Poor Q1 returns catch up on risky fiduciary managers

The Covid-19-induced stock market meltdown – which saw global equity markets fall by about 16 per cent over the quarter – was the first real test for FMs, which were in their infancy during the financial crisis of 2008.

A report from XPS Pensions Group, published on Tuesday, showed that those managers that made the strongest gains through high equity allocations in 2019 were the ones facing the biggest losses at the end of Q1.

On the contrary, managers that made lower returns in 2019 tended to be better prepared for the market falls.

While risk and return have been broadly correlated in previous analyses of the FM market, the three-year picture to the end of March paints a different picture. Around half of managers achieved good risk-adjusted returns - while some outperformed equities with even less risk than a global bond portfolio, others anguished in negative territory, taking more risk and delivering lower returns than the median diversified growth fund.

The survey, which looked at 16 managers responsible for £190bn in pension assets, also highlighted a difference of 10 percentage points between the highest and lowest returning portfolio. A similar dispersion can be seen over the three years to March 31, with a 12 percentage point cumulative difference.

FMs underperforming diversified growth funds

Martin Tingle, chair of trustees of the £20m High Duty Alloys Pension Scheme – a closed defined benefit scheme with different manufacturing sponsors – found the comparison with DGFs and passive funds interesting.

“All the surveys I have seen up until this quarter have shown that the vast majority of FMs would get you a better return for about the same risk when compared with a DGF,” he said.

“I am not quite so convinced after seeing the first-quarter numbers. I am hoping that it will come right and there will be a bounce back.

“The end of March was a particular low point – we hoped FMs would better protect us from the downside risk. I am disappointed that doesn’t seem to have happened, not just with our FM, but [with] others in the survey.”

The research showed, however, that there was a heightened level of activity from FMs during the period, with 75 per cent of the respondents indicating that they had made short-term “tactical” asset allocation decisions during the quarter, either to take advantage of opportunities in the market, or protect assets from further depreciation.

These decisions included strategic asset allocation changes such as reducing equity exposure and increasing cash holdings, to more nuanced changes such as tilting the strategy to have a greater exposure to developed markets, XPS stated.

Neil McPherson, managing director at Capital Cranfield, argued that the comparison between these managers and growth funds “is a bit false”.

“Both FM and DGFs are medium to long-term plays, where you are buying the tactical agility of the manager to react to markets more responsively than traditional asset allocations.”

Mr McPherson noted that the two products are “very broad churches”.

“The test will be on risk profile. If you thought you were buying a risk management strategy, designed to reduce volatility, and results show you actually had an equity-heavy growth strategy with insufficient hedging, you may wish to discuss it with your FM and investment consultant,” he said.

Pieter Steyn, head of delegated investment services UK at Willis Towers Watson, echoed this sentiment: “We often hear FMs are similar, but this shows provider choice is important.

“It looks like the simplest approaches that restrict the investment universe to largely mainstream asset classes worked well in 2019, but ended up being the most ‘expensive’ approach after rolling forward just three months.”

Fiduciary managers – a tough sell?

In light of the performance data from XPS, FMs may be a tough service to sell, argued David Gallagher, partner at Fieldfisher. “The results show that fiduciary management is not working at all for some schemes and is working no better than pooled funds for more.” 

Mr McPherson cautioned trustees looking to switch managers or appoint a new FM to be wary of marketing claims that may not deliver solid results.

They should watch out for “incomprehensible jargon that obfuscates and intimidates, the siren lure of ‘leading-edge’ new investment strategies, and asset classes that just provide your manager a new toolbox to play with that you are paying for”, as well as “opacity in fees and in absolute and relative performance data”.

However, there are experts who believe the popularity of these managers will continue to rise.

Terry Ritchie, development director at Pinsent Masons Pension Services, said: “Things are getting more and more complicated for trustees by the hour with Covid-19, for example.

“Investment is incredibly complicated. The language that is used is not always familiar to lay trustees and they look to FMs to take some of the heat away.”