An introduction to
Delegated Investment Inside: • What is delegated investment? • What are the benefits? • Who is it for? • Controlling risk • Appointing a provider • Glossary • 20 questions for trustees
It’s wise to have an expert focus on yourtofund’s performance. It’s wise have an expert focus on your fund’s performance. In today’s ever-changing financial landscape, you need an expert to keep a watchful eye over your investments. In today’s ever-changing financial landscape, you need an expert to keep
You see, managing investments is becoming increasingly demanding. a watchful eye over your investments. Added complexity means trustees need dedicated investment expertise You see, managing investments is becoming increasingly demanding. to deliver improved performance. Added complexity means trustees need dedicated investment expertise
to deliver The goodimproved news is performance. that, within clearly defined parameters that you set, our specialists make and implement day-to-day investment decisions. The good news iscan that, within clearly defined parameters that you set, They exercisecan their deep and insight every day. our specialists make and understanding implement day-to-day investment decisions. They exercise their deep understanding and insight every day.
Many pension schemes are using our expertise to deliver their investment Many pension schemes are using our expertise to deliver their investment objectives within a risk-controlled framework. objectives within a risk-controlled framework.
To find out how you could benefit from our Delegated Consulting To find out how you could benefit from our Delegated Consulting Services callusus 0800 or email
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Copyright © 2012 Hewitt Risk Management Services Limited. All rights reserved.
Copyright © 2012 Hewitt Risk Management Services Limited. All rights reserved.
Hewitt Risk Management Services Ltd is authorised and regulated by the Financial Services Authority.
Hewitt Risk Services LtdNo: is authorised and regulated by the Financial Authority. Registered in Management England & Wales. Registered 4396810. Registered Office: 8 Devonshire Square,Services London EC2M 4PL. Registered in England & Wales. Registered No: 4396810. Registered Office: 8 Devonshire Square, London EC2M 4PL.
INTRODUCTION
What is delegated investment?
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elegated investment has become established in the UK remarkably quickly. A few years ago it was almost unheard of; now it is part of the mainstream. It has been adopted by a wide range of pension schemes. This guide provides a definition of delegated investment, explains its rise in popularity and highlights the opportunities and challenges that it presents for trustees. It includes a list of what to look for in a delegated provider, 20 questions that trustees might like to consider with their colleagues, as well as a glossary. Delegated investment is the assignment by trustees of day-to-day investment decisions and implementation to a third-party provider – typically either an investment consultant or asset manager – within a framework set by trustees. Delegated investment is also sometimes referred to as “fiduciary management” or “implemented consulting.”
Delegated investment may be new but it is not revolutionary. Trustees delegated stock selection to asset managers many years ago and many outsource administration and other services; now a growing number are delegating asset allocation, manager selection and other investment decisions as well as implementation to third parties. Why now? Trustees are under intense pressure. As well as experiencing long-standing concerns about investment returns, longevity costs and regulation, they face growing calls from sponsors to de-risk their portfolios. The investment strategies adopted to deal with these multiple challenges are often demanding of trustees’ capacity for acting in a timely fashion and their investment expertise. By their own admission, many trustee boards are short of both, which is where delegated investment comes in. Demand for delegation is also growing because many trustees find it difficult to deal
with the complexity of today’s investment decisions within the confines of their quarterly meeting schedules. By delegating to professionals, trustees are ensuring decisions are made and implemented by investment experts every day, rather than just once a quarter. n
“Trustees find it difficult to deal with the complexity of today’s investment decisions within their quarterly meeting schedules”
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BENEFITS
What are the benefits?
