In the first of a three part series on how trustees choose asset managers, Jonathan Stapleton speaks to Richard Butcher and Roger Mattingly about how trustees review asset manager performance.
Editor, Professional Pensions
Managing director, PTL
Managing director, PAN Trustees
Jonathan is editor-in-chief of Professional Pensions. He joined PP in July 2001, launched PP Online in 2006, became editor in 2009, launched Workplace Savings & Benefits in 2012 and became editor-in-chief of both brands in 2014.
Richard Butcher has been involved in scheme governance since 1985 and joined PTL in 2008, becoming managing director in 2010. He is a fellow of the Pensions Management Institute and is on the organisation’s council. In 2017 he was appointed chairman of the Pensions and Lifetime Savings Association (PLSA).
Roger Mattingly is both managing director of PAN Trustees and a principal of PAN Governance. He has previously served as a main board director of two leading pension consultancies in a career that has spanned more than 30 years He is also a past president of the Society of Pension Professionals.
Jonathan Stapleton: Richard, how often do you think schemes should review the performance of their asset managers?
Richard Butcher: The starting point is that legally you are required to review your statement of investment principles every three years. So, there’s always an opportunity to do a full formal review at that point in the cycle. Informally you are reviewing your asset managers constantly – at every single meeting you have, you are looking at their performance, asking what they are up to and whether they are doing what you expect and need them to do.
However, despite the fact that you’re looking at them on a quarterly basis in line with the cycle of your meetings, I would never look at quarterly performance – that’s a bit like trying to steer a ship by looking at the waves that are hitting it at that particular point in time. So you should be looking at one, three and perhaps five-year performance and you should be looking at those numbers quarterly.
Jonathan Stapleton: Do you think that is what is happening generally across the piece?
Richard Butcher: I think it’s a mixed bag. Some look at different things at different times, and there’s no consistent approach to this, barring the legal deadline of reviewing statement of investment principles every three years.
Saying this, I wouldn’t get too hung up with the formal review of asset managers. We have investment consultants who are supposed to do the due diligence on investment managers, and to report back to us if there’s change in that due diligence. As long as they do that and report back any concerns, it shouldn’t be something that exercises too much of the trustees’ time. Trustees should be spending our time on what’s important: the strategic matters.
Jonathan Stapleton: Roger, would you agree with that?
Roger Mattingly: Yes, there should be a constant structure of monitoring which looks, as Richard says, at the rolling periods. The investment advisers should alert the trustees to any concerns. You would also – depending on the scheme’s size – expect to meet with the investment managers at least once a year, maybe more frequently depending on whether there are concerns.
But on that point, one thing we as trustees – especially as independent trustees – are quite hesitant about nowadays is seeing people who aren’t actually making the decisions. Increasingly we want to have a direct dialogue with the decision-makers, the fund managers themselves.
Of course, there is a tension because if they are the fund managers, it could be argued that they should actually be managing the money rather than sitting in front of trustees. But, what we don’t want, and what we can see through, is any sort of cosmetic spin in terms of that particular manager’s performance at any one moment in time.
Jonathan Stapleton: You have both mentioned investment consultants. In our research 92% of respondents said they relied or used an external investment consultant to help them with performance reviews. To what extent are investment consultants key in any review process of managers?
Roger Mattingly: As a sweeping statement, I have to say that the investment consultant community is a mixed bag and there isn’t a consistent level of capability within it.
The investment consultant community is a mixed bag and there isn’t a consistent level of capability within it – Roger Mattingly
Yes, there are some pockets of absolute excellence in terms of advice, competence and knowledge, but there is also a portion that is far more cosmetic and superficial in terms of their advice and know-how.
Chairs of trustees are increasingly keen on making sure they are getting advice from people who really know what they’re doing and really understand what they need to know in respect of fund managers – one should be able to take that as an absolute from day one but it’s not.
Good investment consultants absolutely have a major part to play but the starting point is to make absolutely sure that we surround ourselves with the best possible advisers that we can find, because otherwise the likes of Richard and I are in danger of advising ourselves, which is not what we set out to do.
Jonathan Stapleton: Do you agree with that Richard, and do you feel that sometimes you are in the danger of advising yourselves at trustee meetings?
Richard Butcher: I think there’s definitely the risk of advising yourself; I’ve not found myself in that position yet but there is definitely a risk.
I believe you absolutely have to have an investment consultant to help you review your investment manager.
They need to be a good consultant who looks at the right factors on your behalf – most trustees are lay people who don’t do this as a day job and even professional trustees, who are more familiar with investment matters, will need help.
So we need a competent investment consultant there to help us to interpret the performance in terms of investment performance, risk performance, liquidity performance and other factors. We need the consultant to help us ask the penetrating questions that we perhaps wouldn’t think of and we need the consultants to do the ongoing due diligence on the investment manager. If they’re looking at this every single day, they will see the small changes that we might not see and we expect them to come back and to give us that intelligence so we can interpret what is going on.
Jonathan Stapleton: But, as you say, this isn’t all about performance. Roger, to what extent is this about whether the managers still continue to do what they said they were going to do right at the beginning of their mandate?
Roger Mattingly: It is exactly that Jonathan. I think it is all about the capability of that fund manager to perform going forward and, what is increasingly compelling, are those investment managers that know what they’re about as a fund manager and have opinions and some foresight as to what they think might happen and what will be the impact on their investment strategy.
You would think this should be par for the course but it isn’t and there are fund managers out there that will just sit on the fence in terms of their views of the future and that’s where it becomes slightly disconcerting. It’s all about the trustees having confidence in their fund managers and it very compelling when you have fund managers who speak confidently about what they are doing in an environment that is ever-changing.
