A Comprehensive Guide to Selecting a Fiduciary Manager

Aon Hewitt Delegated Consulting Services A Comprehensive Guide to Selecting a Fiduciary Manager February 2014 Risk. Reinsurance. Human Resources.

Table of contents Overview...2 How to select your fiduciary manager Six key steps... 3 Understanding a fiduciary provider s offering 1. Fiduciary business and conflicts of interest... 8 2. The fiduciary solution... 9 3. Trustee involvement, client service and reporting... 10 4. Fees and performance measurement... 11 5. Operations, risk and the transition... 13 Conclusion...14 Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 1

Overview Appointing a fiduciary manager is an exciting opportunity for trustee, sponsor and provider to work in partnership, creating a bespoke solution that addresses the increasingly complex challenges facing the pensions industry. Selecting the right provider is crucial and it is therefore important to follow a tender / selection process that works for your scheme and which engages with the fiduciary providers from the outset. Anyone embarking on, or considering, a fiduciary management approach will have a lot of questions: What is the next step? How do you go about selecting the most appropriate fiduciary manager for your scheme? Where do you start? What questions should you ask yourself and the providers? In the second part of this paper we outline five areas which we believe are vitally important to delve into when selecting a fiduciary provider, and arm trustees with the key questions for each area to help them fully understand what it is they are buying. Sion Cole Partner and Head of Client Solutions Delegated Consulting Services +44 (0)207 086 9432 sion.cole.2@aonhewitt.com Follow me on twitter @PensionsSion In this paper we have brought together our series of papers released during Autumn 2013 to produce one comprehensive guide to selecting a fiduciary manager. In the first part of this paper we aim to cut through some of the mixed messages reported on this topic by relaying our experience and observations of recent tender processes run by trustees in partnership with their scheme s sponsor. The very best selection processes we ve been involved in have shared a number of similarities. We have drawn these together and summarised them into six key steps for selecting the fiduciary manager that is right for you. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 2

Fiduciary management (or as it s also known, delegated consulting) is a solution which enables pension scheme trustees to execute their long-term strategies efficiently and target better outcomes through a more effective governance structure. Fiduciary managers are aligned with clients interests (through fees and benchmarks) and are directly accountable for results. This is because they take clear responsibility for investment decisions on behalf of trustees, and manage assets relative to liabilities within a clear performance measurement framework. Typically, the fiduciary manager will appoint multiple underlying specialist fund managers on the trustees behalf to manage each element of the investment portfolio. How to select your fiduciary manager While there is currently a lot of media coverage of fiduciary management, it is important to put all comments into context. Our experience suggests that almost all fiduciary management opportunities are now won through rigorous competition, and that trustees are proving extremely effective at ensuring that the partner they appoint is the right fiduciary provider for their unique needs and requirements. The very best selection processes we ve been involved in have followed six steps, run by trustees in partnership with their scheme s sponsor. We believe these offer trustees considering the fiduciary route a good starting point to work from. It is important to work closely with any fiduciary provider and ask questions at every step, ensuring all parties are comfortable. Myth or fact: Fiduciary mandates are being won non-competitively The UK fiduciary market is growing at a rapid pace and is attracting more media attention than ever. Recent months have seen a lot written about the proportion of fiduciary management business that is put out to open tender. The theme of some of this commentary is that, against a backdrop of such a rapidly growing market, far too few mandates are being won on a competitive basis. The UK fiduciary market is growing at a rapid pace and is attracting more media attention than ever. This has been very interesting for us to read, primarily because it simply does not fit with our own experience of what is happening here in the UK. At Aon Hewitt, 100% of our new fiduciary management business over the past 12 months has been won in competitive situations. Also, around 70% of all our fiduciary business since launching has come from pension schemes with whom we had no previous investment relationship. So why is there this big disparity between the commentary and actual experience? The most likely answer is that the fiduciary management market is developing so quickly that it is very difficult for outside commentators to observe the true dynamics and current state of the market. We found that when fiduciary management first emerged the question from interested trustees and sponsors was often what is fiduciary management? and what does it mean?. Now that the approach is more established, the questions asked are more along the lines of who should I appoint? and how do I go about selecting a fiduciary manager?. Perhaps only the providers have so far been able to observe this shift. This new line of questioning leads us onto another topic that has been raised in the media around the fiduciary tender process; if mandates are being won by open tender, who is running the tender process? Our experience is that UK trustees are doing an excellent job of running selection exercises themselves. Fiduciary tenders are being run by trustees Our experience is that UK trustees are doing an excellent job of running selection exercises themselves. The competitive tenders we have been part of, almost exclusively run as a joint exercise between trustees and scheme sponsors, have been extremely well managed. For many organisations, procurement is a core competency, which is perhaps one of the reasons why many have not felt the need for any third party involvement, as the trustees had the skills to undertake this themselves. Another reason why trustees may not have felt the need for outside help from a third party / independent adviser is that they are already familiar with the services they are looking for. Effectively, fiduciary management can be seen as an enhanced delivery mechanism for the services they are already receiving from their investment consultant. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 3

