Independent Trustee Survey 2015: The expert view

Transcription

1 Independent Trustee Survey 2015: The expert view

2 Foreword from Calum Cooper, Head of Trustee Consulting Hello and welcome to Hymans Robertson s 2015 Independent Trustee Survey. As we all know, life never gets easier for trustees of any stripe or hue but independent trustees perhaps feel this most of all. Schemes with independent trustees appear far more likely to have clear, measurable longterm objectives. But schemes...are yet to gear up to this shift...from a balance sheet focus to managing cashflows...that s a very different mindset, and governance challenge. It s in the spirit of acknowledging the extraordinary times in which we live, that we are pleased to bring you the results of our recent survey. While non-professional trustees still fill the vast majority of seats on pension fund boards, the number of independent trustees has seen rapid growth. It is these professional trustees who hold the key to understanding the aims, expertise and characteristics of UK DB funds. Often chairing multiple trustee boards, independent trustees have a unique overview of the pension fund universe and have the technical knowledge to cut quickly to the core issues. Hymans Robertson has surveyed 23 leading professional trustees, who collectively have responsibility for over 100 schemes, to produce our first Independent Trustee Survey. Here s what we found. Schemes with independent trustees appear far more likely to have clear, measurable long-term objectives. With carefully planned milestones in place, these pension funds are in a good position to deal with the right risks in the right order. Long-term, though, the picture is not so rosy. Hymans Robertson estimates that half of the UK s DB schemes are, or soon will be paying out more than they receive. The shortfall has already hit 20bn a year and will top 100bn by But schemes, whether blessed with professional trustees or not, are yet to gear up to this shift in financial dynamic; from a balance sheet focus to managing cashflows, i.e. money in and money out. Just as companies with a strong balance sheets can be susceptible to life threatening cashflow challenges, so too can pensions schemes once they re paying out a lot more than they receive ultimately it s the ability to pay benefits that matter. And that s a very different mindset, and governance challenge. One method schemes have turned to in a bid to tackle some of their challenges is delegating responsibilities via a fiduciary manager. However, our research suggests that independent trustees typically find these arrangements more expensive than the independent advisory model, whilst being less obviously aligned with members best interests. The appeal of lightening trustees workload is strong. However, there are alternative approaches to governance that not only keep control firmly in boards hands, but boost efficiency and reaction times. I hope you find our survey interesting. We remain firmly committed to helping trustees to deliver their members promised benefits, and would be delighted to discuss any of our learnings in more detail. Calum Cooper Partner and Head of Trustee Consulting 2 1 Hymans Robertson market analysis

3 Summary of our findings As pension funds mature, it is clear new thinking is required if pension funds are to secure members benefits safely. Many factors contributing to record funding deficits may have been out of schemes hands, but the investment strategies of the last 15 years have done little to help....even boards with expert trustees have flagged the need to do more to measurably track how well they are progressing towards their goals. While the growth of independent trusteeship has professionalised decision making and helped trustee boards understand their long-term aims, the path to success is still worryingly unclear. Our research shows even boards with expert trustees have flagged the need to do more to measurably track how well they are progressing towards their goals. For decades pension fund trustees have grappled with the twin challenges of acting with the best interests of members, as well as ensuring corporate sponsors can continue to support their schemes. In recent years trustee boards have begun to turn to professional independent trustees to help them navigate their schemes to safety. Participants Hymans Robertson s Independent Trustee Survey took the pulse of 23 independent trustees with oversight of over 100 schemes. The views of five of the leading professional trusteeship firms were represented BESTrustees, Capital Cranfield, HR Trustees, PAN Group and ITS Limited. We spoke to 23 independent trustees, including representatives from five of the leading providers of independent trustees, representing over 100 defined benefit schemes, to find out how these challenges are being tackled and what more can be done. Over nine in ten (95 per cent) said non-professional trustees in the schemes they worked with knew what the long-term goal was for their scheme. And yet the combined deficit of UK DB schemes has hit nearly 1trn. There is a danger that without this measurement, schemes risks will not get managed. This is despite hundreds of schemes closing to new members and sponsors supplying around 500bn of cash injections since the turn of the millennium. Three big bets made by most funds have not paid off. Income from equity investments has been half what was predicted in 2000, while at the same time rock bottom interest rates and improving longevity have added billions to liabilities. Half (48 per cent) of those surveyed said their schemes had not established a plan which would allow them to measure whether they are on the right track to hitting their settlement goals. There is a danger that without this measurement, schemes risks will not get managed. 3