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peed: By appointing a delegated provider, trustees can ensure decisions are made and implemented quickly. In traditional arrangements, many trustee boards find it can take the best part of a year to take a decision and for it then to be implemented. Consider, for example, a decision to invest in a new asset class. This can often take three trustee meetings – or nine months – to finalise. First, there is a meeting to consider the options, then a meeting to decide on the particular asset class and then a meeting to select managers to undertake the investment. After that, yet more time is often lost in legal paperwork and the practical issues of moving money from one manager to another. By then, prices could have soared and the original value opportunity will have been lost. A delegated provider can invest in a new asset class within days. Investment expertise: Many trustee boards include only a sprinkling of investment experts. Yet they increasingly invest in complicated investments such as derivatives and hedge funds. Further, many pension funds have adopted intricate strategies such as liability-driven investment in an attempt to address their financial problems. These are tricky strategies for traditional trustee boards to manage. By appointing a delegated provider, trustees are
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appointing investment experts with the capacity to deal with complexity. Control: It is often said that delegation involves a loss of control; that by appointing a delegated provider, trustees are handing over the reins to a third party. But this claim does not stand up to scrutiny. Trustees still make the big decisions: they set the risk and return objectives and they define the permitted investments. Meanwhile, the provider takes the day-to-day
“Many trustee boards have little time to focus on strategic investment. Much of their time is spent on short-term decisions” decisions and is also responsible for implementing those decisions. The parameters within which providers operate are set out clearly in Investment Management Agreements which, together with clear reporting, give trustees the control they need to carry out their responsibilities. Cost: Another myth about delegated investing is that overall costs rise because providers charge fees on top of those already charged by the underlying asset managers. But trustees have told us that total costs do
not always increase. Providers’ fees can be offset by a number of savings including lower fund management fees. The latter reflect delegated providers’ buying power. Bulk discounts can make a significant difference, in particular for small schemes. Diversification: Diversification presents trustees with a significant governance challenge. Many schemes have been encouraged to diversify their investments in order to reduce risk. But as they increase the number of asset classes and managers in their portfolios, they have to spend more of their scarce time selecting, appointing and reviewing managers. They soon find their meeting agendas are longer than ever. By delegating to third-party providers they can achieve more diversification than can many boards of trustees operating traditionally. Trustee time: Trustees’ meeting agendas are extremely long, swollen by new regulatory requirements. Many boards have little time to focus on strategic investment and find much of the time that they allocated to investment is spent on short-term issues. By delegating day-to-day decisions and implementation to a third-party, trustees can focus on longer-term matters such as the performance of their chosen delegated supplier against their own long-term risk and return targets. n
USERS
Who is delegated investment for?
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elegated investment is used by all timely decision-making, we expect many more kinds of pension schemes. Some are frozen schemes to delegate decision-making. large and some small. Some are open, Similarly, delegation is also proving an some closed and some frozen. Some attractive solution to the challenges of flight have flight plans and some do not. plan management. Flight plans, which are Some are well funded and many are in deficit. long-term tailored investment plans that That said, we have found that delegation has typically incorporate trigger points for de-risking particular appeal for smaller and frozen schemes. as funding levels improve, are difficult to It is easy to see why. Delegation manage, especially within the allows smaller schemes to benefit “Delegation allows confines of a quarterly meeting from discounts on funds that schedule. They require close they would not otherwise enjoy smaller schemes monitoring and timely action and, partly as a result, to access to benefit from when the portfolio hits pre-set a wide range of asset classes (and trigger points. Delegation investment styles) usually open discounts on funds meets these needs. only to larger schemes. Small Trustees can delegate the that they would not schemes don’t tend to have the whole or part of a portfolio. ability to dedicate resources to otherwise enjoy” Many schemes find delegating investment issues in the way that a part of a portfolio – for larger schemes can, for example, by appointing example a particular asset class – an attractive a chief investment officer. way of familiarising themselves with the Frozen pension schemes, which have closed to delegated approach. It allows them to put a toe future accruals, can also benefit from delegation. in the water. Many frozen schemes report having both slow Delegation comes in many forms. But not all decision-making and few investment experts providers cover the whole range. Trustees should on their trustee boards. Given that delegation check the flexibility of their prospective provider. specifically meets the need for expertise and n What trustees want
Why delegated investment helps
Focus on scheme liabilities
Tailored portfolio, driven by liabilities
Control
Trustees set risk-return objectives and monitor performance; clear reporting
Performance
Best-of-breed fund managers (where providers carefully select third-party funds)
Capture market opportunities
Timely decisions and implementation
Lower fees
Discounts from bulk buying and other savings
Lower volatility
More diversification
Time to focus on strategic issues
Delegating day-to-day decisions and implementation to third-party
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RISK CONTROLS
Controlling risks
