Cracks appear under a calm surface

In the fast-changing Dutch institutional market, the buzzword for both asset managers and pension funds is fiduciary management. Ever since the Philips pension fund handed over the entire responsibility for the management of its assets to Merrill Lynch Investment Management (now BlackRock), asset management firms have been adding fiduciary management to the services they offer.

But looking behind the marketing hype, how significant is the development of this kind of service?

"I do think that fiduciary management is a significant development," says Rob Kamphuis, director of business development, F&C Netherlands. "All pension funds are currently redefining what they can or want to do in terms of asset management. However, fiduciary management comes in many forms. Some fiduciary management companies are multiple asset managers, while others are looking for a strategic partner."

The question of what actually constitutes fiduciary management to some extent depends on which asset manager is giving the answer.

Originally defined as a multi-manager solution, the term now refers to the outsourcing of other key aspects of running a pension fund, besides investment management. These include its administration, compliance, risk management and asset management.

"Fiduciary management is an umbrella term, under which you see different types of management," says Ruud Hendriks, head of distribution, Europe, Middle East and Africa, Goldman Sachs Asset Management International (GSAM).

GSAM is widely regarded as one of the more successful players in the field, along with multi managers and investment managers.

"Everybody seems to call their services fiduciary management because it is a hot topic," says Hendriks. "There is a rush of asset managers eager to enter this space because of the potential they see here."

Even so, he says: "We think it is extremely good that people are starting to use fiduciary management more than before."

According to Hendriks, the fiduciary management market is getting very segmented, with some managers concentrating on the very large clients while others run client portfolios worth about €100-€200m.

GSAM however services a wide range of clients, including the €8bn-worth Vervoer pension fund, a sectorwide fund for the transport industry, which the firm acquired as a client last year.

"Fiduciary management isn't really new - it has been well embedded in the Dutch market for a long time," says Marcko van Bergen, managing director, BGI Benelux.BGI itself is not a fiduciary manager.

"We do offer total solutions for pension plans, including help with strategy," says Van Bergen. "But a typical fiduciary manager offers pension fund admin, including multi-manager selection. We manage the strategy but not the admin of the pension fund itself."

However, Van Bergen agrees that the term is often loosely applied.

"Since foreign players such as Goldman Sachs and Russell entered the market, some traditional managers have labelled themselves as fiduciary managers."

He agrees that this particular type of service is wanted. "More and more, pension fund boards are in need of specialists and the requisite skill sets for investment," he says. "There are some who need serious help, so it's no wonder that pension trustees are looking to fiduciary managers to help them out."

But he does not see a further boom in fiduciary mandates.

"It is here to stay, but it is important not to exaggerate its future impact, as the market is pretty much established so far," he says.

Jan Lodewijk Roebroek, chief executive, Fortis Investments in the Netherlands, agrees that fiduciary management is likely to become a permanent part of the investment landscape.

"The asset management industry developed quite rapidly over the past few years, in that the overall investment needs of some of our clients were effectively fragmented," he says. "To a certain extent, part of this trend is being reversed."

He says that at the same time, fiduciary management is also perceived within Fortis Investments as a logical step in the evolution of client servicing towards the firm's larger and medium-sized clients.

"We feel a key area within this concept is to have the ability to select the best possible investment solutions for our clients," he says.

Roelf Pater, chairman of the board of AZL Fiducional, agrees that fiduciary management is not a new phenomenon.

Pension services provider AZL was acquired by ING earlier this year and has now expanded its fiduciary services next to its existing pensions advisory and pension management offerings. The fiduciary services are operating under the AZL Fiducional label.

The need for fiduciary management has arisen partly because of the innate conservatism of the Dutch pension funds, says Pater.

"Many corporate pension funds are cautious investors, with a traditional asset mix of 60%-80% fixed income," he says. "They don't have much internal organisation, so they use actuaries, consultants and asset managers. Using fiduciary managers helps them get over the hurdle of introducing more diversified portfolios which can include emerging market debt, private equity and hedge funds. But fiduciary managers should be seen as more than asset managers." Pater says that what fiduciary managers offer which multi-managers do not is strategic advice (on asset mix) and risk budgeting, which helps set up the asset mix by comparing assets with liabilities.

"We, as AZL, can integrate advice and reporting based on information of both sides of the balance sheet," says Pater. "A party providing only multi-management needs to get information from other sources, assuming he is able to provide the advice and reporting."

