Why delegation can reduce risks and raise efficiency
As many as 1,000 defi ned benefit (DB) pension schemes may ultimately have to cope with an insolvent sponsor, according to a study by the Pensions Institute at the Cass Business School in London*.
In the wake of that, many would face the prospect of being taken over by the Pension Protection Fund (PPF), where the reality for members is often worse than the headlines suggest once reduced pension increments and other benefit reductions are taken into account.
To avert what is likely to be the worst case of falling under the aegis of the PPF, the study’s authors urge all those involved with the industry to plan ahead and adopt suitable measures well in advance of problems. One partial solution that has received much attention in the last few years is greater delegation of investment responsibilities to specialists. Such an approach need not be complicated nor expensive.
Our diagram illustrates a straightforward framework for an investment strategy that can be adapted to many schemes’ circumstances.
From this, three questions flow:
1. Who does what?
Increasingly, trustees are seeking to delegate implementation of heir investment strategy to a fiduciary manager, investment sub-committee or, for larger schemes, an in-house team.
Greater delegation frees up the trustees to focus on setting high-level strategy and oversight. This has the advantage of a clear separation of responsibilities, which enables greater specialisation, quicker decisions and more accountability. It does, however, mean handing day to day control of investment implementation to a third party.
2. What is the role of advice?
Advice may take a different form for schemes adopting a delegated approach. Under a fiduciary arrangement, asset allocation and implementation will usually be covered by an investment management rather than an advisory agreement. Trustees will still want to take advice on strategy, however in many cases this will now be provided by the fiduciary manager rather than a traditional investment consultant.
The trustees are also likely to want to take advice to help them fulfil their crucial oversight function. It is important that any adviser they use is aligned with their interests. Independent trustees or the new breed of fiduciary oversight companies might fulfil this role, while traditional consultants might also be used, as long as they are able to demonstrate their alignment with trustees’ objectives.
3. What to look for when delegating
Clearly expertise will be a key factor. But the core elements of an investment
strategy are usually fairly similar:
- A flight path framework, with pre-set trigger points, as part of a systematic de-risking process.
- A liability matching portfolio specifically tailored to the scheme’s circumstances.
- A growth portfolio of diversified assets which evolves as markets change and opportunities arise.
However, providers’ capability will vary signifi cantly, as will their operational capacity to implement such a strategy. Trustees should be articularly wary of over-complicated or over-engineered solutions and they should maintain a laser-like focus on ensuring that the provider is offering genuine value for money.
Nonetheless, as long as there is no confusion over roles and responsibilities and there is a clear alignment of interests, we believe delegation of investments can help trustees improve their chances of success.
* The Greatest Good for the Greatest Number, Pensions Institute, Cass Business School, December 2015.