4 It s clear that professional trustees help schemes to get a grip on the many challenges they face, but our research also shows both non-professional and independent trustees need more strategic support. In last year s Trustee Barometer, we took the pulse of 100 trustees to better understand their feelings towards areas such as governance, investments and de-risking. They told us they needed real-time data on funding and risk information, greater understanding of de-risking strategies and to boost key relationships within governance structures. The single biggest challenge cited was having a clear understanding of risk and when to de-risk. In response we developed our Road to Resilience 1 to help schemes identify their key risks and strategically manage the myriad threats they face, no matter where they are on their risk journey. Context of clear and simple longterm objectives... [helps]...prioritise which areas should be tackled first. Through the Road to Resilience, trustees are able to find out what risks and opportunities are most pressing to them given the risk progress they have made such as reducing cashflow risk (having to sell assets to pay benefits at a bad time) or reducing interest rate, inflation and longevity risk via Liability Driven Investment or a bulk annuity transaction. In the context of clear and simple long-term objectives, they can then prioritise which areas should be tackled first and then set up a method of tracking their progress no matter where they are on the journey, whether the destination is an insurance solution or self-sufficiency. As well as surveying non-professional and independent trustees, we also analysed the FTSE350 to get a full picture of the market. We found schemes were in the following stages of their risk journey 2 : GROWTH 40% FTSE350 INCOME 50% FTSE350 PROTECTION 10% FTSE350 Our research shows schemes with independent trustees have a greater understanding of the journey through focusing on finding the right proportion and mix of growth assets, boosting income and finally protection against moves in interest rates, inflation and longevity. Just a quarter (26 per cent) of independent trustees said their schemes were still focused on targeting growth to close deficits, compared to 86 per cent of lay trustees. Likewise, lay trustees do not place as much emphasis on addressing capital (cashflow) risks. Just 4 per cent are at this stage where they need to evolve their strategy to navigate negative cash flow. This compares to 46 per cent of schemes where independent trustees are present. In addition, 28 per cent of independent trustees said their schemes were focused on protecting funding levels and ensuring schemes are well placed to transfer risk away. Just 9 per cent of non-professional trustees are in this more advanced position. 1 See Hymans Robertson market analysis

5 Do you think most trustee boards have a measurable plan in place to reach their ultimate goal? 48% 48% 4% Yes No Don t know The Road to Resilience explained Mile 1: Sustainability Manage cost of benefits Mile 2: Growth Take the right risks Mile 3: Income Manage capital risks Mile 4: Protection Transfer risks We asked independent trustees, of the schemes you advise, approximately how many are at each stage of the Road to Resilience? 15% 22% 39% 24% Potentially open to new members, certainly to future accrual, so the focus is managing benefit risk The scheme is closed to new members but paying benefits isn t a concern for many years, so the focus is on growth strategy Paying out more than is being received in contributions, so the focus is capital risks They have the income needed to pay the benefits for the foreseeable future, so the focus is on transfer risks 5

6 Cashflow crisis? What cashflow crisis? The vast majority of DB schemes are now closed to new members. This has helped limit the build-up of future liabilities but has created a problem many pension funds have failed to recognise. A scheme becomes cash flow negative when it is paying out more in benefits than it is receiving from members contributions. Our analysis reveals 50 per cent of the FTSE350 are, or soon will be, cashflow negative. Likewise, 45 per cent of independent trustees report schemes they advise are in this position. Yet awareness appears staggeringly low across other trustees; just 4 per cent realise the impact of demographic changes on their schemes. Currently UK funds as a whole pay out 20bn more than they receive each year and we predict this will grow five-fold to 100bn over the next 15 years as a result of 1 : the number of active members drying up; increased closures resulting from increases in cost due to low long-term returns and National Insurance costs increasing as a result of the abolition of contracting-out; waning employer appetite (and need) for deficit contributions; and pension freedoms meaning more members transferring out their benefits. 20bn shortfall now 100bn by 2030 a year A shift in focus is needed This cashflow crisis has been driven by many issues, including sponsor and regulators fixation with dealing with deficits. This has led to trustees focusing almost exclusively on monitoring funding levels, while cashflows have tended to drift into the rear view mirror. Over eight in ten (83 per cent) of independent trustees we asked said a scheme s asset to liability ratio was the starting point when setting a funding strategy. Just 4 per cent said assessing how much is going in and out of a scheme formed the basis of investment strategy. Funding levels are a logical place to begin when devising how to eliminate deficits but we believe this philosophy is now out of step with how schemes are evolving. 6 1 Hymans Robertson market analysis