For example, the pension scheme may already have a flight plan designed by their consultant; fiduciary management is an effective method of delivering this service to the client as it often involves the design, monitoring and execution of the flight plan (according to pre-agreed parameters). Effectively, fiduciary management can be seen as an enhanced delivery mechanism for the services they are already receiving from their investment consultant. Six key steps to selecting a fiduciary manager The very best selection processes we ve been involved in, run by trustees in partnership with their scheme s sponsor, have shared a number of similarities. We have drawn this together and summarised into six key steps to selecting a fiduciary manager. These are summarised in the diagram below and then outlined in more detail on the following pages. Perform a full site visit Provides an unmatched opportunity to gain a sense of the provider s organisation, philosophy and approach Establish what role you want your fiduciary manager to play Q: What role do I want my provider to play? What level of delegation and what flavour of fiduciary management would work best for us? Work closely with a couple of providers Q: Do the providers understand our needs? What might our solution look like? How well do we work together? 5 6 1 4 3 2 Consider the broad shape of the strategy you wish your fiduciary manager to implement a) b) c) d) Liability benchmark Directive or delegated Open architecture Fees bundled or unbundled Decide on a short list Q: What providers from the long list have the experience and expertise that best match the areas most important to us? Create a long list of providers Q: Which providers do we like from the broad information collated? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 4

