Panel discussion with Will Goodhart, Chair; Sarah Smart, Chair of trustees, the Pensions Trust; Aaron Meder, CFA, Head of investment, Legal & General Investment Management; Diana Mackay, Joint-chief executive officer, MacKay Williams; Robert Gardner, Co-chief executive officer, Redington Seb Dovey, Managing partner, Scorpio Partnership
WILL GOODHART: How, in your view does the investment profession serves its beneficiaries, and how could it do that better?
SARAH SMART: When I worked in fund management we were delivering quite a sizeable billion pound LDI absolute return mandate for a client, and one of my colleagues said. ‘This is a combination effort we are trying to do here in terms of the consultant helping the client understand what their objectives should be and us delivering that.
Do you think it matters that what the consultant is doing isn’t right, as long as we are doing what the consultant tells us to do?’ And I said yes! From the client’s point of view, if what they are getting doesn’t work, they aren’t going to care whose fault it is, they are just going to see the fact that what they are getting is not working for them and they will assume that everyone involved is at fault.
Understanding the client’s needs in totality, not just your part of it, is very important, and the investment profession has a real duty to make sure that other parts of delivering the client’s needs in totality are working as well. It’s not just about returns. As a chair of a big pension scheme I have to sign a statement every year to say I am getting value for money for my clients and trying to get information from fund managers to help me sign that statement is a bit like getting blood out of stone so I’m obviously going to favour the suppliers that make my job a bit easier.
AARON MEDER: There is a gap between clients, the asset owners and beneficiaries, in terms of how they define success, and how the asset manager defines success. One example that I see happen all the time is where there is a [scenario of a] pension fund which hires a fund manager to run a corporate bond portfolio actively against a market index. Imagine a situation where that market index has a 3% issuer concentration in one particular issuer, and we run into a period of economic distress.
That fund manager would sit there and say my benchmark is the market index, so I should be holding 3% if I have no view, but I’m worried now about this particular issuer defaulting. What they might do is instead of holding 3% is that they might hold 2% in that bond, which is a sensible thing in the context. Let’s say that issuer actually defaults. At the next quarterly performance review, the fund manager will walk in with a presentation, and the first page will cover performance.
They will have outperformed the market benchmark by 1% because they will have held 1% less of the bond that defaulted. The client will look at that and say, actually, relative to my liabilities, which don’t have default risk, the fact that you were at 2% still isn’t good because I’ve lost 2% of my assets and I’m 2% short on my liability benchmark. So you’re in a situation where the fund manager and the beneficiaries are defining success so differently in that situation, which is a great example of maybe why we are not a profession at this point at time.
The question is what we should do about it. Three things need to happen. One is cultural, all the way at the top of the organisation, if you look at the mission statement, and if you look at the purpose, if that isn’t more closely aligned, applying that investment excellence to meet client need as opposed to market benchmark, if that isn’t front and centre with the organisation, it isn’t going to allow the organisation to change the product strategy to one that is more aligned to delivering client needs.
A second point would be that you need more people to get closer to clients. You need people who understand the total portfolio context and can engage with clients. The third bit would be around infrastructure and technology. We need to make sure we make the appropriate investments to do this in a scalable way.
WILL GOODHART: Thank you. While we’re on institutions, do you want to jump in Robert?
ROBERT GARDNER: If you take the FTSE 350 in the UK, over the last ten years FTSE 350 companies have paid in £500 billion into pension funds. And yet in 2015 the deficit on a buyout basis was £900 billion. That’s three times bigger than it was 15 years, ago, so we have an asset and liability problem in the UK. That’s in a DB context. If you go to a global scale, Citigroup did a report that said that the unfunded liabilities in the world are $78 trillion dollars. Versus debt of $44 trillion.
In the DC world, how well does your DC communicate to you as a member. Do you actually understand what your pension would do for you, and what it will deliver in retirement? Do you know what’s in your default funds? We are at an inflection point in the UK because DB is dead or dying, and those fortunate to have it are in a great position. The world of DC needs us to be saving more. If you aren’t saving 15%, the chances are you won’t be retiring comfortably. In DC we have a long way to go.
There is a disconnect between the investment management industry, and their consumers. They don’t know who their consumers are. They can tell you about the Sharpe ratio and this bond and that bond, but if you ask them to tell you about their clients, they can’t…article continued in the Summer 2016 issue of Professional Investor [login required].