7 We also asked how trustee boards split their time when considering investment strategies. Unsurprisingly two thirds (64 per cent) of trustees said they spent most time on how fund assets can be best allocated to meet the aims of growth, income and protection strategies. But while over a quarter (27 per cent) spent most of their time on protection and 9 per cent on growth, not one of the boards surveyed prioritised income. This attitude is reflected in the preferences of independent trustees, who often chair the board. Strategy based on providing income was again the least popular answer when trustees were asked what of the four options will contribute most to securing benefits promised to scheme members. Thinking about investments, what do trustees spend most time considering? 64% 9% 0% 27% Asset allocation across these areas Growth strategy Income strategy Protection strategy Steve Delo, Chief Executive, Pan Group Trustee boards don t really appreciate the cashflow challenges - and I would argue that advisers haven t been particularly good at flagging them up and/or advising on the implications. For example, with many pension funds using liquid index tracking vehicles, that have efficient pricing systems, is there any great need to restructure investments to throw off a cash yield that can be used to marry up with the outward cash flow requirements? I think there is scope to over-engineer the administrative aspects of this. Funding levels should be uppermost in trustees minds and understanding where your funding is, and what you can and can t realistically expect to achieve in investment returns, is critical to setting and adjusting a funding plan with the employer (including how negative cash flow will be dealt with). But to get a productive dialogue, the employer needs to understand the issues too. A necessary starting point to robust decision-making by trustees is properly understanding all the moving parts of the scheme s finances and getting some handle on the sensitivities in different market scenarios. This means a need for good advice that needs to be delivered by professionals whose communication skills are up to the job of empowering the lay trustee. 7

8 Simple as abc One in three (32 per cent) of independent trustees we surveyed recognise the way to combat the imbalances of what a scheme receives and spends is to focus on income generation. With 68 per cent of independent trustees saying the best way to combat negative cashflow is to focus on areas other than income generation, there could be trouble brewing. What s the scale of the cashflow challenge? To bring this to life, the following charts show a fairly typical scheme in terms of funding level and recovery plan. It contrasts the following strategies 50% equities and 50% gilts compared to 10% in equities, 70% in bonds and 20% in LDI (leveraged to produce the same level of rates and inflation hedging). Under both strategies we expect the same overall asset returns. However the charts below show the impact of equity volatility. We have assumed a 33% fall in equities over a 4 year period, followed by recovery over the next 4 years and an identical long term return. Typical scheme (50% equities, 50% gilts) Alternative structure (10% equities / 70% bonds, 20% LDI) Source: The View, Hymans Robertson Being a seller of equities during the market downturn has a very serious impact bn. 8 This illustrates very clearly that being a seller of equities during the market downturn has a very serious impact the funding level does not improve over the long term, objectives are not achieved and the company will be faced with more cash demands at each valuation. In terms there would be a deficit of c 50m at the end of the period. By contrast, the alternative strategy is largely unaffected and is in surplus at the end of the period. Scaling this up for UK DB and this 50m becomes 250bn clearly more of the same is treacherous. This is because the contractual cashflows from the bond assets (coupons and redemptions) are used to meet the income requirements we get the expected returns from those assets. And the scheme is not forced to sell its equities they are able to ride out the volatility and generate the required long term returns by avoiding being a forced seller in a downturn.

9 What can be done?...it is crucial to ensure that all cashflows can always be met without the need to sell an asset at an unsatisfactory time...that can be achieved in several ways. We believe the biggest risk for schemes in this position is being forced to sell assets at the wrong time. However, two thirds (64 per cent) of trustees said there was only a low risk to their schemes of being forced to sell assets at depressed prices to pay benefits due. Only 36 per cent thought it was a medium risk. The key issue when holding growth assets is to ensure you maximise the chances of achieving the return you expect to get. Being forced to sell in a market downturn means crystallising a poor outcome. Therefore it is crucial to ensure that all cashflows can always be met without the need to sell an asset at an unsatisfactory time. That can be achieved in several ways: rebalancing from outperforming assets as long as they have achieved the required returns; drawing income from the assets to meet the gap between cash contributions and the cashflows; or structuring the portfolio to allow contractual cashflows, such as interest and redemptions from bonds or loans, to meet a scheme s income needs. This allows the growth assets to remain invested to generate the required returns over the longer term. For instance, over the long-term, trustees may wish to consider assets such as infrastructure, timberland and farmland. For more immediate income needs, specialist high yield loans or emerging market bonds could be more appropriate. The importance of ensuring schemes are resilient to the potential adverse conditions of the future is highlighted by trustees predictions of the most significant risks. The majority (61 per cent) say interest rates staying at record lows for longer is the biggest risk to the financial health of their schemes. This is followed by a quarter (26 per cent) who are most wary of sponsor failure and 9 per cent who think a sustained fall in the growth of assets will be the major obstacle. There are effective measures available to limit the impact of each of these risks; the Road to Resilience is a good place to start to identify the most relevant and prioritise trustees efforts - see here: Hymans Robertson strongly believes an investment philosophy based around a simple ABC approach Asset Backing Cashflow will ensure schemes have the right assets, in the right mix, to deliver the cashflow needs of today and tomorrow. assets backing cashflow 9