Richard Butcher: I think there are a number of characteristics you look for in a fund manager – performance; risk appetite; and having a risk appetite that is consistent with our needs; costs and knowing what those costs are and being able to control them; liquidity/duration; and having a duration that is consistent with our needs. These are the sorts of factors that we should be setting for our investment manager.
In a defined benefit world we base our funding models on certain assumptions about performance. If a manager tells us they are going to produce x per cent or x per cent above something else, then that’s what our model is based on. If we stray away from that, it creates a problem for our model. If they stray away from that, it also creates issues. It’s really important that they do what it says on the tin as opposed to anything else.
In a defined contribution world, it’s very, very similar. We should be disclosing to members what we expect from their pension savings and so there is a similar model around expected returns, expected risk, expected durations and expected costs. And if the manager strays away from that, the members aren’t going to get what they are entitled to expect to get.
One thing I slightly disagree with you on, Roger, is the foresight. I don’t want a fund manager who is going to come into a meeting and tell me ‘this is what I think is going to happen over the next 12 months’ because the only thing I do know is that they’re wrong. Nobody has got any foresight about what is going to happen - Trump, Brexit and the General Election all showed that nobody can really make a sound call. What’s more important to me – and you did allude to this – is about their structure. Do they have an infrastructure and an investment decision structure that accommodates change? As long as they have got a structure in place that anticipates that half of their calls are going to be wrong and half of their calls are going to be right, then we’ll get on just fine.
Jonathan Stapleton: So, you’ve reviewed your managers, you’ve found perhaps one manager is wanting – what’s the course of action you should take? Is it an immediate cull? Do you put them on review, a performance management plan, or is the first call to request a fee cut?
Richard Butcher: It depends on what you mean by ‘found wanting’. If there’s been something fraudulent in their system or if their charges have suddenly doubled overnight for no good reason, then it might be an immediate cull. It’s much more difficult when it comes to them straying outside of the risk corridor you’ve given them or straying outside of the investment return corridor that you’ve given them.
In those cases it’s rarely an immediate cull because there can be all sorts of reasons why they’re not within the corridor and so that’s the point at which you speak to them – asking them why this has happened, what’s going on and what they are doing about it. And your decision about retaining them or getting rid of them will depend on their response. If they’ve got a good explanation and a credible plan to get them back into the corridor, you’d probably stick with them because hiring and firing managers is rarely a good idea as you have both out of market risk and transition costs.
So if they’ve got a credible plan, you give them some time to get back into the corridor. Obviously you review their progress and, if they are failing to make progress, then you are onto the next stage. The critical thing is how long you give them.
Jonathan Stapleton: Do you have a similar approach Roger?
Roger Mattingly: Yes, I think it is hugely useful if the manager understands why they have underperformed, because if they understand then it helps us to understand as well.
On the other hand, it can sometimes be the case where we think we understand why a manager underperformed but they don’t – and it does happen, especially when managers use events such as the Brexit referendum almost as an excuse for poor performance.
It is all about getting to the reality of what’s gone wrong and then deciding whether it is something to be concerned about.
If a fund manager is underperforming because circumstances have just worked against them and going forward their particular model, philosophy and style is likely to prevail, then you would be making a fairly positive decision about staying with them. Conversely, you could argue that if a manager has performed well because of quite a lot of external circumstances, then you might challenge whether you stay with them even though the performance may have been quite sparkling.
Richard Butcher: Outperformance is actually an indicator of risk in the same way that underperformance is. Are they getting outperformance because they are taking on more risk than you want to them to? And that’s why I talk about the corridor – it’s not just a bottom-end view, there’s a top end as well. If you’re outperforming, I want to know why.
It’s not just a bottom-end view, there’s a top end as well. If you’re outperforming, I want to know why – Richard Butcher
The real challenge is how to judge what that corridor should be and the strength of their business case. As Roger said, you’ve got to look at the structural things.
Jonathan Stapleton: There have been criticisms of trustees in the past that perhaps they’re too slow to get rid of managers. Do you think that is fair?
Richard Butcher: You can be too slow; but there are also trustees who have been too quick to get rid of fund managers. When you choose a fund manager, you should spend most of your time debating what sort of investment and performance characteristics you want, investment performance, returns, costs, budget, liquidity and risk. And then a much shorter time discussing the solution.
The fund manager isn’t the be all and end all. What you are looking for is the return that they’re producing and making sure that is consistent with your objectives.
If a manager’s performance isn’t consistent with your objectives then you need to look at what is going on and to establish why they’re performing in that way. You really don’t want to do that too quickly because you incur additional cost should you get it wrong. On the other hand, you don’t want to take too long over such a decision as you could lose return or take on too much risk.
But there is an emotional attachment to most fund managers and you do have to try and break that.
Roger Mattingly: I have to say that, if they have concerns, the investment advisory community does tend to categorise investment managers as a hold, rather than a sell, probably in some cases far longer than they should do.
If they have concerns, the investment advisory community does tend to categorise investment managers as a hold, rather than a sell, probably in some cases far longer than they should do – Roger Mattingly
I think there is a serious amount of judgement involved as to when to move away from a particular fund manager – and to do that, I think you need to speak to the people making the decisions and decide whether they still have what you saw in them in the first place.
Often what is incredibly attractive on day one is enthusiasm, is confidence, is the right support structure within the firm – if those are no longer obvious and evident, then I think you do start to question whether they are capable going forward.