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n a delegated arrangement trustees delegate day-to-day decisionmaking and implementation to a provider who takes on the task of making those decisions and ensuring they are carried out within the parameters set down in its agreement with the trustees. Providers need robust systems to ensure they always act within those parameters. Providers who only use thirdparty funds also need to select these funds carefully, using proven skills of manager selection and extensive due diligence. At Aon Hewitt we normally monitor the risks in every portfolio that has been delegated to us not annually or quarterly but daily. We go further: four teams normally monitor each portfolio each day. The teams cover asset allocation, volatility and other investment risks, investment guidelines and operational risk. As a result of this multi-faceted daily risk monitoring system, we sometimes know about breaches to investment guidelines before the underlying fund manager has noticed anything is wrong. Most trustees find it impossible to achieve this level of scrutiny. By appointing a delegated provider trustees can substantially improve their risk monitoring.
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“Many boards appoint their consultant because they are familiar with them and trust the people” Appointing a delegated provider Most providers are either investment consultants or asset managers. They are competing to provide delegated services. How should trustees choose between them? Many appoint their consultant (or rather their consultant’s specialist arm) as their delegated provider partly because they are familiar with the consultancy and trust the people. Consultants have long provided advice to them; they understand their clients’ liabilities, their relationship with the sponsor and often the history of the scheme. Other trustees appoint asset managers, drawn by their investment track records, clear descriptions of investment process and the investment experience of their staff. As time goes by the two kinds of provider should be judged, at least in respect of delegated mandates, on the same criteria. Consultants must
provide performance track records and asset managers must show they have an understanding of liabilities. Trustees need to be sure their providers can do both. Trustees also need to be aware of the potential for conflicts of interest. On the one hand some asset managers invest delegated clients’ money in in-house funds. In some cases these funds will have passed a number of tests for inclusion in portfolios but this may not always be the case. This is not a problem for most consultants as they are not asset managers and only invest their clients’ money in third-party funds. Either way, trustees need to be sure that their provider • has access to information on • underlying holdings. Consultants are often said • to present other conflicts of • interest. This is because they • are often the established advisor before they (or their • specialist arms) are appointed • as delegated provider. For their • part, some consultants see delegated investment as an • extension of their consultancy • services; in other words they
selection, asset allocation and risk monitoring. The continuity of service provides reassurance. Many trustees who have appointed consultants as delegated providers have not felt it necessary to hold a beauty parade nor to get independent advice. We expect more trustees will get independent advice over time. n
What to look for
are bolting-on implementation to their existing advisory services which include manager
Good understanding of your liabilities Tailoring to your needs Investment credentials High quality third-party funds Opportunity for increased diversification Due diligence process on funds and fund managers Daily risk monitoring Fund discounts Clear legal agreements Clear, unified reporting
• Willingness to work with independent advisors
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GLOSSARY
Glossary A
Accrual.............................................................................. Benefits that build up in a pension fund Asset allocation.....................................................The way a portfolio is split between asset classes Asset class..........................................The main types of investment, e.g. equities, bonds, property
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De-risk.......................................................... Reducing risk through a planned investment strategy Delegated investment...................................... The assignment of day-to-day investment decision- ...................................................................making and implementation by trustees to third-party ....................................................................................providers within parameters set by trustees
F
Fiduciary........................................................A trusted person or entity who acts for the benefit of ..................................................................................... and on behalf of another person or group Fiduciary management................................Often used to mean the same as “delegated investment.” ..................................................................................Sometimes restricted to de-risking strategies Flight plan........................................................ A long-term tailored investment plan that typically ............................................................... incorporates trigger points for de-risking the portfolio as ...................................................................................................................funding levels improve Flight path..................................................................................................... See flight plan above Frozen scheme................................................... A pension scheme that is closed to future accruals
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Implemented consulting . ......................................... Often used to mean “delegated investment” ...........................................................................Sometimes used to describe a relationship where ............................................................trustees delegate implementation but not decision-making ......................................................................................................................... to their consultant Investment consultant.................................... An advisor on investment strategy and the selection ...................................................................................................................................of managers Investment Management Agreement (IMA)... The IMA is a legally enforceable agreement between ............................................... investment managers or delegated providers and pension schemes
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J Journey plan............................................... See flight plan above.