1. Establish what role you want your fiduciary manager to play The terms fiduciary management, solvency management, delegated consulting and implemented consulting are often used inter-changeably as the industry has yet to settle on a universally-accepted term for this business. In reality, they are all flavours of the same thing. Think of this as a bit like the term active management we all know what active management means as opposed to passive management, but we equally accept active management as an umbrella term covering a multitude of potential approaches (quantitative, fundamental, unconstrained, growth, value etc). Fiduciary management is a useful umbrella term, distinguishing this approach from the traditional trustee adviser-manager relationship. However, as with active management, beneath this umbrella lies a huge variety of potential approaches. An important question trustees need to investigate initially is what flavour of fiduciary management do we want?. The answer lies in the governance problem they are aiming to solve. Some want to set the strategy for the pension scheme and then delegate the entire delivery to a fiduciary manager. Others have a governance need in a particular area they may be happy with running the majority of their assets, but want to delegate the management of their hedge fund or emerging markets portfolio, for example. The different options (or flavours ) can be summarised as: Full fiduciary management: This is where the trustees want a solution where they set the overall strategy (including the long-term risk and return objectives) and then delegate all investment decisions and day-to-day running of the portfolio to their fiduciary manager. Partial mandate: With this option, the trustees are looking for a solution which is just for a specific section of their portfolio. For example, the alternatives or liability hedging assets. The trustees would delegate all investment decisions around that section to the fiduciary manager. The trustees maintain the decision making on the remainder of the portfolio. Strategic de-risking mandate: This is where the trustees ask the fiduciary manager to implement the de-risking triggers (typically funding level driven) that form part of the trustees ongoing strategic benchmark. This is often based on funding level or the price of protection. In contrast to some media coverage that talks about there being relatively few full fiduciary mandates in the UK, the majority we are seeing remain those where the trustees wish to set the overall strategy and then delegate the day-to-day delivery of that entire strategy (ie, full fiduciary management). Indeed, around 90% of our UK clients are full fiduciary mandates. 2. Consider the broad shape of the strategy you wish your fiduciary manager to implement There are a number of different elements within this that need to be considered and these are detailed below; a) Liability benchmark For full fiduciary mandates there are two options for the liability benchmark. One option is for the trustees to specify a growth / matching split, say 75% / 25%, and the fiduciary manager is then asked to manage the portfolio according to this benchmark. The agreed split would then dictate the return needed over the liabilities. Alternatively, the trustees stipulate, for example, that the fiduciary manager must generate a return of 2% above the liabilities with a 50% hedge ratio. The manager then has the flexibility on the growth / matching split in order to meet (or exceed) that benchmark. With both options there is some discretion to add value within pre-agreed boundaries. b) Directive or delegated Assuming that the trustees have decided they want to delegate the day-to-day decision-making, they should confirm that this is what the fiduciary providers being considered are actually offering. Some solutions marketed as fiduciary management can simply boil down to a more directive advisory style which leaves final sign off for investment decisions with the trustees. Typically, the number of investment decisions required would be greater than under the traditional approach as the more complex portfolios employed will generate more ongoing decisions. c) Open architecture Some fiduciary managers operate a completely open architecture model. This means they appoint best in class specialist fund managers and do not trade directly in markets themselves. Other providers invest in their own in-house funds (or funds run by an affiliated entity) and / or trade in markets themselves. Trustees need to understand the differences in these approaches and ensure they are highlighted in any proposals given by the providers. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 5

d) Fees bundled or unbundled The fee approach a fiduciary manager adopts very often reflects the heritage of the provider. Providers borne out of asset management houses will typically bundle their fees with those of the underlying fund managers being appointed giving certainty of overall costs but not passing on fee savings or reflecting the cost of the underlying solution. In contrast, providers which have emerged from consultants will typically have an unbundled approach where they set their fees separately from the underlying managers, with fund manager fee savings flowing through to clients. The cost of the underlying solution is clearly shown often a benefit to flight plan clients as the solution is expected to become cheaper over time. It is important that trustees decide which they are most comfortable with and understand any pros or cons of the approaches. 3. Create a long list of providers to assess The breadth of resources required to deliver fiduciary management is substantial, and so there are a limited number of providers. Creating a long list is therefore relatively easy, as we believe there are only nine established providers in the UK, and all are well known. An internet search will yield information about assets under management, people, processes and resources at the fiduciary manager s disposal. This will enable trustees to get an initial feel for whether they like the size, depth of resources, heritage and approach of each organisation. The breadth of resources required to deliver fiduciary management is substantial, and so there are a limited number of providers. While it is unrealistic for most trustees to see and meet with all of these providers, all of the firms will be happy to send through information to interested trustees when asked to outline their capabilities. This broad information is efficient for all parties when at the early stages of consideration. The creation and completion of a bespoke invitation to tender document is extremely time-consuming for both parties, and often unnecessary if it is introduced too early in the process. It can also yield poor outcomes. 4. Decide on a short list of providers This involves focusing on those providers that have the greatest expertise in the areas of most importance to the mandate. We ve seen trustees use a range of metrics for this, and they have proven extremely adept at identifying where different expertise lies. The sorts of metrics that might be used to decide the short list include; what the overall solution looks like, flexibility around tailoring the portfolio, ability to dynamically build the liability hedge over time and how performance is derived. Trustees may ask themselves whether cost is the driving factor, or whether the level of tailoring, incorporation of alternatives or the ability to dynamically de-risk through a flight planning service is most important. 5. Work closely with a couple of providers Fiduciary management is not a product, it is a service with the expectation of a long-term relationship between the provider and trustees. It is therefore crucial to work closely with, say, two selected providers so that they can understand your individual goals and design a solution that is specific to your needs. The very best processes we have been involved in were not simply an RFP followed by a one-hour beauty parade. Instead we, and another provider, have been given access to the trustees (or a subset of the trustees), and are then able to design a proposal and come back to present it to the trustee board for scrutiny. This approach gives providers a chance to produce a tailored proposal and generates fair competition between short-listed providers. This maximises the likelihood that trustees will get what they really need, and also gives the trustees an idea of what it will be like working with the short-listed providers in practice. The best processes we ve been involved in are those where the trustees have increased the depth of their scrutiny as they have firmed up the mandate and narrowed the range of potential providers to those that have the right approach for them. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 6

