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1 I N T E R N A T I O N A L I N S I G H T Paving the way for pension pooling Angela Docherty, senior corporate investment consultant at Unilever plc, discusses the creation of Univest, the company s new cross-border pooling vehicle. Other multinationals are likely to follow this innovative model Why did Unilever adopt tax-transparent crossborder pooling? Consider the structure of our plans worldwide. We are in 42 countries of which 25 have non-domestic assets and they range in size from the UK plan, which is about 6bn now, down to our smallest plan which is less than a million. We are trying to ensure that they all get the best quality investment managers for adding long-term value in a riskcontrolled manner. A preferred provider list does not always offer this because you buy strength and weakness at the same time. Managers that are exceptionally good in one region are not always the best in another. So we wanted something that would allow us to utilise best-in-class managers in every region. Angela Docherty was a driving force behind Univest, the first fully tax-transparent cross-border pension pooling vehicle established for a multinational in the form of a Luxembourgdomiciled Fonds Commun de Placement. It was launched in December Why was pooling the best way to do that? If you look at the range of funds, beyond our two largest funds most of our individual pension plans do not have sufficient assets to develop a sophisticated multi-manager structure themselves. If you are only putting, say, 300m into global equities, to try and replicate what we have done with 14 managers and 22 mandates is extremely difficult. But if you centralise, you get critical mass and will be taken seriously by the investment managers. What made it possible to do this? This would not be possible if the tax authorities were not able to look through the pooling vehicle and tax all of the ultimate holders, the individual Unilever pension plans, according to the tax rates that apply to their countries of origin. Without this you would lose the benefit of double taxation treaties and pooling would not be tax efficient. So the skill that made this all possible was the ability to design an accounting system that page 2 Dutch office opening event a strategic milestone Northern Trust chairman William A. Osborn and over 100 guests marked the opening of the company s Amsterdam office and heard speakers including the deputy director of the Dutch Central Bank. page 5 Don t use VWAP to measure transition management costs Looking at the volume-weighted average price of securities traded is popular, but it over emphasises the efficiency of trades, and overlooks a transition s impact on a portfolio s economic value. page 4 Also inside Private equity record.. 2 Northern Trust committed to extending services globally. Three awards won Northern Trust recognised for the high quality of its services. Issue 3 Spring 2006 Tracking innovation in asset servicing

2 Analysis 2 International Insight Spring 2006 Paving the way for pension pooling page 1 could manage tax transparency. Northern Trust had to enhance its accounting system in order to be able to identify which assets belong to which unit holder. I need to be able to say unit holder one owns 40% of every stock and unit holder two owns 20%, and so on. How did you develop such an innovative structure? We had been interested in the idea for some time, and in 2001 formed a research consortium with Goldman Sachs Asset Management, Northern Trust, Mercer Investment Consulting and one other multinational. By 2002 we had concluded that Luxembourg Fonds Commun de Placement (FCPs) offered the tax transparency we needed. We then discussed the matter with the trustee boards, and in 2004 our two largest pension plans the Netherlands and the UK decided to go ahead. These two funds represent 55% of our asset base, and provided the critical mass we needed. We got approval for the legal documentation from the Commission de Surveillance de Secteur Financier (CSSF) Luxembourg regulator in November The assets went in on 8 December. That is 2.3bn in five regional sub-classes in developed markets. The emerging market subfund launched in February 2006 and comprised another 200m. Is this all of the Unilever pension plans assets? No. The UK pension fund so far has committed roughly 1.25bn out of a 6.5bn plan, and the Dutch plan has Northern Trust was willing to work with us to develop the solutions to deliver and manage the pooled vehicle committed 1.25bn out of a 3.7bn plan. We are now talking to the next ten pension plans, most of which have made a commitment, and we are solving tax and regulatory issues around them investing. Initially, the plans equities investments are going in the vehicle. Phase II Angela Docherty joined Unilever plc in November 1996 and is senior corporate investment consultant in corporate pensions. She focuses on designing the corporate investment policy and has responsibility for selecting preferred investment management and custody providers. Previously, she was director of marketing and a consultant for Stamford Associates (UK) Limited, which she joined in January Before that, she spent 15 years with The WM Company. Angela advises the Leverhulme Trust on investment matters and is a member of the Investment Committee of the United Nations Relief and Works Agency. She also runs a small charity (New Ways), which supports health and education projects, predominantly in Kenya. of Univest