Going into business

Many pension funds have made such a success of their in-house operations that they have gone into business on their own account, offering investment management services to other pension funds.

But is this a wise business move? Or does it mean they take their eyes off the ball in terms of their prime responsibility to their own fund?

Paul Trickett, European head of investment consulting at Watson Wyatt, says there can be problems: "The principal benefit of the internal manager is the strong alignment of interest between client and manager. As soon as external mandates are sought, this special relationship is challenged. To win external mandates, the manager has both to show high levels of skill in a specific area, and to demonstrate that the interests of all clients are well served, not just the interests of the ‘owning' client. While not impossible, this is a difficult balance to achieve," he explains.

Elizabeth Fernando, head of European equities at USS, adds: "For external managers, winning new clients is important, and portfolio managers have to spend time doing marketing and other non-investment work. USS doesn't spend time on marketing and winning new business, which frees up more time and gives us a greater focus on delivery." She continues: "USS has no conflict of interest. Whereas external managers' success is judged by assets under management, USS is judged purely on performance."

Wouter Pelser of Mn Services agrees that managers should be judged on performance, and says Mn Services monitors its internal portfolio and terms as for externally- managed portfolios. "It is also important to have a very strong governance structure with the pension fund client," he adds.

"Our structure is based on confidence. Our client strategy department builds relationships with clients, creating and implementing models with them. What is very important is to make clear beforehand the structure of responsibility between you and the pension fund clients. You see this development more and more in the Netherlands, but only with the biggest pension funds. Besides our own spin-off in 2001, recently we have seen the ABP and PGGM projects.

"I believe the combination of pension and investment manager is very important, as I believe in skill and consolidation. And from the client's point of view, it's important for the asset manager to have a history in pensions because you are working for pension fund clients, so it should be in your blood."

Even so, he agrees there are pitfalls for the pension-fund-turned-asset-manager. "It is very nice to have this commercial opportunity. But you start with one client - your own pension fund - and satisfying that client is the number-one priority. It was clear to us that that was very important, and it was one of the things we focused on."

Pelser also says that a fledgling asset manager has to realise it needs time to change its culture and its processes.  "Finally, what is becoming more and important for investment management is innovation," he continues. "That makes a big difference. You can outsource a lot of things, but innovation is something that must be on your own agenda as a company."

It is clear that there is a cultural aspect to the whole concept of pension funds selling services. While Mn Services, Blue Sky, Cordares and SPF have done so in the Netherlands, with Hermes similarly operating in the UK, most other European countries have yet to experience this development, at least on the same scale.

BVK's Daniel Gloor says: "Although we think that it could make sense for some pension funds to go into the asset management business, this can only be done by very big institutions like ABP or PGGM. In Switzerland, I cannot imagine that this strategy would be accepted."

He says, "First, there is hardly a Swiss pension fund that has the power and the size to carry out this type of business better, more professionally or at a lower cost than the financial industry. The main reason, however, is that the pension fund business is above all an insurance business, and not banking. The asset management part of a pension fund, important as it is, therefore plays ‘just' a supporting role." 

As a successful asset management company within the Netherlands, Mn Services is now starting a UK business to explore the British pension fund market, and has already acquired an office, and hired staff.

"Our fund manager model is very exportable," says Pelser, "But you must not expect to export the business model everywhere, because every country has its own business model. Different cultures can have different experience, and a different way of thinking."

And he suggests that this is an area where the north-south divide in Europe plays a part. "The UK is more open than France, for instance," adds Pelser. "We think both the UK and Germany can be attractive for us."

But ATP's Bjarne Graven Larsen says that setting up an operation to sell asset management to other pension funds is not on the cards. "We have been very clear about this," he says. "First, we want the ATP fund to focus on the big pension and investment issues. Secondly, we want to hire and retain the right people by setting up subsidiaries, making the right compensation structures and allowing them to invest their own money alongside the ATP fund."

He adds: "We have been able to create a structure that is market-standard so it attracts good people. We want to be 100% in control. We can make sure we get the best investments. But we do not want to focus on selling products, because our fund managers will then focus on selling fund management services and not ATP's performance."

However, Rupert Clarke, CEO of Hermes, sees the ability to offer services to third parties as a badge of competence. "It is extremely difficult for a fund to be confident of its in-house team capabilities unless they can prove they can offer a service that is attractive to other arms' length investors," he says. "If other investors are not interested in their offer, why should they be?"

Clarke continues: "With many more third party options now available, it is extremely important to ensure that the in-house investment teams are able to deliver competitive and relevant investment offers to the in-house fund. Both of these considerations point towards a need to introduce disciplines and rewards of the third-party marketplace, although it is important that investment allocations are the responsibility of a distinctly separate in-house capability to ensure the appropriate allocation of mandates between internal and external managers."

Clarke agrees that there is inevitable concern that chasing third party mandates could be a distraction and cause conflict, but believes this is more than offset by the disciplines and accountability that third parties demand from the asset management teams.

He says: "Added to the prerequisite of the need to demonstrate consistent strong performance, the fund can combine the cost savings, insights and transparency of an in-house team with the market benchmarked rigour and performance they will also need to justify their continued support of that team."

And he says that from the point of view of BTPS, this was the principal reason behind Hermes' recent combining of a 35-strong advisory/executive  team dedicated to BTPS, with a multi-boutique asset management business based around a common operational platform, each area committed to being best-in-class in its own specialist discipline.