10 The price of delegation Delegating doesn t remove work and risk; it simply changes its nature and it comes at a price. Fiduciary structures often have upwards of 40 managers, but only 4 per cent of independent trustees in our survey said 15 or more managers would be optimal. Trustees have more issues to deal with than ever before - but we find they are time-poor and often feel they lack the ability to move quickly. It is no surprise schemes have begun to explore ways to reduce the workload of trustees as well as improve the efficiency of decision-making. In recent years more schemes have decided to delegate parts of their management functions. For example, delegated consultancy and fiduciary management are common models offered to schemes by third party consultancies. However, delegation comes at a price. The majority (59 per cent) of independent trustees say fiduciary management is more expensive than independent investment advice. Of those, 29 per cent report the fiduciary route is up to 50 per cent more expensive, while 24 per cent said it is up to two times more expensive and 6 per cent said fiduciary was two to three times the cost of a traditional advisory role. For the avoidance of doubt (and accusations that we re talking our own book) Hymans Robertson does not offer a delegated fiduciary service. We believe trustees should retain control of decisions that affect their schemes and impact on members. In addition, handing over control to a third party creates potential conflicts. The firms acting as fiduciary manager may also offer investment funds, for instance. In some cases, arrangements between schemes and managers can be murky and difficult to define. Delegation may reduce trustees workload but also means an extra layer of scrutiny is required to monitor the fiduciary who has taken on a position of such responsibility. To put it another way: delegating doesn t remove work and risk; it simply changes its nature. We asked independent trustees which type of business is best placed to deliver investment advice aligned to their interests. Nine in ten (87 per cent) said independent investment consultants, one in ten (9 per cent) backed fiduciary managers and just 4 per cent said asset managers were best placed. Fiduciary structures often have upwards of 40 managers, but only 4 per cent of independent trustees in our survey said 15 or more managers would be optimal for their scheme. The most popular number of individual manager appointments was between three and five, with nearly half of trustees stating this was the optimum. 10

11 Another option...a directive consulting approach gives trustees breathing room to focus on high level strategy...[this] equips schemes so they can act quickly. In addition, 59 per cent of our respondents told us they expect a series of specialist managers working alone will deliver better investment returns, after costs, compared to a multi-asset mandate delivered by a single manager. Delegating asset management is what most schemes do, and multi manager funds have been around for a long time. Many fiduciary offerings are just that; multi manager funds in specific asset classes. The key for us is that the fiduciary responsibility remains with the trustees and we believe that trustees should continue to have intellectual skin in the game. That means retaining control through appropriate governance arrangements, while delegating asset management in the most effective way. There is another option available for trustees who feel they need something extra to support their decision making. We think a directive consulting approach gives trustees breathing room to focus on high level strategy while advisers get off the fence and make recommendations right through to taking care of implementation. This kind of relationship equips schemes so they can act quickly when the need arises. In addition, it ensures conflicts of interest cannot arise as trustees retain control and costs come in far below fully delegated services. How many separate manager appointments do you view as being optimal for your Scheme (or similar)? 13% 48% 26% 9% 4% 60% 50% 40% 30% 20% 10% 0% < > 15 11

