BlackRock: in expert hands – Andrew Stephens
Many pension schemes still find themselves facing a significant funding challenge. Andrew Stephens, managing director of BlackRock's UK institutional business, discusses the benefits of outsourcing to a fiduciary manager.
The tough conditions that pension fund managers have experienced since the onset of the global recession have yet to abate in 2014. Interest rates remain close to record lows and equity markets are going sideways - but the challenges facing managers run much deeper than coping with a tricky market environment.
Although developed market returns of 20-30% last year led to some optimism returning to the sector, many schemes remain underfunded. They also face increased regulatory pressure to have a reasonable recovery programme in place and a target time frame in which to eliminate their deficits. As these time horizons become crystallised, trustees are now far clearer on the return objectives they need to meet. The challenge they have is meeting them.
With yields close to or at record lows, the search for returns is intensifying - and traditional asset classes alone can no longer be relied upon to provide them. Accommodative central bank policies have been a major factor in driving valuations across the asset-class spectrum, meaning that average correlations are likely to rise as markets normalise.
Well-structured portfolios, built with the prevailing market conditions in mind, will have two crucial elements: the first is diversification; the second is dynamism. Successfully incorporating these elements within investment portfolios requires market literacy, broad asset-class expertise and the portfolio management tools to adjust allocations appropriately over time.
The governance burden required of trustees to become familiar with new asset classes, let alone invest in them at the right time, is not something that many can carry.
Means to an end point
Against a complex market backdrop, how can schemes ensure their plans are managed in a timely and appropriate manner?
Delegating the management of plans is increasing in the UK and across Europe. In fact, recent surveys have indicated that about 30% of the market will go to some kind of fiduciary management in the next five to ten years.
There are three primary factors driving this change. First, clearly defined objectives provide outsourcing partners with a definitive target to work towards. Second, the requirement for dynamism needs daily, hands-on investment skill. And third, the breadth and complexity of the investment landscape is difficult to navigate, particularly if it's not your day job.
A common misconception among underfunded schemes is that they face actuarial, accounting or legal challenges. In fact, the requirement to move a scheme to a fully funded position is primarily an investment challenge - one that requires investment expertise to solve.
In simple arithmetic terms, a scheme that is 80% funded, and is seeking to be fully funded in ten years' time, requires a return 2% above its liabilities every year. Responsibility for meeting this objective can be wholly or partly outsourced.
Degrees of delegation
Does outsourcing mean that trustees lose control of their investment strategy? No - if anything, outsourcing allows trustees to focus on the strategic objectives of the scheme rather than the minutiae of daily investment decision-making.
In practice, outsourcing arrangements vary from only delegating tactical asset allocation decisions to full fiduciary mandates in which all investment decision-making is outsourced. Diversified growth funds, whereby clients give managers control over some or all of their asset allocation, have grown to more than £80 billion in the UK alone.
Another, more strategic, approach to outsourcing is referred to 'journey management' or 'flight path investing'. Here, trustees and their advisers set up a programme to dynamically manage the strategic allocation over time. An increasing number of our clients at BlackRock are adopting this approach.
A balancing act
The decision of whether to outsource - and to what extent it should be done - ultimately boils down to one question: will outsourcing increase your scheme's chances of reaching its objective? From a strategic perspective at least, the answer is very likely to be yes.
Schemes that monitor market conditions and scheme funding levels on a daily basis, and adjust their strategic allocation accordingly, stand a greater chance of meeting their objectives than those that do not. Very few trustee groups have the governance resources and requisite portfolio-management tools to run such strategies.
When it comes to the tactical and medium-term asset allocation decisions, however, the answer is less clear-cut. Outsourcing these elements of an investment strategy may increase manager risk and requires significant due diligence up front.
While fiduciary management can provide significant benefits for trustees in terms of outcomes and a reduced governance burden, finding the right partner will require a significant initial time investment for clients.
Choose your partners
Once a company has decided to outsource, how does it go about identifying the right partner? There is significant and increasing choice available to trustees, including specialist fiduciary managers, all-purpose asset managers (such as BlackRock) that include fiduciary management as a key part of their offering, and investment consultants using their implemented platforms.
The type of partner chosen will vary from trustee to trustee. When plans choose an outsourcing partner, they are usually embarking on a long-term relationship.
BlackRock urges trustees to make themselves aware of all the options available to them before making a decision. Evidence shows that more than 80% of existing fully outsourced arrangements in the UK did not follow a competitive selection process. We also strongly encourages schemes that are thinking about this option to properly test the market before selecting their partner.