Case for quick-off-the-mark fiduciary management

The view that asset allocation is the main source of returns from investment markets has long been held by academics. Recent years have seen this theory increasingly tested in practice as investors first looked to spread their assets around a wider range of asset classes, then to limit losses and maximise opportunities by a more active approach to asset allocation.

The experience of two savage equity market downturns in the past decade, and the collapsing prices of all risky assets in the credit crisis, has been a big factor in persuading investors to widen their horizons and consider more sophisticated strategies.

So far, early results from some fiduciary managers suggest it pays off. A number of UK pension funds have taken the step of handing over day-to-day control of investment decision-making and manager selection to so-called fiduciary managers — often investment consultants but also big fund managers.

Good results

Several have reported attractive results. It was reported in August that Towers Watson had handsomely beaten its benchmarks over the year to March 2010 in its role as delegated chief investment officer for the Merchant Navy Pension Officers Fund (MNOPF). Cardano also revealed good results for its five fiduciary management clients, outperforming liabilities and easily outstripping the returns achieved by the average pension fund, although failing to meet its own longer-term performance target. And P-Solve has similarly produced the goods, at least for the Selex pension fund.

Making nifty asset allocation decisions is an important element in their success, although they would all deny they are making tactical asset allocation decisions, otherwise known as market timing.

Towers Watson says it has a three to five-year horizon and will look to change allocations in expectation of big changes in valuation. The point is the ability to move quickly once an opportunity or risk is identified.

Robert Brown, chairman of the global investment committee at Towers Watson, relates how the consultant identified a great opportunity to switch out of equities and into index-linked gilts in mid 2007, and wrote to its clients suggesting they do so. Only a few made the move. Deficits might be a lot lower among FTSE 100 companies (many of which are Towers' clients) if more had followed the advice and taken what proved to be top of the market profits.

Appointing a fiduciary manager is one way of avoiding missing out on opportunities, although that assumes the manager knows what it is doing and makes the right calls.

The £3 billion (Dh17.73 billion) Merchant Navy Officers Pension Fund commissioned KPMG to help its trustee body identify global best practice in fiduciary management, before last week confirming Towers Watson as its delegated chief investment officer (CIO).

Roger Urwin, investment expert at Towers Watson, is co-author of several academic papers on investment governance with Gordon Clark of Oxford University. The pair has identified a number of core attributes of best practice, and not surprisingly, Urwin believes the arrangement it has come to with MNOPF ticks all the boxes.

The key point, he says, is being able to respond quickly. Investment committees do not take enough decisions, and cannot manage on their own, so an executive team is critical.

Checks and balances

Perhaps the most important element of the arrangement for MNOPF is the checks and balances to be introduced via an independent adviser, yet to be appointed. Andrew Waring, chief executive of MNOPF, says the adviser will, among other things, comment on the ongoing suitability of the delegated CIO.

This sounds a bit like jobs for the boys. Towers Watson has turned itself from an independent adviser into part of the in-house team at MNOPF, so someone else has to take over the role of independent adviser. Urwin admits the independent adviser will look a bit like a traditional consultant, but it is important the adviser can challenge the delegated CIO, he says.

So will the interest in dynamic asset allocation fade if or when markets return to "normal" and trend upwards? Trustees may decide collecting asset class returns from equities, bonds and property is good enough when those returns are reasonably reliable. Regular rebalancing of a strategic asset split could come back into favour.

But the simplicities of yesteryear are long gone. Pension funds are working to outperform their liabilities and improve their funding position, taking profits and reducing risk if they outperform targets.

Even when the outlook improves, it is likely to remain a question of grabbing what you can when you can — and being quick about it.