April 2018 saw the launch of the IC Select Fiduciary Management Performance Standard (FMPS) ,which helps pension schemes compare the skills of fiduciary managers hired by trustees to manage their Scheme assets on their behalf.
It comes at a time of unprecedented regulatory scrutiny of investment consultants and fiduciary managers by the Financial Conduct Authority (FCA), and Competition and Markets Authority (CMA). Both have argued that trustees are not receiving the necessary information to allow them to assess performance and judge value for money when selecting fiduciary managers.
The CMA has called for “the introduction of industry standards for how investment performance is reported to customers.”
Why the Standard is necessary
Full fiduciary management takes place when a pension scheme delegates the investment management of the assets to a single manager, and benchmarks its investment returns, net of all costs, against a liability benchmark. FM continues to grow rapidly in the UK, having increased ten-fold over the past ten years. It is estimated that 13% of pension schemes now use fiduciary management¹.
However, trustees have struggled to compare fiduciary managers. The problems in performance reporting originated from each provider using a different methodology to calculate performance and risk. This was combined with a lack of transparency, standardisation, and consistency in the way fiduciary manager performance was presented to potential clients. This led to accusations that managers were ‘cherry picking’ their performance record, when responding to invitations to tender.
Many of the problems can be solved by moving to a standard basis for classifying funds, calculating returns, and displaying performance. Consequently, IC Select engaged with the UK’s leading fiduciary managers, industry professionals and the CFA Institute to produce a co-ordinated approach. With the support of a steering group, it has agreed a standardised methodology for data calculation, along with a presentation of fiduciary management performance for selection purposes. The UK’s fiduciary managers have agreed to comply with the standard².
The introduction and adherence to the FMPS will put trustees in control of the information they receive, avoiding the potential for cherry picking funds by fiduciary managers, and provide trustees with confidence that the performance data provided has been calculated on a consistent basis, and is being presented in a standardised manner.
How it works: IC Select Solution
The formation of composites is at the heart of the FMPS. They comprise similar funds grouped together, with performance and risk calculated on an average basis for funds in the composite. As a result, it is not possible for a FM to show the performance of its best fund. A composite can be comprised of just one fund if the fiduciary manager has no similar fund.
The FMPS track record utilises the specific liability benchmark of each client and recognises when the trustees have imposed restrictions, over hedging or assets.
Focus for trustees
We would recommend that when trustees are seeking to judge the investment skills of fiduciary managers they focus upon the green areas, be cognisant of the orange variables, and ignore the red areas. This is because the green shaded areas assess the fiduciary manager’s ability to add value, on both the asset and liability side, relative to the liability benchmark without any restrictions. We would expect different investment market conditions to affect the asset mix, and the extent to which the interest rate and inflation exposures are hedged at different points during the investment cycle. The return ranges are IC Select’s recommendation, but individual fiduciary management firms are free to define their own composites to, for example, define narrower or wider return targets. The standard also caters for the fact that all pension funds liabilities and therefore objectives are different, so, unlike investment products, a single benchmark is unlikely to be appropriate. Pension schemes will have different return targets and may have hedging and asset type restrictions, where, for example, 30% of its assets are invested in a property that cannot be sold. The FMPS takes the differences into account but allows users to assess the unconstrained full discretion performance of different fiduciary managers which is the best way to assess their skill. In practice, most fiduciary managers have around 10 composites and some are consolidating these into fewer umbrella composites. For example, combining narrow return target client portfolios with wider return target client portfolios, such as liabilities +0.51% to 1.0% and +1.01% – 1.5% become an umbrella composite of liabilities +0.51% – 1.5%.
Each fiduciary manager will have a list of all their composites and trustees should request any composites relevant to their situation knowing they will have been calculated on the same basis by all those fiduciary managers adhering to the standard.
The benefits for trustees
The FMPS provides trustees with many advantages:
+ any trustee board carrying out a fiduciary management selection exercise can request the performance information in line with the Standard direct from the fiduciary managers at no cost
+ each fiduciary manager will have a list of core performance composites on different risk and return characteristics for the trustees to select from
+ as performance composites are calculated on average performance for a group of clients, it prevents the fiduciary managers from reporting on only their best performing funds
+ when requesting performance information on the Standard, trustees can have confidence that performance has been calculated and verified on an industry standard basis
+ trustees can be confident that the information they are getting will be presented in a standardised format
The IC Select Fiduciary Performance Standard was frequently referenced by the CMA during its current review of the investment consultant and fiduciary management industry. Responsibility for the standard will transfer to the CFA Institute by 2020, to become part of the Global Investment Performance Standard. Leading third party evaluators of fiduciary managers such as Barnett Waddingham, Hymans Robertson, LCP, KPMG, and XPS Investments, have publicly backed the standard requiring the fiduciary managers to comply with it or explain why not. The FMPS will put the trustees in control of the due diligence of the fiduciary managers they are assessing and removes any chance of ‘cherry picking’ of performance records by the managers. This is good for trustees, good for the managers, and good for the industry.
¹Source: CMA Investment Markets Investigation Provision Decision Report, 18th July 2018
²Aon Hewitt, BlackRock, Cardano, Charles Stanley, Goldman Sachs Asset Management, JLT Investment Solutions, Kempen Capital Management, Legal & General Investment Management, Mercer, P-Solve, Russell Investments, Schroders, SEI and Willis Towers Watson.