Special Report - Pensions Risk Management: A strong hand – when outsourcing the pension fund is the best option

With many company defined-benefit schemes recently closed to new entrants, some finance directors are keen to engineer a buyout of the company pension scheme and get it off the books. But the collapse in the financial markets has caused many deficits to balloon and that has to be addressed before a buyout can be contemplated.

Additionally, amid the crisis, FDs have realised the impact that their lack of control over one of the largest assets on their balance sheets ­ a product of the Robert Maxwell pension plundering scandal which led to the industry handing control to independent trustees from FDs and management ­ has on their grasp of the bottom line.

For trustees, the collapse in the financial markets has caused pension deficits to soar and caused them to worry that the company may not be able to fund the future liabilities of the scheme. Much has changed. “The credit crunch has shown that financial markets are often more volatile than have been assumed in the past,” says Marcus Hurd, head of corporate solutions at Aon Consulting. Typically, trustees tended only to meet four times a year ­ but markets ‘happen’ all the time and so reaction times have to be quicker in the future.”

As a result, an increasing number of FDs and trustees are now thinking about outsourcing the running of their pension funds to the professionals, a process commonly referred to as implemented consulting, delegated consulting or fiduciary management.

All three are different names for the same thing: outsourcing more of the running of the pension fund to an external company, with trustees deciding how much risk they are comfortable with and then handing it to the manager to get the best returns within those risk levels, rather than hiring individual investment managers themselves.

Same difference
But there is some discussion about the differences. Industry observers point out that implemented consultancy tends to be carried out by one of the big pension consultants, whereas fiduciary managers tend to be from outside that top quartile by size ­ but the terms are used interchangeably.

Not every fund will go down this route. “It can be more expensive than the traditional consulting solution,” says Paul Trickett, Watson Wyatt’s head of European consulting.

But it can save money over the long-term because while you pay a higher fee to the implementation consultant or fiduciary manager, you are only paying them, rather than shelling out different fees to a number of different investment managers.

Long-term cost savings
Patrick Disney, managing director of SEI’s EMEA institutional business has one client who estimates that they have reduced their costs by a third in this way: “Long-term costs can be saved by delegating to one company, the fiduciary manager, rather than having direct contracts with five to 15 firms,” he says.

The most common way for many companies to use implemented consulting or fiduciary management is to give the power to hire and fire investment managers to your investment consultant. “Most pension funds have been struggling over the past 12 months and acknowledge that they cannot carry on the way they are,” says Brett Smith, part of the corporate team at Towry Law.

“Fiduciary management is becoming a major growth area.” Trickett says that Watson Wyatt currently provides “some form of implemented consulting” to around 35 funds and that between five to 10 of those clients opt for full-scale implemented consulting.

“When funds take this option, they typically agree with us how much risk they are willing to take and then hand over the portfolio, so we can make the most efficient use of this risk to generate the best possible returns,” he adds.

There is also a growing trend for clients to ask to change the asset allocation mix in line with economic cycles, says Trickett. The proportion to which the assets are allocated, for example, between equities, property, bonds and commodities depends on which asset class looks like it will generate the best possible returns at that point in the economic cycle. As the cycle changes, so too does the asset allocation.

Aon’s Hurd believes companies are adopting a variety of answers to the question of pension fund performance. “Sometimes the solution might be as simple as recruiting professional financiers to the board of trustees. Or other companies might simply appoint their own advisers.”

Some companies are undertaking an implemented consulting approach so that they can get the company pension scheme into shape to make buyout a possibility. Disney says that some of his clients have been asking for this sort of assistance.

And Hurd believes this strategy would pay off handsomely. “The crunch sparked a huge fall in the pricing of corporate bonds, making it possible for those companies with their house in order to enter into a buyout. That opportunity will arise again over the next five years ­ and it would be a shame to miss it a second time.”