However, the advent of fiduciary management has raised the fear that pension funds may have problems handing over control of their fund to an outside body.

Pater gets round this problem neatly.

"It is the trustees who are the real fiduciary managers," he says. "But it is difficult for them to keep abreast of developments so they need advice to fulfil their duties. We try and investigate the investment beliefs of the trustees and fit in with them."

But he agrees that some trustees fear they are handing too much control to fiduciary managers.

"There should be a board discussion about the governance structure," he says. "The important thing is that the reporting system for the managers is transparent. And when the fiduciary manager is selecting fund managers, it is important to see the selection process. Furthermore, trustees should feel comfortable with their fund's asset mix and strategy, otherwise they shouldn't hire a fiduciary manager."

But he says that trustees could still protect the fund by hiring a consultant to monitor the fiduciary manager.

Wouter Pelser, client institutional officer, Mn Services, says: "I don't think there are problems of control. It is important to organise the right checks and balances. You must define responsibilities and roles of both the pension fund and fiduciary manager properly. If the contract sets out the right way for the fiduciary manager to communicate with the pension fund, I think it can actually help the confidence of the pension fund."

He says that fiduciary management means the pension fund trustees can focus on their own specific approach and what's important for them. It can also supplement the pension fund's own governance and organisational structure.

Pelser says: "We can support the pension fund's accounting procedures. Our certified accountancy statements can be helpful for the accounting control of the pension fund."

But he says it is also important to have a good relationship between the two parties.

"The fiduciary manager should organise the fund management in the right way," he says. "For example, internally, the fiduciary manager has to define the different functions very well, so the account management team is setting up mandates for the asset management unit. The separately embedded risk control department plays a very important role too."

As a fiduciary manager itself, Mn Services combines disciplines such as investment policy, ALM, asset management, risk management performance measurement and reporting.

Pelser says: "It is becoming more and more important for fiduciary managers to take a holistic view, and do all the analysis for the pension fund, not just the investment. For instance, you need to know about the liability side in order to formulate investment policy."

"Boards have to understand that they are still accountable for the management of the portfolio," agrees Kamphuis. "I do think that some pension funds believe that having a fiduciary manager means they can get rid of a lot of detail. But they still need to communicate with the fiduciary manager and tell the manager what they are doing." Kamphuis says these pension funds have to budget a big set-up time at the outset for agreeing with the fiduciary manager how the pension fund is to operate and what structures should be used for doing this. Once this has all been agreed, it should be reflected in the reporting by the managers.

"The duty of the fiduciary manager is to bring to the table the most important issues," says Kamphuis. "The trustees should make sure they understand the reports which the manager gives them."

"We are strongly of the view that if you use fiduciary management, there are a couple of decisions you can't outsource," says Hendriks. "You are responsible for your asset allocation and risk budgeting. Those two things are of vital importance to pension fund boards. Some pension funds think if they hire a fiduciary manager they can outsource these decisions but we think boards should be in control of these areas."

Hendriks says GSAM tries to create a dialogue by which both the manager and the client can come up with sensible decisions. "The way we report on an integrated level is one of our key strengths," says Hendriks.

The company provides a written monthly report, and a quarterly report. On top of that, GSAM has daily discussions with the head of asset management or whoever liaises with them from the pension fund.

"We believe the pension fund should install an external investment committee, which includes professionals, and which looks after what we're doing," says Hendriks. "That committee should be our first point of reference. It is important for our clients to understand what we're doing. We arrange seminars and write papers to help them to be better informed. We think of fiduciary management as a partnership, so it's important that the investment committee has the same level of understanding as ourselves."

Hendriks says that transparency is an area where the manager should take the initiative, reporting to clients in as open a way as possible.

One important aspect of this is the fee.

"We don't charge a packaged fee - we try to unbundle the constituent parts," he says. "Some of our competitors work with a base - ie fixed-fee, which includes everything. We charge a base fee plus a performance fee. Furthermore, our clients can pay fees direct to the fund managers."

 

LDI

The insistence by some fiduciary managers on including the liability side of a pension fund's balance sheet in their investment thinking underlines the importance that LDI has acquired over the past two or three years.

Asset managers in the Netherlands have geared themselves up to meet the demand for LDI strategies, but how much demand has there really been?

