By Dr Iain Clacher and Dr Charlotte Stephenson
About the author
Dr Iain Clacher is an Associate Professor in Accounting and Finance at Leeds University Business School and is the co-director of the Centre for Advanced Studies in Finance. His main research interests focus on: pensions and retirement saving decisions, pension investment and infrastructure, and sustainable pension systems. Dr Charlotte Stephenson is the editor of the Research and Innovation blog.
This third report, investigating what trustees look for when selecting pension fund managers and consultants, forms the final part of a series of reports that provide a deeper analysis on trustees’ perceptions of costs and value, investment risk and return, as well as manager and consultant selection.
Wider ‘problem’/need for research
This behavioural finance study observes the impact behavioural biases can have on scheme investment decisions made by 197 mainly defined benefit (DB) trustees and scheme managers in the UK. The schemes range from those with less than £15 million, up to £5 billion. The analysis for this final report is split into two parts:
1. What trustees look for in their fund managers and fund manager selection
2. The relationship between trustees and their investment consultants.
Collecting the data
Interviews of trustees from different pension schemes were conducted, to gain perspectives across a range of issues, including the value of fund management and the role of investment consultants.
The research team
Partnering with Aon Hewitt – a leading global provider of investment consulting services and adviser to pension scheme decision-makers – I have worked with Leeds University Business School colleagues Dr Richard Hodgett and Dr Simon McNair to undertake research exploring trustee investment decision-making.
In our first report, we outlined the trustee landscape, providing a profile of the average trustee including their level of financial literacy. In the second report, we looked at the prominence of costs and fees with respect to investment decision making and considered both the explicit and implicit fees associated with fund management. This third and final report investigates what trustees look for when selecting pension fund managers and consultants.
Main findings from the research
Trustees and fund managers
“How would you describe value in the fund management process – what is it you pay for?”
Primarily, trustees believe fund management is about performance and risk, with the interplay between these key factors being of particular significance. A common theme highlighted that performance must be risk adjusted, that is to say, the search for performance should not be interpreted as performance at all costs. Yet on more than one occasion, it was raised by respondents that fund managers go beyond the mandate, running excess risk relative to the trustees’ objectives. In doing so, fund managers are taking a major risk, as there could be significant implications to the fund if such transactions were to underperform.
This led into the concept of how performance should be measured. In most instances, trustees understood that performance is not something that happens immediately and that a strategy or a fund requires time for performance to emerge. Trustees are therefore willing to give fund managers time to perform, but they will also re-allocate the mandate if performance does not materialise.
What do trustees look for in a fund manager?
As outline above, trustees are focussed on risk-adjusted performance, having a longer-term view with respect to investment performance and reviewing mandates. These findings support the outcomes of the second report, whereby trustees were shown to focus on investment strategy first.
“We pay for alpha not beta.” – Independent trustee, small to mid-size schemes
Trustees regularly review both their investment strategy (at least 64% annually) and their investment managers (at least 57% annually).
The factors deemed important in manager selection differ between large schemes and small schemes. The trustees of larger pension schemes place more emphasis on ‘soft; factors, such as investment philosophy and decision-making. By comparison, smaller schemes focus on ‘hard’ factors (past performance, costs and fees, fund size, firm size and volatility) to a greater extent than that of larger schemes.
Trustees and investment consultants
When asked “How would you describe the investment consultant process?” a more diverse range of views (than that of fund management) surrounding investment consultants and the investment consultant process was given.
What do trustees look for in an investment consultant?
Irrespective of scheme size, there were a number of core characteristics trustees’ value and look for in investment consultants. With factors such as the provision of clear advice, understanding the situation or the scheme, and the goals of trustees and risk management, all ranked as significant. There was a broad range in how trustees viewed investment consultants, from a service provider with a limited remit, to a sounding board for trustees to road-test ideas with.
In response to the question “How reliant on your investment consultants is your scheme?”, smaller and larger schemes on average stated “a lot”. It was highlighted that smaller schemes are much more reliant on their investment consultants than larger schemes, which is understandable given the depth of resource and wider pool of expertise often found in larger schemes. Of concern, a small number of schemes across all sizes stated that they are completely reliant on their investment consultant.
When alternatives to the investment consultant’s recommendations are put forward, they are regularly considered. However, 19% of trustees do not readily engage in any process of considering alternatives, which is not optimal for robust decision making. Smaller schemes are not considering alternatives frequently, a consequence perhaps driven by:
- A lack of expertise or experience on the trustee board
- A lack of resource to allow for alternatives to be considered
- That the trustees of smaller schemes are less willing to challenge or critique the advice they are given
76% of all respondents stated that the rejection of investment consultant recommendations does not often occur. However, one question to consider is whether the specific goals and objectives of trustees put constraints on the operations of investment consultants?
In the bid to be successful, investment consultants are more likely to tailor their recommendations to the goals and objectives of the trustees, rather than giving a balanced view. To add to this, if an investment consultant knows the investment views and preferences of their client, it would be unlikely that they would recommend an approach the client would dislike, even if such a recommendation would be in contrast to their professional opinion. This is resulting in the tailoring of advice to the goals of trustees, and not necessarily what the investment consultant believes is the optimal strategy. Presently, it is unclear as to how trustees would respond if they were to be given advice that conflicts with their views, or whether investment consultants are able to have such honest conversations with trustees surrounding these issues.
This report has shed light on the relationships between trustees and their fund managers and investment consultants, providing insight into the interactions which are fundamental to the investment processes of pension schemes and are much more complex than previously thought.