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Investments: the poor cousin

Published by Professional Pensions - 2nd of December 2019

Trustees need to increase their focus on investments and demand more from their advisers, argues Donny Hay.

One of the most baffling paradoxes in the world of defined benefit (DB) trustees is the fact that one of the most complex and costly aspects of their responsibilities receives less time generally and is less well supported. We are of course talking of investments, or the poor cousin of the other main responsibilities of funding, compliance and benefits.
 
Mediocrity has marred the investment arrangements of DB funds for many years. Pension schemes were on aggregate fully funded before the 2008 financial crisis. Over the past ten years funding levels have remained static at around 90% with the aggregate deficit of DB schemes doubling to almost £200bn with no improvement in sight.
 
Some say that, if DB pensions were not compulsory, they would have gone bankrupt years ago. Now is high time to act in order to improve transparency, investment returns and most importantly funding. This can be achieved through greater focus upon investment governance, higher professional standards, more delegation and greater oversight - after all, what gets measured gets done.
 
In some ways it's hardly surprising given the more structured worlds of funding, compliance and benefits with rule-based triennial valuations, accounts being prepared to meet recognised accounting standards, and benefits payments ceding to the trust deed and rules. In contrast, investments are complex, much less structured, and inherently unpredictable.
 
In addition, the above mentioned three areas of trustee responsibility are all better supported by recognised professional qualifications i.e. actuaries, accountants, and lawyers respectively. So, who is there to support trustee decision-making around investments?
 
A 2012 survey of investment consultants by IC Select revealed that over 50% of investment consultants advising DB pensions schemes did not have a professional qualification, and of the majority of those that did, it was the Investment Management Certificate. Something that is generally seen as an entry level qualification for graduates and a stepping-stone to higher investment qualifications such as the CFA. 
 
However, anecdotally, things seem to have improved in recent years. For example, in the six fiduciary management selection exercises carried out by IC Select over the past 12 months, the teams put forward to work closely with the trustees contained a high proportion of CFA-qualified professionals (over 75%). However, our experience working with pension schemes using an advisory approach reveals a much lower percentage with professional qualifications - often less than 50%. Trustees should demand and expect better.
 
This governance gap in DB pensions has left many pension funds and members much worse off and cost billions to boot. Research showing that good investment governance can add 1-2% per annum to a DB pension scheme's investment returns has been largely ignored. Trustees need to spend more time solving the hardest problems, which can also potentially contribute the most value.
 
In addition, all stakeholders - e.g. The Pensions Regulator (TPR), trustee boards as well as third-party evaluators, such as IC Select - need to be more demanding regarding increasing and improving oversight of pension schemes investment advisers, whether investment consultants or fiduciary managers, to help trustees measure success and judge value for money.
 
The review from the Competition and Markets Authority identified and proposed remedies to correct many of the competitive problems affecting those using fiduciary managers and investment consultants. These measures, along with TPR's helpful guidance, will improve investment governance and lead to increased consolidation of DB schemes. Indeed, we expect to see strong growth in fiduciary management, sole trustee and master trust arrangements.   
 
It's our belief that in the next five to seven years a significant proportion of today's 5,450 DB pension schemes will be using one of these consolidated models much like what has happened in countries like the Netherlands and Australia.So maybe investments will finally have their time in the sun. 
 
Donny Hay is a director at IC Select
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Wednesday, 08 July 2020