BGI is a serious player in the LDI market, running several billion-worth of the €10bn LDI market in the Netherlands.

"We have geared ourselves up, and have seen a lot of demand," says Van Bergen. "It is not something that's going to go away - it's a structural change in the industry."

Van Bergen agrees that there was fear of over-hype.

"Many managers said they were geared up because they saw LDI as the linchpin of investment strategies of the future," he says. "But we've had a constant stream of LDI products for almost a year now, and everyone is fed up with it."

However, he says that BGI is not experiencing any disappointment.

"From my perspective, it is not a hype that can carry on for ever, but I am very happy with our position," he says. "Over the past six months we have had about 30 individual meetings on LDI, out of 200 Dutch pension fund clients."

F&C runs around €1bn of the Dutch LDI market.

"There is demand for LDI, but we should see it as part of risk management in general," says Kamphuis. "FTK opened the eyes of Dutch pension funds to risk, and they want a quick fix. Some of them have done something about it, but not many have immunised their interest rate risk."

Kamphuis says that using LDI means a pension fund has freed up some of the risk in their portfolio, so it then needs to look for alternative ways of adding marginal return. This means it needs a more focused investment strategy.

"At Mn Services, we don't talk about LDI, but about balance sheet management," says Pelser. "It means taking the holistic view, understanding all risks and hedging some of them. In this sense, LDI demand is increasing in terms of knowing the fund's risk profile, and overall, there is high demand for matching products. I expect demand to continue as more and more pension funds and service companies are aware of studying the risks."

"There is a demand for LDI and I definitely think it will grow further," says Lex Solleveld, senior product manager, sales solutions department, Aegon NL. "Last year, there was a growing demand to cover EU inflation. Now there's a growing demand for Dutch inflation, which is more complicated to match."

Aegon is in the process of launching this year a global tactical asset allocation fund AUGUST and is also about to launch an EU inflation-linked product which allows clients to buy EU inflation from the capital markets in a cost-efficient way.

But other managers are not so bullish about LDI.

"The demand has not been as big as expected," says Pater.

"The idea was to get back to a healthy funding ratio after the market falls of 2000. But the equity markets have come back up again, while interest rates have remained fairly low. So the need did not materialise as expected earlier, as pension funds started closing the gap."

Roebroek is equally cautious.

"Changes in regulation in the Netherlands have definitely affected the way pension funds look at their interest rate exposure against liabilities and, consequently the development of liability-led investments," he says. "And it is true that not all pension funds have fully hedged their exposure in the past few years."

But he says that does not necessarily mean there is spare capacity in the LDI market.

"We feel that in those situations where LDI solutions have not been installed, these were conscious decisions. In our view, little interest rate exposure is left that has been overlooked."

 

Alpha separation

One area in which pension funds are rethinking their investment strategies is in separating the search for alpha (manager outperformance) from beta (the performance of the market). This enables them to see exactly how asset managers are performing - for instance, managers cannot hide behind an upward movement in the market.

"Alpha separation is a good thing in a world of LDI-led investment, because absolute return then becomes an even bigger necessity for a pension fund," says Van Bergen. "And LDI reduces the risk in the portfolio, enabling you to take more risks in alpha strategies."

Van Bergen says many fund managers are now offering alpha separation. "At BGI, we are specialists in both beta and alpha, not stuck in the middle like traditional managers," he says. "We are now seeing the fruits of that strategy because a lot of our clients think like that as well."

"Alpha separation is a logical extension of the solutions that are being offered by the industry," says Roebroek. "The price for beta exposure is different from alpha, allowing investors to construct their portfolio in an efficient manner and to make explicit choices. This certainly makes it much more transparent to see how asset managers are performing, but with the present set of performance attribution tools in the market, this should not be the driving force
as such."

Roebroek says that in his company's view, the reason behind the alpha/beta split is much more the liability-driven approach.

"The beta portfolio is the ‘matching' portfolio while the alpha has to create the ‘icing on the cake'," he says. "Pension funds need beta and alpha," says Pelser. "As a manager, I believe we make the search for alpha more efficient. The important thing is to bring focus into your portfolio where you want to play markets actively. Otherwise you should by the index."

But he warns: "At a product level, to make a clear separation between the two doesn't always sense. It works in more efficient markets, such as European and US equities and government fixed income portfolios. But it doesn't make sense in long only emerging market equities, small cap equities, US high yield and emerging market debt."