from an investment point of view is to look at alternatives and bonds. What decisions does the investment committee make? The Univest prospectus shows the return target and the risk target for each sub-fund and we select managers that 2005 a record year for private equity fund raising Northern Trust to extend support in the sector Delegates at this year s Super- Return private equity conference, held February in Frankfurt, heard how 2005 was a record year for private equity fund raising. According to the European Venture Capital Association s preliminary estimate, 60 billion was raised in Europe alone, more than twice 2004 s 27.5 billion. This explosive growth reinforces the importance of our considerable commitment to private equity, says Sue Baines, business development manager, Global Fund Services. We have already extended our administration centres for general partners from Guernsey to Dublin and plan to roll-out further locations globally. In addition, we will be introducing Michael Mandahl of Nexit Venture receives his prize from Allan Nedergaard, Northern Trust s head of Nordic sales new services in The bank is also canvassing the requirements of limited partners in Europe, with the intention of providing specialist custody, supporting cash flow drawdowns. Northern Trust is one of the world s largest offshore private equity fund administrators. The bank sponsored a stand at SuperReturn, taking the opportunity to discuss with clients its plans to broaden support and develop new services for the private equity industry. The winner of our ipod prize draw was Michael Mandahl of Nexit Ventures, a Stockholm-based venture capital firm.

3 Analysis 3 International Insight Spring 2006 we believe will deliver on both those requirements. Mercers does the primary research; the due diligence is carried out by the manager evaluation committee, which comprises the chief investment officers of the two largest funds, myself and the head of Unilever Corporate Pensions. We make recommendations to the investment committee with regard to all issues. What are the benefits of this for the individual plans? It is important to emphasise that this is a partnership with the trustees. We firmly believe a primary responsibility of the trustees is strategy, and this is what really determines whether you can meet your pensions promise. Getting strategy right is 90% of the outcome implementation, picking the managers, is only about 10%. We are offering simplified implementation solutions carried out by Unilever investment professionals. Do you think others will follow your example? The nature of the multinational is critical. One of the reasons this works for Unilever is that we have so many different countries and we are not dominated by a US pension plan. Generally, multinationals have been simplifying pension plan structures for 10 years and pooling is a natural progression. Why did you choose Northern Trust? When we started the consortium, Northern Trust had been a preferred custody supplier since 1997 and had custody of over 60% of our assets. We talked to several custodians but found that Northern Trust was more openminded and recognised that Unilever was potentially leading edge. When we selected Northern Trust to manage Univest in 2003, we were confident it had designed an accounting system that allowed it to remit withholding tax at the pension fund level. The ability to offer an accounting system that can identify, at a very detailed level, what assets are being held by which beneficial owner is critical. Without this you cannot deliver the level of transparency required. Northern Trust was willing to work with us in partnership to develop the solutions to deliver and manage the pooled vehicle. How else did Northern Trust help with the creation of the plan? I would add that Northern Trust successfully lobbied the Luxembourg Minister of the Treasury, Luc Frieden, to abolish the country s 0.01% subscription tax. This ensured the FCP vehicle in Luxembourg was competitive especially in regard to the recently created Irish Common Contractual Fund. Three awards crown landmark year Northern Trust s focus on excellence secures wins Northern Trust won three prestigious awards in the first quarter of 2006, recognising the quality of its custody services globally, its focus on excellent client service and awareness of clients needs for increasingly sophisticated and robust services. Best global custodian Global Pensions magazine named Northern Trust Custodian of the Year for 2005 at its annual awards event held on 23 January at London s Gibson Hall and attended by 500 senior financial services industry delegates. A panel of 16 judges representing major pension funds and custodians from across the globe selected Northern Trust from a short-list. In February, Northern Trust was awarded Best Global Custodian in Asia Pacific by Asia Asset Management magazine and European Pension Fund Custodian of the Year by International Custody and Fund Administration magazine. This was the third consecutive year Northern Trust had won the award in Europe. Landmark year These awards came at the end of a landmark year in which Northern Trust launched tax-transparent, cross-border asset pooling vehicles for multinational pension fund clients, re-launched its global Passport client reporting system and completed the acquisition of Baring Financial Services Group. Hold the dates 8 June Nordic conference, Radisson SAS Royal Hotel, Helsinki; 22 June client party, Victoria and Albert museum, London.

