Roundtable: How should schemes pick fixed income managers?

Dinesh Visavadia: It is tempting to give fixed income managers a mandate that is unconstrained and let them manage the risk for us. However, we always come across the question of how to evaluate that manager skill? Trustees rarely have that expertise.

Anthony Fletcher: The quality of your adviser is pretty important here.

Graham Wardle: There certainly is a role for active management. In fact, I am totally against passive management in the fixed income space.

Question everything, particularly active management. Things might not go the way you want them to, but at least you have a recorded robust discussion as to why you made that decision

Sophia Heathcoat, Barnett Waddingham

Sophia Heathcoat: There is an asymmetry of risk with passive. In that respect it is quite different to equities. However, you need to find a manager who also has the resource to understand the covenant in what you are buying and who can drill down into the detail.

Wardle: That is why, certainly in private debt markets, it is really important to understand what a manager does in terms of filtering possible opportunities. They start with hundreds and end up maybe investing in two or three.

Pensions Expert: How can schemes make sure their consultants are helping them find the best managers?

Heathcoat: Consultants need to focus on finding the right strategy for the scheme first and foremost. Asset allocation is the next stage once you have your target and your risk budget.

However, there needs to be a strong challenge from trustees to advisers. Question everything, particularly active management. Things might not go the way you want them to, but at least you have a recorded robust discussion as to why you made that decision.

Wardle: I agree with you entirely about challenging investment consultants and managers – that is my main role really.

Fletcher: I am staggered at how little understanding pension fund committees have of the fixed income market. The need for education is absolutely dire.

Visavadia: It is a very difficult asset class. Since the crisis things have improved, which is great news because we have been forced into the fixed income market in recent years. We have discussed how looking globally for opportunities is the right way forward because it gives you a much bigger universe. But the issue that the trustees have always grappled with is assessing the resource, the ability and the skill of the manager.

Edward Farley: When you look for global opportunities I think, first and foremost, you want to feel that the asset manager you are talking to is global, rather than based in one country with no resources elsewhere. It does not need to be every single country but it should be properly global.

From a credit analyst point of view, you want to see that there are analysts who have good local access to the management. In high yield for example, you need people who understand the local bankruptcy law.

Track records are important. In my mind the one-year track record is the least important number, you want to see how somebody does over a cycle and you want to see consistency in different market cycles.

Alexandra Martinez: You should also pay attention to turnover of the fund managers. Are you getting a house view, or one manager’s view? You can have a lot of local knowledge, but if you have a high turnover of people, how consistent can you be?

Farley: It is all about the team that produces the ideas. A disciplined investment process is huge.

Martinez: I agree. However, I have seen a lot of multi-asset credit products and diversified growth funds that mix a lot of products together, and I do believe there needs to be one visionary.

Farley: You need key skill sets in all the different products that go into a MAC fund, with everybody feeding in their best ideas. You have to have a CIO who is taking in all these ideas from a bottom-up perspective, matched with economists, to make calls between asset classes.

Martinez: Multi-asset products are now very sophisticated. If you start comparing them on how they actually have done over a long period of time, the dispersity of results is considerable.

Farley: And the dispersity of the products. What does multi-asset credit mean? You line 10 managers up and they will give you 10 different answers. Their returns will look wildly different – some of it is repeatable, some of it is not.

Martinez: Schemes could borrow from insurers, who are volatility-driven. You could say, ‘I want to have maximum 7.5 per cent volatility, what can you get me for that?’ That might not be the right way, but it is an option.

Visavadia: In one of my previous roles we thought about how we wanted to invest our fixed income portfolio and the outlook for each of the classes for the next five to seven years. We then came up with a benchmark with all the risk and return parameters factored in, then we found the manager to deliver it for us.

As trustees, we are the best people to actually decide what the objectives for a scheme are. It delivered really well for us for 10 years.

Martinez: We also need to think about how to measure performance. What kind of benchmark are we going to use and how are we going to hold people accountable on the decisions they make?

Farley: It is a great question, because as an asset manager I can say, ‘I have beaten my benchmark, what a brilliant result’, but my benchmark might have done appallingly versus every other asset class.

Martinez: There is also the question of fees. If you go to the Netherlands or Sweden, for active managers they pay a fixed performance fee for anything over the beta, and they do not do business unless you do it this way. Here in the UK we are lagging behind in those kind of conversations with the managers.

Farley: It is important to make sure that you are not incentivising the manager to take lots of risk to try to improve a bad year.

Martinez: No, and you choose the manager who will not take that risk.

Fletcher: Most schemes I have come across that were on a performance fee were disappointed at having to pay more than they expected to because the manager performed as they said they would.

Visavadia: Performance fees can work, but the risk should be symmetrical. You do not share the upside without the downside.