 

Consolidation

Within the Dutch asset management industry, there have been some interesting alliances and consolidations. Recent moves have included ING's acquisition of Dutch pensions provider AZL and the tie-up between Mn Services and the PME pension fund.

The assumption in the industry is that in order to survive, firms have to be big, and be able to provide a full suite of services to pension funds. But is this actually the case?

"There is consolidation, but there are several ways this can take place," says Kamphuis. "There will be more and more alliances and partnerships. And as clients are demanding more and more tailored solutions, we are also seeing the alliances between different partners who are active in the same area."

He says this also applies to pension fund clients. "For some pension funds, it makes sense to review whether they want to be independent and can manage their portfolio internally, or to hire an external manager," he says.

On the supplier side, Kamphuis says that unless they wish to remain boutiques, small investment managers need to form alliances with other providers if they are going to manage a pension client's overall portfolio.

"The choice is either to be big and manage everything internally, or remain small and take partners," he says.

But he says one potential problem with this is that trustees may not be able to cope with all the different counterparties involved, instead of just the one company.

"I agree that you have to be big, but what is a critical mass?" asks Van Bergen. "The bigger providers will have 50 or 60 investment staff, and the smaller firms between five and ten. Is that big enough? I don't know." He acknowledges that with size comes the advantage of economies of scale, and the ability to provide specialities.

But he says that while bigger firms might give the best overall service in the long run, there will from time to time be specific areas where smaller firms have the edge, so there might still be room for niche players.

"It seems likely that there will be further consolidation in the Dutch market and in the European market generally, says Pelser. "We think Mn Services can play a role in the European market, as it often follows Dutch trends."

PME recently outsourced its investment to Mn Services, with a view to handing over the pension admin at a later date. The fund is now the largest shareholder in Mn Services, along with PMT.

"Mn Services is in a very strong position because of our recent partnership with PME," says Pelser. "Pension funds think it's very important to be a robust pensions supplier, so the winners in the current marketplace will be robust companies. It is however possible to be robust and disciplined without sacrificing creativity."

Pelser says there will always be a place for the niche player, including those who are suppliers to fiduciary managers. "However, it is the bigger companies who have the scale to search for good worldwide asset managers in multi-manager asset allocation, and to find good private equity and real estate firms," he says. "It also means you can be a player in the labour market - it is very tough to find the right staffing." Some years ago, Aegon NL bought TKP, the former pension provider for the Dutch telecoms and postal sectors. Aegon has recently bought another pension provider, Optas and started a co-operation with
A&O.

"The number of pension funds is declining," says Solleveld. "In the end, the big struggle to service pension funds will be between the large insurance companies and the large industry pension funds such as PGGM and ABP. The big question is whether the two groups will end up the same, or whether there will be a distinction between them."

"The key criterion remains the quality of the staff who drive performance, and the ability to organise them within the firm in order to serve your clients in the best way," says Roebroek. "Within asset management, size as such should not be the key driver in industry consolidation, as long as a minimum size is reached. However, the recent consolidation trend merely underpins the idea that you need to bring all competences that are requested in order to deliver full service under one roof."

Pater says: "In the long run you need to have consolidation, because the world is getting more and more complex. And as manager, you can use economies of scale."

However, he does see a chink in this trend. "Two years ago, when interest rates were lower, there was more of a drive towards consolidation," he says. "Now, with the funding ratios at a healthier level, pension funds see the need to have their own identity."

 

SRI

For pension fund sectors in most European countries, SRI is a relatively slow-burning issue. In March this year, however, SRI suddenly leapt into the public domain with a Dutch TV documentary, Zembla, that revealed that the four largest pension funds in Netherlands were investing in firms manufacturing cluster bombs and landmines.

This started a public debate as to whether pension fund portfolios should exclude companies involved in these sectors, as well as those using child labour or polluting the environment.

Both companies and unions have come up with proposals on how to deal with this issue.

"Employees expect their pension fund to do the right thing," says Kamphuis.

In the Netherlands, pension fund trustees already have to disclose their voting behaviour at the AGMs of companies in which they invest.

"Ultimately, however, trustees have to decide whether or not to exclude more stocks from the portfolio, or go for maximum return," adds Kamphuis. "It also comes down to the constitution that pension fund trustees are bound by."

"We do see the need from our clients to define a policy on sustainability in a more explicit way," says Roebroek.