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Liabilities....................................Obligations to pay, e.g. pensions Liability-driven investment................. A framework for managing assets in a way that reflects liabilities, e.g. a bond portfolio that produces cash flows that match expected pension outflows Longevity.............................................................Life expectancy
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Manager selection............................The choice of fund manager ...............................................................best suited to invest a portfolio
R
Risk......................................................... The variability of returns
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Stock selection...................... The selection of individual securities ......................................... e.g. equities and bonds for a portfolio Swaps................... A contractual agreement allowing two parties to exchange one stream of cashflows for another
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CHECKLIST
20 questions to consider Yes?
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No?
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Do we spend enough time on investment issues?
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Do we make investment decisions too slowly?
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Are our investment decisions implemented promptly?
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4
When our consultant’s view of a manager changes, do we switch managers quickly enough?
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Have we missed investment opportunities through slow decisionmaking or implementation?
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Do we deal with complicated investment issues?
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Do we feel comfortable using derivatives to control risk?
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Could we deal with complicated investment issues better than we do?
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Do we spend more time on strategic investment issues than we spend on day-to-day investment issues?
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Do we invest in as many asset classes as we would like?
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Do we have time to devote to more asset classes and more managers?
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In respect of our flight plan, do we make changes quickly on hitting trigger points? Or, if we were to adopt a flight plan, do we know how quickly we would be able to make changes on hitting a trigger point?
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Is our scheme big enough to justify appointing an in-house chief investment officer?
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Yes?
No?
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Are market indices our primary benchmark for measuring investment performance?
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Do our regular investment reports provide a clear, unified view of the whole portfolio?
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Do we monitor risks as often as we would like?
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Does the portfolio benefit from bulk discounts?
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Have we delegated stock selection?
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Have we outsourced administration?
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20
Would we like to know more about delegated investment?
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If any of your answers are in a red box please call 020 7086 9352 for more information.
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2012 Aon Hewitt Delegated Investment Survey 2012 Aon Hewitt Delegated Investment Survey is Aon Hewitt’s third large survey on delegated investment and covers the views and experiences of 329 trustees and other stakeholders. It also provides commentary on the findings by Aon Hewitt’s experts. If you would like a copy of the survey findings, or to learn more about Aon Hewitt’s Delegated Consulting Services, speak to your usual Aon Hewitt consultant, go to aonhewitt.co.uk/delegatedconsulting, email
[email protected] or call 0800 279 5588.
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Disclaimer Copyright © 2012 Aon Hewitt UK Aon Hewitt Limited is registered in England & Wales. Registered No: 4396810. Registered Office: 8 Devonshire Square, London, EC2M 4PL. Nothing in this document should be treated as an authoritative statement of the law on any particular aspect or in any specific case. It should not be taken as financial advice and action should not be taken as a result of this documentation alone. Consultants will be pleased to answer questions on its contents, but cannot give individual financial advice. Individuals are recommended to seek independent financial advice in respect of their own circumstances.
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About Aon Hewitt Aon Hewitt is the global leader in human resource consulting and outsourcing solutions. The company partners with organisations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. For more information on Aon Hewitt, please visit www. aonhewitt.com. This Guide was first produced in association with Engaged Investor in 2011 and has been updated and reproduced by Aon Hewitt.