4 Analysis 4 International Insight Spring 2006 Northern trust global investments Trade evaluation debate VWAP is popular but it does not measure total cost of a trade With investment managers focused as never before on how to maximise performance in an environment of low expected equity markets returns, the costs of transition management have come under the spotlight. Yet, approached in the wrong way, this emphasis on transition management actually destroys any incentive to manage a transition in a way that maximises economic value. Transition management is often used when a pension fund switches managers. The pension fund s holdings would then change from the outgoing manager s model portfolio to the incoming manager s. Recent years have seen big advances in how this is done. Even so, some market participants are choosing to adopt a simple approach looking at the volume-weighted average price (VWAP) of the securities traded over the duration of the transaction. This emphasises efficiency of trading but overlooks the impact on a portfolio s economic value. Disadvantages of VWAP For many, VWAP becomes an easily understood way of bringing transparency to transition management and the benchmark against which to measure the actual prices achieved. But using VWAP as a benchmark does nothing to encourage transition managers to maximise economic value. Grant Johnsey With VWAP, even if you make a bad trade you won t be more than a few basis points adrift Instead, transition managers have an incentive simply to execute their trades in line with market trading volumes. This is relatively easily achieved with today s order management software. Investment advisers and broker dealers like VWAP because even if you execute a bad trade you will not be more than a few basis points adrift, says Grant Johnsey, a Chicago-based senior strategist in transition management. Pension plan sponsors like it because it is a simple way of seeing that their trades are executed near the market average that day. VWAP does not take into account implementation costs beyond commissions, taxes and bid-offer spreads. Indirect costs, such as the impact of the transition on market prices and the lost opportunity cost, are as important. Implementation shortfall By contrast, the implementation shortfall method does include these costs. This method makes the target portfolio the benchmark. The transition manager estimates the performance shortfall between this benchmark and the portfolio in transition over the time of the transition. The success of the transition is then judged against this estimate. This encourages the transition manager to safeguard economic value through, for example, using derivatives to move market exposures into line with the target immediately and minimising the market impact of trading. Simon Hutchinson, London-based strategist in transition management concludes: With VWAP you are just trading in line with market volumes. Implementation shortfall encourages you to minimise costs and risks with a view to where you want to get to. l This article is issued by Northern Trust Global Investments Limited (NTGIL). Opinions expressed herein are subject to change at any time without notice. NTGIL is authorised and regulated by the Financial Services Authority in the United Kingdom. Registered office: 50 Bank Street, London E14 5NT. Registered in England This newsletter is issued by The Northern Trust Company (TNTC) and Northern Trust Global Services Ltd (NTGS). TNTC and NTGS are authorised and regulated by the Financial Services Authority in the United Kingdom. Registered office: 50 Bank Street, London E14 5NT. TNTC is registered as a branch in the United Kingdom, branch number BR and NTGS is registered in England IRS Circular 230 Notice To the extent that this newsletter concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. For more information about this notice, see This material is directed to market counterparties and intermediate investors and should not be relied upon by private investors.

5 News 5 International Insight Spring 2006 Key strategic move as Northern Trust opens in the Netherlands New office takes relationship managers closer to growing client base Rick Waddell Chief operating officer and head of Corporate and Institutional Services Outlook Northern Trust marked the opening of its Amsterdam branch on 21st March with a special evening event held at the Heineken brewery in central Amsterdam. Over 100 guests from the Dutch financial services community joined Northern Trust representatives, including Northern Trust chairman and chief executive, William A. Osborn, in celebrating this strategic milestone for the bank. Guest speakers Dr Willem Vermeend, a former secretary of state for finance, and Sierd de Wilde, deputy director of the Dutch Central Bank, provided lively and insightful commentary on the Dutch financial services industry and local economic conditions. Expansion across Europe Located in the World Trade Centre, Amsterdam, the new office represents a key step in Northern Trust s expansion plans across Europe and enables the bank to provide enhanced local support for its clients. The office will be staffed mainly by relationship management and business development personnel, with full account management support provided by Dutch-speaking professionals from Northern Trust s London We wanted to get closer to our Dutch clients so that we could enhance our understanding of their needs Contact Northern Trust For further information on any issues covered in this newsletter, please contact: Opening ceremony: Bill Osborn, chairman of Northern Trust, cuts the tape, as branch manager Paul Cutts (left) and