Evercore Pan Asset

The Uk pension fund movement has taken a hammering in recent years. Most private sector schemes have been closed to new members. Some have been closed to further contributions from employees. Many are in large deficit. Now all schemes have to pay a levy to take care of schemes that get into difficulties, adding to the costs of pension provision for all those companies that are standing by their liabilities.
 
The reasons for the large deficits include the low yields on bonds, the growing life expectancy of pension fund members and the poor performance of share based investing in the main investment markets over the last decade. Company managements welcome the longevity pressure as individuals as it means longer lives on average for us all, but worry about it as they try to balance the books. There is nothing that can be done to manage it. Nor can management do anything about current low bond yields. They mean that when a company wants to provide for the pension payments by buying an annuity or putting the fund into the relatively safe position of holding just bonds, it needs more money to pay any given range of pension payments.
 
So the issue that can be managed is the one that Trustess need to concentrate on – the investment performance. Over the last ten years there has been little or no return on buying and holding shares in the US, UK, Western Europe or Japan. The traditional stance of a pension fund, to hold around two thirds of the money in shares to enjoy growth in dividends and capital outpacing inflation, has not worked. Meanwhile, as returns have disappointed, the fees and charges have often gone up. Funds need an Actuary, an Investment Consultant, Investment managers, investment custodian, a legal adviser and administrators to handle pensions and member records. This wide range of expertise can add up to quite a lot of fees.
 
As the fund disappoints, so quite often more work is done by consultants to examine options. Should the fund change Investment managers? If so, a beauty parade and selection process is opened. Should the fund change its asset allocation? This may require a special study. Should the trustees change the Investment Memorandum and any guidelines that contains for the fund managers? How should the company make good the deficit? Does it comply with the rules? Has it filed an appropriate deficit reduction plan? What impact will all this have on the levy? Serious work has to be done, and fees paid as a result. 

One of the ways that things might be improved is to go over to a different model of managing the money. This could be called the Fiduciary Manager model. In this the Trustess appoint a single Fiduciary Investment Manager/adviser who is responsible for the asset allocation. That manager implements the agreed strategy through direct investments or through appointing specialist investment managers for the various assets required. He is responsible for managing the managers and has an incentive to keep the costs of investment management down, as they will impact on the performance. He is answerable to the Trustees for the overall results – both the results of the asset allocation which will mainly drive the performance, and the individual methods of implementation that can add or subtract from the total. There will be no need for additional asset allocation advice from time to time, as the Fiduciary Manager keeps the asset allocation under review at all times. He may not wish to change it very often, but it is his duty to alert Trustees or to take action within guidelines when necessary.
 
The evidence shows that asset allocation is central to investment returns. The main reason for poor returns from many pension funds over the last few years has been the disappointing performance of western shares, where most funds have been heavily invested. If the funds had held emerging market and Asian shares they would have done much better over most time periods. If they had been more in property and bonds they would have done better. If they had gone into cash as the Credit Crunch got underway they would have done  well, and even better if they reinvested once the worst was over.  
 
Trustees should not despair of their deficits, or think investment management can never make a difference. It can. The first requirement is to concentrate on the Big Picture, the asset allocation, which makes the difference. Then you have to find people who can make sensible calls that cut your risks and boost your returns. You should not be looking for people who think they can shoot the lights out or always choose the hottest market or asset. You should be looking for some commonsense about income and value, and some understanding of what to do and how to cut risk in violent cycles. Most people say they now understand the advantages of diversification to cut risk, yet so many of the assets they diversified into prior to 2008-9 turned out to be just as volatile as the share markets they were replacing.

As published in Investment Week