To run these smaller sums in segregated accounts creates workload problems for investment managers as they attempt to risk- manage each individual client, observe different benchmarks, and adhere to different mandate constraints such as those imposed by ethical investments. If a pension scheme asks a manager to invest £50m on a segregated basis in Indian equities, the manager – who may be more accustomed to running no less than £100m in a segregated account – might view a small mandate like this as a distraction.
It could help everyone, therefore, if pension funds got comfortable with pooling their investments into funds.
This would be easier for some than for others. Investors’ attitudes about pooled funds vary across Europe. In the UK, large pension schemes in particular are accustomed to a segregated service. However, managers and consultants indicate that attitudes are changing, albeit slowly, and a greater acceptance of pooled funds is emerging in line with pension funds in France and Germany where pooling is more common.
Rob Barrett, head of institutional sales at HSBC Global Asset Management, says: “There is a move by pension funds in the UK towards pooled funds from segregated mandates. Corporate pension funds are moving faster, while local authority schemes are moving with less speed.”
Gavin Orpin, partner at Lane Clark & Peacock (LCP), a UK pension fund consultancy, says: “There has been a move to pooled arrangements across the board because of the increasing complexity of vehicles used by pension funds, such as hedge funds. You would have to be a big scheme to set up a segregated hedge fund mandate.”
Phil Barker, head of European business development at Standard Life Investments, says: “We had a couple of occasions last year where institutions invested for the first time in a pooled vehicle with sums of €40m-€50m. The cost and ease arguments swayed them. As clients look to spread more money across different sectors, pooled funds become more popular.”
Client research by Greenwich Associates into European pension schemes showed that in 2007, 30% of externally invested money went into segregated mandates.
But the figure dropped to 25% in 2008. However, the slack was not taken up by pooled investments, which stood at 11% in both years. What had happened is that pension schemes had taken segregated money in-house.
But the research indicated a vast difference in attitudes between countries about pooled investments. Belgium had 80% of its business in segregated mandates, but the reverse was true for Austria. It could be the case that fund managers in Belgium are prepared to run segregated mandates for lower amounts of money than elsewhere. Greenwich said it would not comment on a client report.
Nilgosc, which administers the Northern Ireland local government pension scheme, forbids its active managers to invest in pooled funds. “We have it in our investment mandate agreements with active managers that they will not invest in pooled funds” says Deane Morrice, secretary to the fund.
“Pooled funds are usually hard to get out of. Around ten years ago we replaced a manager and found it took six months to get out of their pooled funds and, of course, you can lose money in the meantime.
“In segregated mandates it is a lot easier to buy and sell your investments.”
Morrice also says pooled fund fees can be less transparent. “However, I can see the advantages of pooled funds if a pension scheme is entering a new or specialist market. Emerging markets is a good example of where it would be better to begin with a pooled fund until building up to, say, £150m (€168m) before looking for an active manager if the market does well. We have thought of doing this. We currently have an emerging markets passive pooled fund and when we see markets stabilise, we may then tender for an active manager.”
Nilgosc, which has around £3.1bn in assets under management, currently has 37% of its scheme invested in pooled funds on a passive basis. There are a number of index pooled funds with L&G Investment Management, covering emerging markets, global and UK equities, and bonds.
On top of the pooled segment the scheme uses active managers to try and outperform benchmarks.
“The minimum we give to active managers is £150m, and usually more like £200-£250m,” says Morrice.
John Belgrove, principal in the global investment practice at pensions adviser Hewitt Associates, says: “Local authority pension schemes have certain regulations that limit them having too much exposure to a pooled fund. For example, exposure to life policies with a single provider is limited to 35%. But local authorities can still have a fully diversified approach, even if they are only mid-size. Local authorities are very concerned about transparency and segregated mandates offer them greater transparency.”
Barrett, of HSBC, says: “Since the Robert Maxwell pension scandal, people have put more and more controls in their investment activities and segregated mandates are very bespoke. A scheme might not want to invest in a particular company or sector, for example. But in a pooled fund you have to default to whatever the manager’s position is.
“Local authorities do a large amount of due diligence. Everything they do is in the public eye and so everything has to be right. Local authorities have to hire more and more people to know that their assets are safe. But pooled funds under Ucits III are well regulated and this means a risk manager is not needed.”
