Roundtable: William Parry from Buck Consultants, HR Trustees’ Giles Payne, Russell Investments’ David Rae, Ralph McClelland from Sackers and Towers Watson’s Pieter Steyn, discuss how recent changes in global markets have affected the fiduciary world, in the final part of this roundtable series.
David Rae: We have been through a period where equity market returns have been very strong, even though they have not been sufficient to outweigh the increases in liability values.
But actually what is important now is how on earth you generate returns that you need in an environment where we expect returns to be lower amid higher volatility that is expected to remain higher.
That is the challenge trustees face today: it is not looking back and not comparing performance that has gone before but actually trying to make an assessment about whether the process is appropriate and sufficient to deliver the results.
Ralph McClelland: This should be a great test of fiduciary appointments because a lot of them have happened in the past three years, so the data that is produced around this period is going to be, probably, the first major kind of indication for a lot of these appointments about whether or not they are doing what they promised to do, in terms of investment performance in a more volatile market.
Pieter Steyn: This period of time is going to be very interesting for the fiduciary management landscape. In our shop, the portfolios have been configured with this kind of environment in mind, and a relative view, I think, is quite an important one, of fiduciary management appointment versus the traditional route.
Many of the traditional portfolios are set up with a single scenario in mind – high growth markets – and we just do not really see that running from here.
I think March 31 2015 is an interesting date; it is a date where lots of valuations are taking place. The year leading up to March 31 was a very, very difficult year for many pension funds. It was quite widely publicised that the average pension fund dropped their funding levels by more than 10 per cent over that period and, interestingly, in the fiduciary client space, at our organisation, funding levels were up over that same period, so there is a very marked difference through different risk management.
There are schemes out there that are more advanced and do not necessarily need [fiduciary management], but there are still a huge number of schemes that really will benefit from having that added investment expertise
William Parry, Buck Consultants
William Parry: A big difference between what fiduciary managers are doing and traditional consultancy appointments is you find the hedging ratios in the fiduciary space are much, much higher.
So the kind of professional investor, if you will, is saying your hedging level should be well up into the 50, 60, 70 per cent region, and one fiduciary manager I know starts at 100 per cent, whereas in many traditional appointments, the trustees are still lagging at a 20–25 per cent sensitivity to interest rates.
What that really shows is how many schemes there are that could really benefit from fiduciary management. There are schemes out there that are more advanced and do not necessarily need it, but there are still a huge number of schemes that really will benefit from having that added investment expertise.
Rae: Is it not odd that the fiduciary arms of traditional consultants would see their clients with much higher hedge ratios and yet the advisory clients at the same organisations have much lower hedge ratios? It may be that all of the trustees within the advisory firms are unable to make decisions, but that is unlikely. So there must be something either in the nature of the advice or the way the relationship works that means this dichotomy exists.
Giles Payne: There is a natural tension with the employer because, by effectively hedging out interest rates, you are fixing a cost and then you are investing against that cost.
There is this very, very long-held perceived notion that interest rates are going to go up. Whether they are or whether they are not – expectations are baked into the market. And a lot of people do not understand that those rising interests are already reflected in the market and so they sort of just hang on to the view that interest rates are going to go up and that is going to close out, whatever it is, 10–15 per cent of my deficit, by rising interest rates. And that, unfortunately, is a real misunderstanding of how the market works on forward rates.
Whereas, by appointing a fiduciary manager you are accepting that you do not really fully understand what you are doing and therefore you will be accepting a greater degree of the advice provided.
Steyn: As an organisation with both arms, I characterise it as more consistency inside the fiduciary book and a bit of variability in the advisory arm. So we see very high hedge ratios in the advisory client space as well, but we also see lower hedge ratios for various reasons.
Parry: Coming back to your point about why the fiduciary managers typically tend to have higher hedge ratios, it is because if you have a blank sheet of paper it is much easier to say, ‘Fine, what hedging do we think we need to interest rates?’, and not get caught up in what has happened in the past.
Trustees with low hedging ratios often look back at interest rate movements over the past few years. If you have been running this as a punt for the last 10 years and you are waiting for that to come in, then it is much harder to increase the interest rate sensitivity within the assets.
There is this very, very long-held perceived notion that interest rates are going to go up. Whether they are or whether they are not – expectations are baked into the market
Giles Payne, HR Trustees
Rae: That same discussion and negotiation exists between trustees and corporate sponsors, particularly around the interest rate view.
Rightly or wrongly, a lot of corporate sponsors come to the table with an entrenched view around interest rate expectations, and typically the other side is a more balanced view about the likely opportunity and the size of the risk being run in that one position.
It still seems strange that should be the only difference between fiduciary management and advisory-type solutions.
Pensions Expert: Where do you see the market going in the short, medium and longer terms? What kind of innovations are in the pipeline?
Payne: Aggregation gives you assets; it gives you access to different assets and certainly more sophisticated solutions.
There are going to be more and more schemes with very little link to the company at all, which are just a cost burden to the company, which they are looking to manage with minimum effort and maximum certainty to get off their books in a certain time. Fiduciary management means reduced input time and hopefully better outcomes if you get the right solutions.
Read the other three sections of this roundtable series:
