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Fiduciary Management Insights Overview 2013 March 2013

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Page 1: Fiduciary Management Insights - EY · Fiduciary Management Insights – Overview 2013

Fiduciary Management Insights Overview 2013

March 2013

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Confidential — all rights reserved © Ernst & Young LLP 2013

Introduction 5

What is fiduciary management? 6

Benefits of fiduciary management 7

Appointing a fiduciary manager 8

Delegating to fiduciary managers 11

Monitoring fiduciary managers 12

Final thoughts 14

Getting help 15

Contents

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During 2012, Ernst & Young hosted a series of four webcasts to introduce pension trustees and company representatives to the concept of fiduciary management. In all, over 500 individuals participated in these webcasts. During these events, we asked participants for their thoughts on a variety of subjects.

Participant responses were interesting and varied. They illustrate both a keen interest in the rapidly growing fiduciary management market in the UK and Ireland and the key questions stakeholders have about best practice in pension scheme governance.

This short publication captures their views along with some of our insights and I hope you find it useful and informative. If you have any questions, please don’t hesitate to get in touch.

Kind regards

Iain Brown Partner and Head of Fiduciary Management Services Ernst & Young LLP

March 2013

Introduction

5 Fiduciary Management Insights – Overview 2013

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With today’s acute focus on pension cost and deficits, managing a pension scheme’s assets is more important than ever.

Whilst the traditional advisory model upon which pension trustees and sponsors have historically relied has stood the test of time, many trustees and sponsors are finding that a more ‘hands-on’ approach to investment governance is required to cope with today’s more sophisticated investment approaches.

For some, fiduciary management may be the best solution to this governance challenge.

What is fiduciary management? Fiduciary management is an investment governance solution that involves trustees delegating certain elements of the investment process to an investment expert – the fiduciary manager.

The fiduciary manager will employ best practices in pension scheme investment management, including:

► Managing the pension assets relative to the liabilities using techniques such as hedging of risks

► Maximising investment diversification

► De-risking as market conditions allow

Delegation and its benefits In our experience, not all trustees have the time, governance budget or access to the economies of scale to effectively implement these best practices – the fiduciary manager does.

In the fiduciary management model, the trustees decide which investment processes to delegate to the fiduciary manager. Figure 1 breaks down the pension investment process into its components to show possible delegation levels under a fiduciary management structure.

The purpose of this delegation is twofold:

► Firstly, activities which are better left to the expert are delegated

► Secondly, by delegating lower level investment activities like hiring/firing investment managers to the fiduciary manager, this frees up the trustees’ (finite) time to focus on those investment processes that matter the most

In practice, the responsibility for setting the risk/return budget will always be retained by the trustees.

6

Figure 1: the investment process for a pension scheme

Delegation level

Hiring and firing investment managers I

Making tactical asset class decisions and deviations based on market conditions II

Allocating different asset classes within the growth and matching portfolios III

Incorporating a dynamic asset class de-risking methodology IV

Determining and managing the split of growth and

matching assets V

Setting and amending the risk/return budget

Most important investment processes

Least important investment processes (but often most time is spent here)

What is fiduciary management?

Jargon: Fiduciary management is sometimes called delegated (investment) consulting, implemented (investment) consulting or solvency management. For the most part, these titles can be used interchangeably.

Fiduciary Management Insights – Overview 2013

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Fiduciary management enables trustees to spend their time focusing on the investment matters that are most important. It also enables fast decision making, an important capability in the face of rapidly changing market conditions.

From our conversations, both trustees and sponsors have been receptive to the ideas that underpin fiduciary management. As can be seen from Figure 2, the vast majority of survey participants felt that fiduciary management could improve pension scheme investment governance.

Indeed, webcast participants recognised that best practice pension scheme investment management now includes several dimensions (Figure 3). Trustees are increasingly finding that they do not have the time or expertise available to actively manage and monitor the investment of a scheme’s assets.

Figure 2: do you think that fiduciary management has the potential to improve pension scheme investment governance?

47%

36%

1%

16%

0%

10%

20%

30%

40%

50%

Yes Possibly No Not Sure

7

Benefits of fiduciary management

Figure 3: what do you believe is the most important aspect of best practice scheme investment management?

14%

55%

19%

10% 2%

De-risking All equally importantAsset diversification HedgingNone of the above

Ernst & Young insight: ► While trustees generally initiate the process and always

make the ultimate decision, we have found that, in a number of cases, scheme sponsors have been the driving force behind their scheme’s migration to a fiduciary management model.

► For instance, in one case, the sponsor recognised that the trustees did not have the expertise to implement liability hedging – something that was deemed desirable by the business. Appointing a fiduciary manager addressed this issue.

Fiduciary Management Insights – Overview 2013

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There are over 15 firms providing fiduciary management services in the UK or Ireland. In addition to coming from different backgrounds (see next page), our research has shown that there are significant differences between their offerings in terms of:

► Approach to portfolio construction

► Resources dedicated to fiduciary management

► Internal infrastructure

► Market segment focus

► Fees

At present, we are seeing more fiduciary management mandates at lower levels of delegation (e.g. Levels I to III as defined in Figure 1) than at higher levels of delegation. Figure 4 below illustrates this based on data we collected in June 2012 – we believe this sample is representative of the UK&I market. We expect this to change and develop as trustees and sponsors become more familiar with the fiduciary management concept.

Appointing a fiduciary manager

Delegation level

I II III IV

> £1bn

£500m – £1bn

£100m – £500m

£10m – £100m

< £10m

V Size = concentration of pension schemes

8

Figure 4: distribution of fiduciary management mandates by level of delegation (Ernst & Young sample)

Ernst & Young insight: ► It is a common misconception that fiduciary

management only ‘works’ for a certain size of pension scheme. This is not that case - schemes ranging from under £10m to well over £1bn are successfully using a fiduciary manager in some capacity.

Fiduciary Management Insights – Overview 2013

Size

of a

sset

s

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Confidential — all rights reserved © Ernst & Young LLP 2013

There was no clear consensus amongst our webcast participants as to what category of fiduciary manager is best placed to provide fiduciary management services to UK&I pension schemes. This is in line with our experiences from selection exercises where we have found that trustees are willing to consider firms from all of these backgrounds as potential candidates for the fiduciary manager role.

Appointing a fiduciary manager From our market research, a significant number of fiduciary management mandates have evolved from traditional advisory relationships whereby trustees have appointed their incumbent investment advisor as their fiduciary manager. That being said, we are finding that trustees and sponsors alike are increasingly seeing the benefits of appointing a fiduciary manager following an independent selection exercise.

Client insight: “The appointment of a fiduciary manager for our pension scheme has increased the investment knowledge and awareness of our trustee board.”

Chairman of trustees

Fiduciary Management Insights – Overview 2013 9

The different fiduciary management providers We can broadly categorise the firms offering fiduciary management services in the UK&I into the following backgrounds:

► Stand-alone fiduciary management firms (often originally from the Netherlands)

► Benefit consultancies

► Manager of managers

► Fund managers

► Investment banks

Stand-alone firms

Investment banks

Fund managers

Manager of managers

Benefits consultancies

Fiduciary management

landscape

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Confidential — all rights reserved © Ernst & Young LLP 2013

No, 7%

Yes, 51%

Not Sure, 41%

Appointment by formal tender Over half of webcast participants believed that appointing a fiduciary manager through a formal tender exercise would be best practice (Figure 5). Moreover, the majority of participants believed that an independent third party advisor was necessary to help run a selection exercise (Figure 6).

Understanding, comparing and learning more about the various fiduciary management providers can be a complex and time-intensive process, especially for those new to the concept.

An independent selection consultant like Ernst & Young can guide trustees through these complexities. They can engage the market and invite appropriate fiduciary managers to tender. Their expertise can enable them to identify and explain the differences between fiduciary managers.

Figure 5: do you believe formally going to tender should be best practice?

Figure 6: do you believe you need an independent third party advisor to help run a selection exercise?

Yes, 73%

No, 12%

Not sure, 15%

Ernst & Young insight: ► We have found that a common misconception is that,

upon appointing a fiduciary manager, you will benefit from ‘full fiduciary management’ from day one. This is often not the case - it can take some time before this happens.

► For instance, transition management will be required to facilitate the migration of investments from the current investment manager to the fiduciary manager in a cost effective manner. In addition, the Fiduciary Management Agreement – the document which governs the relationship between the fiduciary manager and the trustees - can take some time to execute.

► Moreover, before setting out in their duties, a fiduciary manager needs trustee buy-in. In practice, this means that in the early months of a relationship the fiduciary manager’s role is very similar to the traditional advisory structure. For instance, it can take several months to introduce a de-risking strategy including an interest rate/inflation hedging program.

10

Appointing a fiduciary manager (cont’d)

Fiduciary Management Insights – Overview 2013

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Figure 7: if you were appointing a fiduciary manager, how would you approach the ‘what should we delegate’ decision?

Delegating to fiduciary managers Apart from setting the scheme’s risk/return budget, which cannot be delegated, the level of delegation to a fiduciary manager is extremely flexible. The level of delegation can be changed as the relationship between the trustees and the fiduciary manager develops.

In our experience, many pension schemes start at a lower level of delegation (e.g. permitting the fiduciary manager to hire and fire investment managers and make tactical asset allocation decisions). In these cases, we have found that, as the trustees become more comfortable with their fiduciary manager, they will often increase the level of delegation.

Getting the level of delegation right and consolidating these choices in the Fiduciary Management Agreement are some of the most important decisions the trustees will make.

Getting delegation just right ► Almost 70% of the participants in our 2012 survey felt that

they would approach delegation delicately, and would initially only be open to lower levels (Figure 7).

► Less than one third of participants would be comfortable with high levels of delegation at the outset.

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59%

31%

9% 1%

Minimal delegation

Open to starting with higher levels of delegation

Uncomfortable with higher levels of delegation

No delegation

Ernst & Young insight: ► We have found that many trustees’ concerns about fiduciary management relate to a perceived loss of control. However,

delegation does not mean a loss of control. We have found that many trustees feel they gain control by working with their fiduciary manager to set an effective strategy and agreeing a framework within which the fiduciary manager can operate to achieve a successful outcome. These strategy setting discussions often lead to the trustees developing a greater understanding of what makes the real difference from a pension scheme investment perspective and, in particular, a shift of focus from an asset-only lens to an asset/liability lens.

Fiduciary Management Insights – Overview 2013

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Monitoring fiduciary managers Appointing a fiduciary manager is only the start of the journey. An overwhelming majority of webcast participants felt that, once appointed, a fiduciary manager needs to be monitored (Figure 8).

In our view, monitoring does not mean questioning every decision the fiduciary manager makes. Instead, it involves evaluating whether value has been added by the fiduciary manager and if their approach has been consistent with the Fiduciary Management Agreement and, more generally, with the trustees’ reasons for appointing them in the first place.

This requires the consideration of several quantitative and qualitative factors including investment performance, quality of advice, generation of new ideas, trustee training, fees and quality of reporting. In our experience, the qualitative factors are just as important as the quantitative.

Monitoring a fiduciary manager, just like periodic reviews of other pension scheme service providers, is an expression of good governance. Indeed, the largest percentage of our webcast participants felt that the greatest benefit of monitoring a fiduciary manager would be an enhancement in the overall governance of the scheme (Figure 9).

Figure 8: do you believe there is a need for a fiduciary manager to be monitored?

Figure 9: what do you believe is the greatest benefit of monitoring a fiduciary manager?

93%

3% 3% 4%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Yes No Maybe Don't know

28%

43%

7%

16%

6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Follow bestpractice

Enhancedgovernance

Audit trail Ensuringvalue formoney

Don't know

12

Ernst & Young insight: ► In relation to value for money, we have found there are

often significant variations in fees between fiduciary management providers. In two recent selection exercises, one for a £50m pension scheme and one for a £500m pension scheme we observed fee variations of 90% and 25% respectively between the cheapest and most expensive providers.

Fiduciary Management Insights – Overview 2013

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Forms and frequency of monitoring Monitoring can be delivered via formal reports or attendance by an independent monitoring consultant at trustee or investment sub-committee meetings. The frequency of this monitoring depends on the preferences of the trustees.

Most webcast participants felt that fiduciary managers should be monitored on an annual or quarterly basis (Figure 10).

In our experience, we have found that frequent monitoring is beneficial as soon as a fiduciary manager has been appointed. As the relationship between the trustees and fiduciary manager becomes more established, a lighter touch monitoring approach may be more appropriate.

Figure 10: how often do you think a fiduciary manager should be monitored?

Ernst & Young insight: ► Best practice has always been to monitor what has been delegated. Under the traditional advisory approach, where only

security selection is delegated to investment fund managers, best practice has always been to monitor those managers in comparison to their benchmarks and their peers. In our view, periodic monitoring of a fiduciary manager is merely a logical extension of this process.

3%

42% 49%

5% 1%

0%

10%

20%

30%

40%

50%

60%

Never Quarterly Annually Every 3 - 5years

Onlyfollowing asignificant

event

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► Based on our regular research meetings with fiduciary managers, and the interest shown by both trustees and sponsors, we believe that fiduciary management will continue to grow rapidly in the UK&I.

► An increased awareness of the fiduciary management solution and the recognition of the ever-increasing complexities of the investment world will drive new appointments of fiduciary managers in 2013.

► Furthermore, we believe that fiduciary managers will continue to refine their solutions and develop a market niche. We think it will become more important than ever to understand the differences between fiduciary managers before making an appointment.

► A consensus seems to be developing that monitoring a fiduciary manager is an essential initiative.

Final thoughts

Fiduciary Management Insights – Overview 2013 14

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Against the backdrop of an ever-developing fiduciary management market and varied solutions, obtaining independent help can be very beneficial. Ernst & Young is able to help trustees and sponsors in:

► Identifying the right investment governance solution

► Running a fiduciary management selection exercise

For further information, please visit www.ey.com/fiduciarymanagement or contact:

Getting help

Sean Bottomley Director

Tel: +44 113 298 2327 Mob: +44 7740 923 265 Email: [email protected]

Christopher Bown Director

Tel: +44 20 7951 3231 Mob: +44 7730 733 861 Email: [email protected]

Iain Brown Partner

Tel: +44 20 7951 7546 Mob: +44 7977 023 389 Email: [email protected]

15

Vicky Paramour Senior Manager

Tel: +44 20 7951 1458 Mob: +44 7789 030 921 Email: [email protected]

Adam Poulson Senior Manager

Tel: +44 113 298 2424 Mob: +44 7876 397 927 Email: [email protected]

Matthew Mignault Senior Manager

Tel: +44 20 7951 7630 Mob: +44 7827 257 370 Email: [email protected]

Nancy Stockmeyer Senior Manager

Tel: +44 20 7951 8131 Mob: +44 7917 502 825 Email: [email protected]

Philip Wheeler Senior Manager

Tel: +44 141 226 9557 Mob: +44 7786 313 701 Email: [email protected]

Tony Martinez Manager

Tel: +44 20 7951 2241 Mob: +44 7920 822 527 Email: [email protected]

Fiduciary Management Insights – Overview 2013

Rob Heaton Manager

Tel: +44 113 298 2519 Mob: +44 7767 494 887 Email: [email protected]

► Assisting with the initial appointment of a fiduciary manager

► Monitoring a fiduciary manager’s performance

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Ernst & Young LLP

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About Ernst & Young

Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

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The UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited.

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© Ernst & Young LLP 2013. Published in the UK. All Rights Reserved.

In line with Ernst & Young’s commitment to minimise its impact on the environment, this document has been printed on paper with a high recycled content.

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