What are the keys to selecting the right manager?

David Hosford: The usual advice you get is to narrow down and have a shortlist. It often feels that there is not a clear winner within that shortlist and it then becomes quite a subjective decision as to which is most appropriate for that scheme.

You do, on occasion, find there is a particular feature that swings it and is something more objective that you can hang a decision on. But it can come down to, ‘They are all trying to do the same thing; they are doing it in different ways.

Performance records and expectations are in the same ballpark. Who do you feel most comfortable with?’ And at that point, any one is as good as another, almost. I guess it comes back to the providers trying to differentiate why their process, or how their fund is structured, is better.

But if you are looking at the output of the return and the risk profile, then you can target the same things with very different strategies; the trustee is looking for the output and what is under the bonnet is perhaps less important.

It can be almost random which one you go with sometimes, because there is not a clear standout.

Pensions Expert: How do you differentiate?

Kevin Frisby: Well I think the key question is: if you are looking for a manager, where is it going, with what other asset classes and what other managers is it going to be sitting next to?

The key question is: if you are looking for a manager, where is it going, with what other asset classes and what other managers is it going to be sitting next to? 

Kevin Frisby, LCP

So if there is a defined benefit scheme with a lot of equity, you might be looking for a low correlation with equity. You might say, ‘Well, past performance is no indication of how they are going to behave,’ but I think it is what we have and quite often, with managers, there is some power of prediction from past returns.

Some DGFs definitely do have a lower correlation with equities, so we look at things like downside capture and we think that is quite a powerful predictor. And we have been doing it for long enough to see how it has been faring in practice.

So, if still heavy in equities, I would be looking for that flavour of manager, as it were.

Jonathan Reynolds: It is primarily a risk-based decision. That is the key focus. You have to ensure you do not get into what I would refer to as old-style trusteeship, looking at benchmarks and manager performance.

It is all about managing the risk profile, understanding the risk and getting away, at times, from what is like modern day alchemy – the idea of equity-style returns and bond-style volatility. I would prefer that was boxed off, that phrase, because it is like alchemy.

It is nonsense, really. I mean what it comes down to is: do I, as a trustee, understand the risks that I have here? Understand the risk of the DGF on a standalone basis and then understand the risk in terms of my whole portfolio, and is this right for me?

It can be dangerous at times, when you have past performance stats, because it can be very alluring, draw you in, but it is not the key issue. The key issue is understanding the risk and whether it is appropriate for the scheme.

Pensions Expert: And how deep do you have to go into the product or the provider to ascertain these things? Is it necessary to look at where the DGF is invested?

Reynolds: Absolutely but it is very, very difficult. You have a more traditional DGF, where effectively diversification is the key and then, at the other end of the spectrum, you have significant derivative exposure, and that becomes very difficult for trustees to get a handle on exactly where their money is and what exposures they have.

So it is a very important decision, but that is why I say it has to be risk-based, rather than almost like getting caught in the headlights of these fantastic returns. Because the financial crisis, if it taught us anything, it is that there are lots of unexpected ways of losing money, and we want to try and avoid that happening again.

Frisby: In terms of past performance, I think it is important to look under the bonnet to see how they have got that performance because some DGFs have used duration extensively. They have gone into bonds and they have done very well, but I think a lot of DGFs now are quite shy of using duration because rates are nailed to the floor.

The financial crisis, if it taught us anything, it is that there are lots of unexpected ways of losing money, and we want to try and avoid that happening again

Jonathan Reynolds, Capital Cranfield

They do not think that duration is necessarily a good weapon, either for returns or for risk mitigation. They are quite nervous. So they may have produced great returns in the past five years because they have had a lot of duration, but they have no duration now so the question is: how are they going to generate those returns now?

Nick Ridgway: It is not just the statistics of the fund, though they are very helpful to see how they are related to other asset classes, but it is also about considering the absolute return profile of that strategy.

If you have confidence that the return profile is deliverable in an environment where you think it should be deliverable, based on what you know the manager is trying to achieve, then you can be confident that is a good manager to pick.

If it is slightly inconsistent – for example, the manager states they are very good at asset allocation, but then you look at the attribution and all of its returns have come from equity beta – then you need to question the strength of that manager.

Mike Brooks: This is where it breaks down to where do you expect that return to come from? Is it equity beta? Is it bond beta? Is it alpha or is a diversified set of other risk premiums and where do you feel it makes sense, prospectively, to get that return?

Kevin’s point is very well made, that the tailwind we have had for bonds over a very long period now is becoming a headwind, and I think everyone is recognising that and so it is harder to generate returns. I think you need to cast the net wider to generate those returns and some strategies will rely more on their alpha rather than underlying risk premiums, and can they consistently deliver that? What are the skills of that manager and the breadth to do that?

James Monk: An important part of the consultant’s job, when they advise any trust or sponsor to use a manager, is: what does success look like, what does failure look like? So what are the triggers which might make you review this particular strategy?

If Percival Stanion leaves the Baring multi-asset fund, is that a trigger that would mean you disinvest? And disclosing these up front when you appoint the manager is super important.