12 How do adviser fees compare for Fiduciary Management vs. independent investment advice? 12% 29% 29% 24% 6% 35% 30% 25% 20% 15% 10% 5% 0% Less for fiduciary versus advisory Same fees for both Up to 50% more for fiduciary versus advisory 1 to 2 times multiple for fiduciary versus advisory 2-3 times multiple for fiduciary versus advisory Alan Pickering CBE, Chairman, BESTrustees Delegation is at the heart of trusteeship. Fiduciary management is used to describe many forms of delegation. Before deciding to go down this route, trustees need impartial advice. I doubt that this advice should be provided by an existing supplier if that supplier hopes to be the beneficiary of the delegation. Trustees need to decide what to delegate and to whom and to give serious consideration to the exit route should the arrangement not work out as hoped. Outcomes and value for money are more important than cost alone. Good governance should be applied to the supervision of the manager and it should never be seen as a substitute for governance. 12

13 Time and priorities Trustees have to deal with splitting their time across many tasks and it can be hard to pinpoint what to prioritise and when. Schemes with the best governance typically have knowledgeable trustee boards and focus closely on clearly defined objectives. When asked which three tasks trustees spent most time on, independent trustees told us monitoring funding levels, asset allocation, assessing risks, and governance were priorities. Assessing how well the scheme was progressing against funding targets was the most important task to 43 per cent, while 26 per cent said debating key risks and protection strategies took up most time. Assessing the fund s asset allocation and governance also ranked highly. Schemes with the best governance typically have knowledgeable trustee boards and focus closely on clearly defined objectives, independent trustees say. Interestingly, having a strong covenant or good investment managers was not seen as essential in running a successful investment strategy. No trustees ranked either of these as the most important reason for investments working well. However, when we reversed the question, one in four (26 per cent) of independent trustees told us a poor relationship with the sponsor was the main reason why their most challenging scheme was struggling. A lack of expertise on trustee boards was seen as the biggest obstacle for 30 per cent of independents. The range and breadth of answers to these questions highlights the fragmented nature of pension fund strategy. Whether schemes are targeting a fully insured settlement or aim to be self-sustained in perpetuity, they need to have a clear understanding of the risks they face and the best order to tackle them in. Breaking these down into manageable milestones is key, even for those schemes with the benefit of a professional trustee at the helm. We hope you find the Road to Resilience useful in your role supporting UK schemes put themselves on a surer footing. Keeping a close watch on a scheme s progress through the principles and milestones we have developed is a good place to start. 13

14 Conclusions This project would not have been possible without the many respondents and contributors. Our aim is to improve the collective understanding of the pensions community and improve the security of UK DB pensioners benefits....the time to ensure schemes are resilient in the face of impending cashflow hunger is now. We thank our independent trustees expert whose input as made this possible. We found both the results and the process of conducting the survey fascinating and insightful and we hope you ve found enlightening. As we worked through the process, we were struck by two main things. Firstly, it s clear to us that the use of professional, independent trustees does appear to enhance scheme governance. That sounds like an obvious conclusion, but it s an important one for schemes who may be considering whether to invest in the services of professional trustees. In addition, our findings show schemes with professional trustees are typically better prepared to tackle the many challenges facing DB schemes. Secondly, though, we were concerned to find that even professional trustees were not placing enough focus (in our view) on cashflow management of the schemes they re involved with. Funding levels are vital but cashflow and income management is also crucial, and deserves more attention. The fact that many respondents to our survey didn t highly rank the need to focus on income and cashflow requirements to drive strategy is, we believe, a cause for concern. With an unprecedented set of pressures and challenges facing schemes, it s no surprise that the most urgent problems get dealt with first. However, we think the time to ensure schemes are resilient in the face of impending cashflow hunger is now. If there is demand from professional trustees we will repeat this survey annually, so we d love to hear your feedback. Get in touch For more information or to have a chat, please feel free to give us a call: Calum Cooper Partner and Head of Trustee Consulting T E John Walbaum Head of Investment Consultancy T E 14

15 About Hymans Robertson Partnering clients of every shape and size Trustees choose Hymans Robertson for our tailored advice and personal service. We ve seen most things, having been in business for nearly 100 years and advising over 180bn of assets. Our client list is representative of the UK pensions market as a whole. This means we have experience of looking after schemes of all shapes and sizes. Experts in every sector We don t limit ourselves to a single sector. We work with the pension schemes of over 40% of the FTSE350, privately owned businesses, not-for-profit and close-to-government bodies, plus the subsidiaries of overseas parents. Whatever your industry or the nature of your business, our experts will bring you insights born from experience. Thinking long-term It s not the size of our client relationships that matters to us; it s their longevity. We work most effectively with clients who think like us: long-term. Whether you re a 50m+ fund looking for cost-effective full-service support or a 5bn+ fund searching for niche expertise, we ll put together the right team so you get what you need for your scheme. 15

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