Sierd de Wilde of the Dutch Central Bank look on office, located close to the bank s global operations teams. The Netherlands is a key market for Northern Trust and one in which we have been active for many years, says Paul Cutts, managing director of the new office. We have always serviced our Dutch clients well but we wanted to get closer to them so that we could enhance our understanding of their needs and the local market. Northern Trust already has a strong client base in the Netherlands, having serviced Dutch clients since The bank provides services to more than 25 pension funds, insurance companies and asset managers. Services include global custody, fund administration, risk management and foreign exchange, as well as other innovative solutions, such as tax-transparent cross-border pooling. A suite of asset management capabilities help institutional investors to boost revenue generation and enhance their asset management arrangements. Penelope Biggs, global head of business development, C&IS: penelope_biggs@ ntrs.com, tel: +44 (0) Hedge funds face alternative decision Appetite for investing in alternative assets remains high. Hedge fund exposure, in particular, shows no sign of abating, but recent research commissioned by Northern Trust has uncovered some interesting trends in this area of alternative investment. Our latest paper, The Forced Institutionalisation of the Hedge Fund Industry, published in May, looks at the consequences of institutionalisation on both investors and managers, focusing on regulation and standardisation, institutional asset allocation and administration. Hedge fund industry will split One key finding was that the industry is moving towards a split, with managers needing to choose their client focus between the traditional source of hedge fund assets (wealth management), and the higher volumes generated by institutional business providing, of course, firms have the necessary capabilities. There is concern that institutionalisation of the industry will saturate market capacity, reduce hedge fund managers opportunities and ultimately impact on performance. Furthermore, the increasing interest in other alternatives, such as private equity and real estate, will add to the pressure on hedge funds. From an administration standpoint, the fundamental requirement is to get the basics right that is something we never forget the importance of at Northern Trust.

6 Analysis 6 International Insight Spring 2006 Global Fund Focus is written and designed by The Clerkenwell Consultancy In the Netherlands, new pension legislation is starting a revolution in investment objectives. Regulations are forcing pension funds to measure performance primarily against the ability to meet liabilities on an ongoing basis, thus triggering huge changes in perception of risk. From January 2007, Dutch pension funds will have to implement new rules called the Financieel Toetsingskader (FTK). These require pension funds to hold not only a buffer of 5 percent over guaranteed liabilities but also additional capital based on the fund s risk profile. This significant shift in objectives is starting to be mirrored elsewhere. In the UK, exceptionally large pension fund deficits are focusing trustees minds on how they will meet liabilities. Pension plans are beginning to shift away from measuring performance against composite market benchmarks towards inflation index-linked enhanced benchmarks. Widespread interest Quite how widespread this change is can be seen from the interest in new risk reporting tools prepared initially for the Dutch market. We recently visited some Dutch clients and they all wanted some form of Pension funds call for help Move to liability-driven investing causes Dutch and UK pension funds to rethink reporting models help with their regulatory reporting, says Ian Castledine, investment risk senior consultant. But UK clients are also interested and want to see what we are doing. Both Dutch and UK plans Ian Castledine Dutch clients want help with their regulatory reporting face significant challenges. In the Netherlands, FTK regulations require minimum funding equal to 105 percent of liabilities. However, there is also a stipulation that assets must be sufficient to absorb unfavourable market developments within one year so many plans may seek to exceed the minimum. In the UK, pension fund deficits are reportedly estimated at nearly 70bn for FTSE 100 companies alone. The new Dutch regulations propose that pension plans monitor their ability to meet obligations through either a standardised central bank-devised reporting model or an in-house model. Most pension schemes are adopting the standardised model, rather than paying to develop their own. Monthly monitoring As a result, Dutch pension plans are seeking reporting templates that monitor the relationship between assets and liabilities on a monthly basis. These templates measure liability coverage ratios as well as predictive risk metrics from multi-factor risk models and value-at-risk ratios, on an ongoing basis. It is these reporting templates that are also attracting so much interest in the UK. Pension fund trustees want us to take long-term projected cash flows from their actuaries and discount them back to show alongside asset valuations, monthly performance and predictive risk reports, says Castledine. Looking forward, whether other countries adopt regulations as prescriptive as those in the Netherlands or not, the trend is clear. Pension plans everywhere, encouraged by new accounting standards that require assets and liabilities be marked to market, are taking a more realistic view of their obligations. northerntrust.com