Understanding a fiduciary provider s offering 6. Perform a full site visit before signing up Once trustees have firmed up the mandate they want and narrowed down to a couple of providers, we believe they should then visit those providers on site. This gives them a chance to meet the primary decision makers, see the middle office, back office and portfolio management personnel, and to speak with the people that will be running their portfolio on a day-to-day basis. A site visit provides an unmatched opportunity to gain a sense of the provider s organisation, philosophy and approach. We always offer trustees the opportunity to visit us on site and encourage this as we believe this is an essential part of any selection decision. A site visit provides an unmatched opportunity to gain a sense of the provider s organisation, philosophy and approach. In the first part of this paper we summarised the six key steps that we have seen trustees follow when selecting a fiduciary provider. When undertaking this process, it is important to ask the right questions as this will allow trustees to compare providers more easily through gaining a greater understanding of the solutions on offer, the merits of each, and offering the chance to flag any concerns. In this latter part of the paper, we identify and briefly outline five areas which differ between providers and which we believe are important for trustees to understand in order to gain insights into the provider s offering. We will look at the key questions within each of these five areas that will help trustees fully understand what it is they are buying and therefore make an informed decision on which solution / provider is the most suitable for their scheme. Five key areas We have identified five key areas which differ between providers and which we believe are important for trustees to understand in order to gain insights into the provider s offering. The key areas we have identified are: 1 Fiduciary business and conflicts of interest 2 The fiduciary solution 3 Trustee involvement, client service and reporting 4 Fees and performance measurement 5 Operations, risk and the transition But what are the questions trustees need to ask in order to get the answers they need to make an informed decision? In the following sections we outline why each of the key areas are of vital importance and then provide the questions within each that will help trustees to identify the provider that is right for their scheme. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 7