He adds: “I think it will happen that local authorities move across to pooled vehicles.”
One driving force for pooled vehicles is liability-driven investment (LDI).
Geoff Cook, global head of fund administration at BBH & Co, says: “Liability-led investing has also driven the development of pooled vehicles. To drive economies of scale LDI strategies have been put into fund wrappers. This helps investment managers because it is easier to obtain pricing and leads to lower fixed costs.”
He adds: “Conversations about these with UK local authorities are emerging.”
Orpin, of LCP, says: “Within LDI, a pension fund can get access to a greater range of swap counterparties through a pooled arrangement. In a segregated mandate this is likely to be more concentrated.”
An LDI strategy entails a fund entering into long-term swaps agreements. The fund generally wants the best price on a particular day and this is likely to be offered by only one bank, meaning swap arrangements can often be concentrated. With a pooled arrangement there is more flexibility, since the trades are done on a number of different days as and when different clients enter the funds.
Orpin adds: “Also, an ISDA agreement for a segregated mandate could require five to ten agreements within it for each bank it may want to deal with, creating a documentation issue. But in a pooled fund the manager looks after all this for you.
“Further, it is not a good idea to have all your swaps with one bank because of counterparty risk.”
Orpin says that in general he finds clients are very receptive to pooled funds. But a disadvantage for them is that they cannot use a global custodian for the entire pension scheme. Each pooled fund will have its own custodian selected by the fund manager.
Nevertheless, LCP does have a large client of around £1bn that is 100% invested in pooled funds. The client did this in order to reduce unrewarded risk, to diversify its arrangements and to implement its strategy more efficiently, says Orpin.
Pooled funds offer investment managers the opportunity to gain from economies of scale, but managers say they would not actively try to persuade pension funds to choose the pooled route.
Ominder Dhillon, UK head of institutional sales at Scottish Widows Investment Partnership (Swip), says: “If we have a pooled fund that meets the client’s specifications then we will cover this when we pitch for business, but we leave the choice of pooled versus segregated to the client. The fees charged would reflect their choice.
“The minimum investment that we accept for a segregated mandate varies by asset class. Generally you’ll find for equities that as little as £50m would be accepted, while for bonds £100m is more common.
“Having said that we have clients with £100m that have gone into pooled funds because the fund does what they are looking for and they don’t lose out in terms of service.”
“Pooled funds can be 10-20% cheaper, but it depends on the mandate,” adds Dhillon.
But for products with capacity constraints like emerging markets, there would be no price difference.
Barker, at SLI, says he typically sees £100m-plus going into segregated accounts. Barker adds that SLI is seeing demand for pooled vehicles increasing from European banks.
“The banks look for segregated mandates and pooled funds for different parts of their organisation. Their starting point is always the process. If they like the process then they look at the type of wrapper. They might look for a combined mandate, whereby they want a segregated account with a specific benchmark, but if they like the manager they might then invest funds from another part of the bank, such as a fund-of-funds product, in a pooled fund.”
Benchmarks are a barrier to moving from segregated to pooled funds.
Dhillon, at Swip, says: “Historically pension schemes in continental Europe were far more likely to invest in pooled funds rather than segregated mandates. In the UK it tends to be larger schemes that invest in separate accounts, but an increasing number of pension funds are more willing to invest in pooled funds if they are of the right size and right benchmark.”
Barrett, of HSBC, says: “It can be difficult to get the right benchmark, but specialisation has seen a proliferation in benchmarks and a consultant can construct a portfolio that should match a fund’s overall benchmark.”
Pooled funds also offer bargaining power. They give clout to investors in disagreements with managers, as has been seen with certain money market funds found to be invested in asset-backed securities.
But despite their advantages, in the UK at least, vendors still have some persuading to do.
Morrice, at Nilgosc, remains overall sceptical. “Right now I think there are many managers who are worried about picking the wrong shares. They might prefer to put investors’ money into a pooled fund so that they benefit from a greater range of shares, so that those that underperform will hopefully be compensated for by those that do perform well.”
But he adds: “If the managers invest directly in segregated shares they have a greater risk of underperformance and therefore, in my opinion, with the ongoing uncertainty of current markets it is a less risky and safer option to invest in pooled funds at present.” ©2009 Funds Europe