on its own track record rather than on the median return among its peers in the IAIM. With the public pension fund reaching E5 billion by the end of 2000, the total investment management fees could be around E12.5 million in the first year. Fees for the proportion of the fund which would be passively managed in index-tracking would be in the range of 10 to 15 basis points, making E12.5 million an higher-end estimate. Somers made the point at the conference that there would be no bonzanza for investment managers. The NTMA expects that the assets could rise to one-third of GNP by 2020, which would represent about E25 billion at today’s GNP.

Caldwell also confirmed that assets under management by members of the IAIM had nearly trebled since 1997, having increased from ?49 billion to ?120 billion. Most of this increase is due to the arrival in the IFSC of Europlus, the fund management arm of Credito Italiano.

International lessons

Professional arm’s length boards, private asset managers and market-based benchmarks were some of the e common features of the best, new funded public pensions schemes in OECD countries, said Robert Palacios of the World Bank. To guard against political interference in investment decision making, he said, the best method was for a public pension fund to adopt as its mandate the achievement of the highest possible risk-adjusted rate of return, as is the case with the private pension funds.

The best of the new public pension funds have increased equity holdings, and significant foreign investment.

They also employ a reliance on index funds where available and limits on shares of individual firms held. These new OECD initiatives apply a ‘private sector regulatory framework for fiduciary responsibilities and investment rules’, Palacios said.

The factors required for successful funded public pensions included a large domestic savings sector and deep and well-regulated capital markets, ‘with the pension fund not too large relative to either’. He also emphasised ‘good government’ as a critical success factor.

Bad examples

He pointed to a range of public pension or quasi-pension funds in a variety of countries which suffered from poor governance structures, including boards where executive control was exerted through political appointments, exclusive in-house investment management and unclear investment mandates. Such funds were commonly geared towards social investments, development projects, support for particular firms and markets and the forced purchase of public sector debt. Many of these funds had negative real returns relative to deposit rates, an average being minus 1.8 per cent. Even in Japan and Korea, real returns relative to bank deposits were just under 3 per cent.

Palacios presented data showing that the average real return relative to income growth for such public funds domiciled in countries from the US to Uganda was minus 8.4 per cent, with no fund exceeding 1% growth relative to income.

By contrast, private pension funds across a wide variety of countries generated real growth relative to incomes of plus 4 per cent on average over long periods. The figure for Ireland for the years 1984 to 1996 was 6 per cent, while the UK came out on top with nearly 8 per cent.
Palacios said that the experiments and debates in OECD countries on private investment of funded public pensions was a reaction to historically poor results. He pointed to the most interesting cases as Canada’s CPP Investment Board, Japan’s Nempuku, Sweden’s AP funds, Norway’s Petroleum Fund and the US proposals for a National Thrift Savings Plan.

Irish case

In his presentation, Somers highlighted the economic factors which supported the case for creating the funded pension scheme. He instanced a change of 250,000 between 1994 and 1999 in the estimate of Ireland’s population in 2011 by the Central Statistics Office, arising out of changes in migration. Thus, Ireland’s dependency ratio - the size of the labour force relative to the population over 65 years old - has been lowered, especially in the years up to 2010. From a present level of 3.6, it will move to 4.2 by 2008 and then fall steadily to 3.4 in 2015 towards 1.5 in 2055. The trend is downwards, so pre-funding of pensions liabilities now makes sense, said Somers.

Somers cited the interim report of the Commission on Public Service Pensions of August 1997, which said that ‘the annual cost of public service occupational pensions is projected to increase threefold from ?540 million per annum in 1995 to ?1.4 billion per annum over the next thirty years’. The Commission is due to issue its final report ‘shortly’.

As regards plans to manage the fund, Somers said that an annual real return of 5 per cent could be expected. The pension funds - one for social welfare, one for public sector pensions - would approximate over one third of GNP by 2020. It was likely to be heavily weighted towards real assets.

A major issue affecting policy for the two funds is that they will not have the same solvency requirements as private sector occupational pension funds. This is particularly acute for the social welfare fund. It is labelled a ‘Social Welfare Reserve Fund’ since it will not technically be a pension fund and it is not envisaged that it will fully fund social welfare pensions.

A fundamental point which Somers drew attention to was the difference between the funding requirement of social welfare pensions if they are linked to the consumer price index, rather than to wages. By 2016, the social welfare pensions will cost 2 per cent of GDP, if linked to the CPI, but 3 per cent if linked to wages. In 2046, the figures are projected to be 1.9 per cent and 6.8 per cent. Trade unions seek the linkage to wages. The Department of Finance entered a reserve on this recommendation of the National Pensions Policy Initiative, and the issue is still in play.

In his remarks at a recent NTMA press conference, the Minister for Finance signalled that the fund will have a ‘trigger point’ which may require more funding than the planned 1 per cent of GNP currently planned. Operating without the same solvency requirement as a private pension fund will present a particular challenge for the definition of the trigger point.

Speaking at the Montgomery Oppenheim investment conference later, John Corrigan of the NTMA said that the new State funds represented ‘a very public bet that equities would outperform bonds over the long run’, in response to a question about paying down the national debt as a first step.

Representative board

Dr Rosheen Callender, an economist and National Equality Secretary at SIPTU, emphasised to the IAIM that a partnership approach should be brought to the governance of the new pension fund.
Trade unions had a strong view on the need for a partnership approach ‘to the key question of who supervises and monitors the administration and investment of the new fund’ Calleder said.
‘Pension funds must be supervised by bodies that are fully representative of all interested parties - the social partners, and other relevant experts and professionals - so that the investment and management of these very substantial funds will be subject to full democratic control and accountability’.

As regards investment policy, Callender went beyond the recommendation from Palacios to maximise risk-adjusted rate of return. Investment strategies should include ‘maximising the returns of the fund while also observing ethical standards; tailoring investments to the needs of the people for whom they are intended; balancing people’s wish for investment in socially-desirable projects with their right to have a high degree of security in relation to their pensions; and dealing with such difficult issues as to whether national pension funds should have the right to invest in a totally unrestricted, international environment so as to achieve optimal returns.’

The NTMA points out that Minister McCreevy had said earlier that the decision to set up the funds was different to the policy of investing in infrastructure and that the funds should be run on a commercial basis.

It is yet to be decided what the governance structure and the investment philosophy of the public pension fund will be. The NTMA is at present an agent of the Minister for Finance. The setting up of a decision-making board of trustees would be a constraint on the role of the NTMA as manager, as its expected role.

Corrigan said that conflicts of interest relating to the NTMA’s bond role would be avoided by investing the funds in real assets, not bonds. The appointment of external managers would also help avoid conflicts, he added.

Callender further added that the board of trustees should appoint the investment managers to the fund. How the responsibility for appointment of investment managers would be shared between the NTMA and a board of trustees is one issue to be clarified. The announcement by the Minister for Finance in July, cited by Somers, stated that ‘the proposal to be contained in the Bill will enable the NTMA to manage and invest long term funds held by the State where the Minister or trustees concerned requires such a service’. What managing and investing means in this context, and the relationship to private sector managers, will require substantial clarification over the next year. In one model, the NTMA, as manager, could have discretion to appoint discretionary sub-managers. In another, the NTMA would advise the decision-making board of trustees. These issues are all to play for in the coming months.

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