Special Report - Pensions Risk Management: A strong hand – when outsourcing the pension fund is the best option

With many company defined-benefit schemes recently closed to
new entrants, some finance directors are keen to engineer a buyout of the
company pension scheme and get it off the books. But the collapse in the
financial markets has caused many deficits to balloon and that has to be
addressed before a buyout can be contemplated.

Additionally, amid the crisis, FDs have realised the impact that their lack
of control over one of the largest assets on their balance sheets ­ a product of
the Robert Maxwell pension plundering scandal which led to the industry handing
control to independent trustees from FDs and management ­ has on their grasp of
the bottom line.

For trustees, the collapse in the financial markets has caused pension
deficits to soar and caused them to worry that the company may not be able to
fund the future liabilities of the scheme. Much has changed. “The credit crunch
has shown that financial markets are often more volatile than have been assumed
in the past,” says Marcus Hurd, head of corporate solutions at Aon Consulting.
Typically, trustees tended only to meet four times a year ­ but markets ‘happen’
all the time and so reaction times have to be quicker in the future.”

As a result, an increasing number of FDs and trustees are now thinking about
outsourcing the running of their pension funds to the professionals, a process
commonly referred to as implemented consulting, delegated consulting or
fiduciary management.

All three are different names for the same thing: outsourcing more of the
running of the pension fund to an external company, with trustees deciding how
much risk they are comfortable with and then handing it to the manager to get
the best returns within those risk levels, rather than hiring individual
investment managers themselves.

Same difference
But there is some discussion about the differences. Industry observers point out
that implemented consultancy tends to be carried out by one of the big pension
consultants, whereas fiduciary managers tend to be from outside that top
quartile by size ­ but the terms are used interchangeably.

Not every fund will go down this route. “It can be more expensive than the
traditional consulting solution,” says Paul Trickett, Watson Wyatt’s head of
European consulting.

But it can save money over the long-term because while you pay a higher fee
to the implementation consultant or fiduciary manager, you are only paying them,
rather than shelling out different fees to a number of different investment
managers.

Long-term cost savings
Patrick Disney, managing director of SEI’s EMEA institutional business has one
client who estimates that they have reduced their costs by a third in this way:
“Long-term costs can be saved by delegating to one company, the fiduciary
manager, rather than having direct contracts with five to 15 firms,” he says.

The most common way for many companies to use implemented consulting or
fiduciary management is to give the power to hire and fire investment managers
to your investment consultant. “Most pension funds have been struggling over the
past 12 months and acknowledge that they cannot carry on the way they are,” says
Brett Smith, part of the corporate team at Towry Law.

“Fiduciary management is becoming a major growth area.” Trickett says that
Watson Wyatt currently provides “some form of implemented consulting” to around
35 funds and that between five to 10 of those clients opt for full-scale
implemented consulting.

“When funds take this option, they typically agree with us how much risk they
are willing to take and then hand over the portfolio, so we can make the most
efficient use of this risk to generate the best possible returns,” he adds.

There is also a growing trend for clients to ask to change the asset
allocation mix in line with economic cycles, says Trickett. The proportion to
which the assets are allocated, for example, between equities, property, bonds
and commodities depends on which asset class looks like it will generate the
best possible returns at that point in the economic cycle. As the cycle changes,
so too does the asset allocation.

Aon’s Hurd believes companies are adopting a variety of answers to the
question of pension fund performance. “Sometimes the solution might be as simple
as recruiting professional financiers to the board of trustees. Or other
companies might simply appoint their own advisers.”

Some companies are undertaking an implemented consulting approach so that
they can get the company pension scheme into shape to make buyout a possibility.
Disney says that some of his clients have been asking for this sort of
assistance.

And Hurd believes this strategy would pay off handsomely. “The crunch sparked
a huge fall in the pricing of corporate bonds, making it possible for those
companies with their house in order to enter into a buyout. That opportunity
will arise again over the next five years ­ and it would be a shame to miss it a
second time.”