Fiduciary management within DC pensions is on the rise as more and more schemes take an interest in the model. Fiona Rintoul reports.
Fiduciary management has long been a familiar concept for defined benefit (DB) pension schemes. Today, it is also a possible solution for defined contribution (DC) pensions schemes, and several providers have entered the market.
“Fiduciary managers are turning their attention to DC, and how best they can bring the good work they’ve done for DB schemes to DC,” says Niall Alexander, head of DC at River and Mercantile Solutions. “This in turn has created a market, meaning the interest in fiduciary management has snowballed.”
Some of these providers of fiduciary management for DC schemes are asset managers, while some are investment consultants, sometimes working with asset managers. Aon Hewitt, for example, launched a DC fiduciary management service in 2014 with an investment platform provided by BlackRock.
So, how widespread is the practice in Europe? Well, there has been considerable uptake of fiduciary management solutions by DC schemes, but the market remains small compared to DB, according to Keira-Marie Ramnath, head of fiduciary management oversight and selection at PwC UK.
Variation across Europe is also marked.
“The different European countries are at different stages, because they all had different starting points,” says Paul Boerboom, founding partner of Avida International, an institutional asset management advisory service.
The Netherlands has moved from DB to hybrid and is proceeding – not without difficulty – towards DC. In France, first-pillar state provision is still important. In Germany, many companies still have pensions liabilities on their balance sheets, and there is a plethora of long-established specialist pension savings vehicles such as Pensionskassen and Spezialfonds. Collective defined contribution (CDC) pension schemes are used in the Netherlands and Denmark, and the UK government has signalled its intention to legislate to allow CDC benefit provision too.
“Not a pure fiduciary”
When assessing the size of the market for DC fiduciary management solutions, there are also questions of definition to address. Group personal pension plans and master trust strategies themselves represent a fiduciary management approach but have never been considered “pure DC fiduciary management”, observes Alexander.
“These arrangements are built for the mass market, so are unlikely to effectively reflect the needs of individual schemes,” he says. “But DC fiduciary management within single employer trusts is definitely on the rise, with more and more schemes taking an interest.”
Whatever the current pace of development of DC pension provision in individual countries, an ageing population in Europe means that DC is assuredly the future. With the responsibility for retirement provision thrust on to the individual, good investment outcomes at a reasonable price are essential if the system is to function. A well-constructed fiduciary management solution can help to make this objective a reality.
“A collective approach provides better access to investment opportunities at a better price, particularly in the alternatives sector,” says Boerboom.
In this way, DC schemes can try to work towards mirroring the sophistication of DB schemes. Right now, the asset allocation within DC schemes is typically much simpler and less variegated than that of DB schemes, potentially putting future pensioners at a disadvantage.
“On the DC side, you’ve got lifestyling and greater flexibility in terms of lifestyling, but in terms of the make-up of the underlying asset allocation, there is much more use of more expensive alternative-type strategies on the DB side,” says Ramnath.
However, increasing levels of competition and more asset managers entering the DC fiduciary management market are leading to innovation around products and ways of setting up the asset allocation. This is becoming more necessary with each passing moment, as investment products become more complex and various, with even the passive universe now encompassing a wide variety of tilts and strategies that require a view.
“It’s about the principle of what they are trying to achieve,” says Ramnath. “The investment market is more complex and there’s a lot more variety out there, so schemes need help with structuring.”
In her view, help navigating that complexity plus bargaining power are the main reasons for a DC scheme to opt for a fiduciary management solution. And if there has sometimes been criticism of the way fiduciary management is delivered for DC schemes, that is perhaps because the link between managing the assets and what members need – a certain level of income in retirement or an income threshold – has been lost.
“Successful fiduciary management in DC is bringing that link back by developing an investment strategy that, given the scheme’s contribution rates, delivers on members’ needs, after fees,” says Alexander.
When deciding if fiduciary management is the right way to achieve a more sophisticated and potentially higher-yielding strategy, much depends on the size of the scheme, says Boerboom. Fiduciary management is a good solution for schemes with €5 billion or less under management. Above that, schemes can organise the asset allocation themselves and avoid an extra layer of fees.
Costs and decent margins
Cost is a consideration. In a 2015 DB fiduciary management survey by Aon Hewitt, 62% of respondents saw cost as a disadvantage. And there is a flipside to that equation too.
“My concern is whether providers can make a decent margin out of this,” says Boerboom.
This is especially true of providers that aim to offer a pan-European solution. A complex brew of legacy systems and country-specific regulations makes this a tough task, though Boerboom says that a handful of providers have developed very good pan-European products.
Another reason that DC scheme providers may opt for a fiduciary management solution is to allow them to spend more time on strategic issues, such as how best to define and meet member needs, and on other aspects of DC provision, such as communications strategy. It is perhaps easy to underestimate the importance of the latter, but in DC, effective communication with scheme members is almost as important an effective investment strategy.
“Communications and investment strategy are the two key components in DC,” says Alexander. “Communications has long driven engagement, and investment strategy drives the outcome for members. DC fiduciary management allows schemes to spend more time on communications to drive engagement, without sacrificing the outcomes for unengaged members.”
Digitalisation plays a role here. As Nicolas Hubé, director of global benefits at Johnson & Johnson, noted in a recent interview, the digital revolution completely changes how we access information and how we perform transactions. DC pensions are part of that revolution.
“Like any other employee benefits, retirement benefits, local or cross-border, must adapt in both design and delivery,” says Hubé. “Digitalisation opens the door to more flexible approaches that give employees more choices.”
In the individual DC world in particular, robo-advisers could help with portfolio implementation.
“A lot of research is going into that,” says Boerboom. “Robo-advisers could make things more cost-efficient.”
The drive towards environmental, social and governance (ESG) investing is another important market-wide trend. Boerboom says: “People are looking for green solutions. Europe-wide, offering green, environmentally friendly DC is a way for fiduciary managers to differentiate themselves.”
When considering the future of fiduciary management, it is also important to look at the bigger rewards and compensation picture. Here in Europe, we can learn lessons from more developed markets such as Australia, says Ramnath.
“The workforce is becoming a lot more mobile. That requires increased flexibility in the way we structure benefits.”
In fact, in 30-40 years’ time, with people working longer and in a more flexible way, there may be no pensions at all in the traditional sense, Ramnath says. Instead, people may simply buy some form of insurance, such as morbidity insurance.
Underlying these developments is a move towards greater individual choice, and this presents a clear need for one thing: education. Experience to date, such as with 401k in the US, suggests that individuals typically don’t make good decisions when it comes to investing their pensions pot. That has the potential to become a social issue, and Boerboom therefore sees a big role for government in solving the problem.
“People need to be made more financially literate,” he says. “That’s an important part of the fiduciary management offering.”
And it’s not just individual savers who need education. Employers and other scheme providers may not be as well informed as they could be either. After all, as Boerboom notes, DB is in the DNA in many European countries, and this is all new.
“Our main challenge is a lack of awareness,” says Alexander. “While we have been doing DC fiduciary management for many years, many schemes are still unaware that this is a viable solution to better improving members’ engagement and outcomes.”
As the market develops, Ramnath sees more providers coming in. Some are recognisable names from the asset management side, while others are more boutique managers. But all may face the problem identified by Boerboom: fiduciary management for DC pension schemes is labour-intensive and requires skill, but may not be particularly profitable.
“It’s a low-margin business,” he says.
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