What do you see as the big issues affecting European pension funds?
Regulation, accounting and these days, convention, mean that mark to market has finally come to most jurisdictions. Pension funds no longer enjoy diplomatic immunity. As yields fall, the present value of liabilities rises. At very low yields, that effect becomes increasingly pronounced. Thus a fall in yields from 6% to 5% does not increase long dated liabilities as much as a fall from say 3% to 2%. Thus, at these super cooled levels, European funds are experiencing extreme increases in liabilities, unmatched by their assets. Underfundedness, a collapsing real yield together with a chronic lack of long dated, safe, “growth” assets is a profound challenge for most European pension funds.
How do these issues differ from country to country?
Some countries are more heavily regulated than others. In the UK for instance, there is intense regulatory focus on adequate corporate funding for pension funds (which, typically stand alone). There is a strong requirement for a risk management game plan. However, in Germany, where most pension plans have not traditionally been separately funded, the issue is less clear and is often described as “complicated”. Pension liabilities sit on the sponsoring corporate balance sheet and, although it is generally agreed that they are not typically fully funded, it is less straightforward to measure assets against liabilities. In the Netherlands, there appears to be a far higher level of discretion afforded to the pension plan and to the corporate. In addition, the obligation to fund the pension plan is contingent on the funding level of the plan. Inflation protection is not as hard coded elsewhere as it is in the UK.
How do you work with funds to solve these issues?
We do three things.
First, we map the risks within the pension fund. These exposures (or risks) may be on the liabilities side (interest rates, inflation, longevity) or on the asset side (equities, credit, property, etc). We ensure that the pension scheme can articulate its risks clearly and accurately.
Second, we construct a path to full funding. This involves assessing an appropriate level of risk for the plan, a timeframe, a required rate of return and an expected rate of return.
Third, we negotiate between corporate sponsor and pension fund so that both can agree an effective funding and risk management strategy.
What sort of solutions and expertise do you provide that funds cannot source within their own organisation?
Our analysis is akin to a sophisticated MRI scan and measures the plans risks and required asset performance in detail. That is very difficult to achieve in-house – about as difficult as carrying out an MRI at home.
We also offer very tight control over the pension plan’s asset managers. This means we work with the pension plan to devise an asset allocation that is appropriate, we help select suitable asset managers and then we ensure that the asset manager delivers on its mandate. It is our version of fiduciary or implemented consulting.
Finally, because we are in constant discussions with market participants and pension plans responsible for over £200 billion of assets, we are at the coal face of the pensions advisory work. This allows us to pass on a lot of our expertise and experience.
How do Trustee boards compare within different countries in Europe?
The strategic decision making process varies markedly across jurisdictions. Some countries (such as the UK) have distinct trustee boards that meet solely to make strategic decisions with respect to pension plan strategy. They may or may not be market professionals. Often they are drawn from the ranks of ex-corporate management. Other countries (such as the Netherlands) tend to have professional market practitioners making key strategic decisions. In others, the decision makers may be located within corporate treasury.
Are there any meaningful gaps in knowledge?
In any trustee board where there are willing but essentially non-professional individuals running the pension plan assets, there is likely to be an insufficient level of market expertise available. Increasingly, pension plans require complex capital markets based instruments to manage the risks in the pension plan. These may take the form of derivatives or structured or contingent assets. Just as very few people who have never worked in a hospital are able to carry out neurosurgery, not many people who have never worked in the capital markets or asset management industry, have a sufficiently deep understanding of the workings of these instruments. In addition, there is often an insufficient appreciation of the effect of market movements on the pension plans assets or liabilities.
How do you help with this in terms of being transparent and clear enough for Trustees to understand?
We spend a huge amount of time familiarising pension plan trustees with basic jargon and terminology. This takes the form of regular seminars as well as repeated use of key concepts. We go through them until all of the trustees are able to use the concepts for themselves. Examples include Value at Risk numbers, PV01 values and helpful acronyms relating to Required Rates of Return, Rate of Return at Risk, hedging ratio, etc.
What does a good Trustee board look like in terms on knowledge?
On a “good” trustee board, every member will have a working understanding of all the drivers of risk within the pension plan and will be able to quote risk levels and required rates of return. They will understand all the jargon associated with pension risk management and will be able to describe the actions taken by the plan to mitigate risk and to maximise return. They will also understand the asset classes in which the plan is invested and will be able to interrogate their advisors and asset managers in depth. They are not afraid to be controversial or to challenge popular opinion. A good trustee board will be unlikely to fall victim to Groupthink.
How do you tailor services for the different sizes of funds in terms of the different needs they may have?
Small pension funds tend to have very different needs to large funds. For example, smaller funds will often need investable products that are pooled rather than segregated. Larger pension plans may require bespoke solutions designed specifically for them. We help our clients to understand the various offerings that are available and assist in the due diligence where appropriate. For small pension funds this can mean spending a lot of time getting them set up and familiar with the asset classes that they need to consider.
What safeguards do you have to ensure smaller funds are not neglected?
Most of our clients are large (£500m and above). However, we spend a lot of time with asset managers and banks helping them to construct platforms that are accessible to small pension plans. This includes offering risk analysis at a level of detail that would not typically be available to a small pension plan. Often, a small pension plan will not have access to sophisticated investment advice. We are keen on the concept of a colour grid that enables small pension plans to answer a few simple questions by which they can categorise themselves by risk and fundedness. This can be highly effective without requiring a lot of expensive analysis.