Pension schemes risk losing potential returns by moving too slowly when changing investment strategy, with some waiting months between investigating and implementing, consultants have said.
Missing out on returns due to slow implementation, also known as ‘event shortfall’, can make radical differences to returns and complicate manager performance monitoring, with a three-month delay costing schemes millions of pounds.
Investment adviser State Street Global Markets examined close to 6,000 transition events globally and found 70 per cent had a “transition engagement period” (the time between initial engagement with a transition manager and setting a benchmark for the new investment) exceeding two weeks.
The State Street research paper said: “A delay cost of three months could easily eliminate years of alpha expectations.”
“We were trying to work out what the average period of slippage would be,” said Steve Webster, head of portfolio solutions sales at State Street. “A significant proportion of that block was in excess of three or four months.”
He added: “Even though we can’t see the whole picture, what we can see shows there’s a significant period of time.”
Webster said schemes making a substantial allocation change should consider entering into an interim agreement with a transition provider.
However, it is possible to tackle event shortfall in a variety of ways.
When seeking to speed up implementation, some schemes look to appoint fiduciary managers. But Calum Cooper, partner at consultancy Hymans Robertson, said schemes could match the speed of delegated managers by preparing for changes such as derisking before reaching the desired level of return.
He said: “You need to have done a lot of the preparation so when the time is right you can implement risk reduction very quickly.”
Lynda Whitney, partner at consultancy Aon Hewitt, said schemes could deal with the risk of slippage in one of three ways: by working to improve monitoring; by delegating to external parties who are free to act on behalf of the scheme; or by just assessing whether they could tolerate the risk and accepting it.
“All three are perfectly acceptable; all three can work for clients,” she said.
However, she added these approaches were more suitable for defined benefit schemes.
“Defined contribution is different because at that point you have individual members making the decisions… they want to make the decisions quite quickly,” said Whitney.
“If you’ve got DC trustees and they’re reviewing the lifestyle structure, those sort of exercises are much more involved.”
Due to being mostly invested in pooled funds, DC schemes are less susceptible to slippage, said Richard Butcher, managing director of professional trustee company PTL.
He said: “It’s a slightly different issue for the vast majority of DC schemes… the chain of decision-making is much shorter generally.”
He added schemes should avoid becoming too focused on minimising slippage, as they can form a short-term mindset poorly suited to pension scheme investment.