1. Fiduciary business and conflicts of interest The breadth of resources needed to deliver fiduciary management is substantial, and so you need to be confident the provider has sufficient scale and commitment to be your long-term partner. Most providers will have a dedicated fiduciary team (varying in size). However, given the scale needed to deliver fiduciary management services and depending on the breadth and complexity of the solution being offered, it is likely that this team will then draw on the wider resources of the business and leverage wider firm expertise. It is important to understand this and establish who will be dedicated to your particular pension scheme. The breadth of resources needed to deliver fiduciary management is substantial, and so you need to be confident the provider has sufficient scale and commitment to be your long-term partner. Equally, it is important to understand the provider s existing client base and establish what experience they have of schemes following a similar mandate to yours. There is no substitute for speaking to somebody who already has a relationship with the provider does the provider have references you can contact? There will be some existing clients who will not act as references purely due to the time burden this may represent which is perfectly understandable but most providers will naturally aim to be able to reference nearly 100% of their existing relationships. A crucial area that needs a detailed and open response from the fiduciary provider is around conflicts of interest. The potential conflicts around the setting and implementation of the investment strategy can vary between providers so it is important to understand if there are any, and, if so, how are these managed and minimised? Another example of a potential conflict of interest would be around remuneration. Fees are covered in more detail later in this document, but at a high level you must be clear how the provider is remunerated and consider any conflicts this may potentially create. For example, one provider may have an open architecture model where they only invest your assets with external fund managers, whereas another may invest in its own in-house funds (or a mix of both). Utilising in-house funds can sometimes bring significant economies of scale, while open architecture gives greater independence and access to best in class fund managers. There is a balance to be struck, and different trustee boards will take different views on the merits of each approach at the initial stage you just need to make sure you understand what the provider is offering. The key questions 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 What is the size of your UK fiduciary business in terms of assets under management and number of mandates? What is the size of your UK fiduciary business in terms of dedicated personnel and personnel that feed into the solution more broadly? Is the team that would be running our fiduciary mandate based in the UK? Can you demonstrate your commitment to your fiduciary business? Is your fiduciary business a strategic focus to the overall business / firm? What proportion of your clients are full fiduciary (i.e. full scheme assets with a liability benchmark)? Can you tell me the range of scheme sizes that you provide fiduciary solutions to, including the average? Do you have examples of working with clients of a similar size to us who have appointed you for a similar solution to what you are proposing? Can we contact any of your existing clients to get references from them? Are there any key conflicts of interest and how are they different from any conflicts that you might feel are inherent in a traditional advisory approach? If you have an investment consultancy business and a fiduciary business, are they separate entities? If your fiduciary business interacts with other business units are there any conflicts and, if so, how are they managed? Will I still need an investment consultant and, if so, can you work with my existing investment consultant? What are your views on working with a third party evaluator / independent adviser during the tender process? Have you worked with any third party evaluators during the fiduciary tender process of existing clients? If yes, have you felt comfortable that the third party evaluators have managed their own conflicts of interest during the tender process? Would I need someone to oversee you as my fiduciary manager? Is the pay and bonuses of your staff linked to client performance? Does any of your fiduciary team s remuneration get invested alongside our assets? Will you earn any additional revenues from this relationship other than the fiduciary management fee we will be paying you? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 8

2. The fiduciary solution Understanding the details of the actual solution being offered by a provider is crucial to making an informed decision on which one to select. It is important to establish early on who will be making the decisions, and whether you have any power of veto or whether changes are made automatically without any prior approval. An important element of the fiduciary solution which needs to be understood is the strategic benchmark design and choice of investment objective. Fiduciary management is essentially the process of delegating day-to-day decisions to a better resourced entity. It therefore follows that in most cases trustees should take ownership of the objectives and broad investment guidelines / restrictions, but should not generally involve themselves in the dayto-day decisions around asset allocation and investment manager selection. That said, there are many legitimate situations where trustees will want to express a preference in their portfolio, and it is therefore important that you establish whether a fiduciary provider has sufficient flexibility to allow this (both now and in the future). An important element of the fiduciary solution which needs to be understood is the strategic benchmark design and choice of investment objective. It is vital to ask what range of target returns are on offer (and the risk / return profile that will be achieved). As with all organisations, some fiduciary managers are more conservative than others which makes it important to establish whether the provider s offering will bring sufficient potential to suit your scheme s needs. The key questions In order to be able to answer some of these questions, the fiduciary manager may need some basic information from you. This could, for example, include aspects such as your scheme size, current investments, what you are trying to achieve and if you want to keep or change your risk / return levels. 1 2 3 4 5 6 Can you demonstrate the expected benefits of your solution for our scheme and provide examples of how you have delivered similar benefits to existing clients? How would we establish the investment objective and corresponding strategic benchmark? How much of our time would be required for this exercise? Can we change the strategic benchmark and / or investment objective at any time? What would you recommend as an appropriate benchmark for our scheme? If it is a benchmark based on our liabilities, how would it be structured? What level of input and information will you require from our Scheme Actuary? Will we have any power of veto over your decisions, or will you seek our approval prior to any decisions being taken by yourselves? 7 What range of target returns are you able to offer us? 8 9 What level of risk is commensurate with the returns on offer? (NB risk can be measured in different ways so trustees need to decide how they want to look at this. For example, volatility or VaR) How do you decide, a) the split of assets between growth-seeking and liability-matching, and b) the allocation within these? All of these elements should never feel like a cookie cutter approach that doesn t allow you sufficient input to ensure the solution is tailored specifically around your scheme. As a scheme de-risks, its performance benchmark changes and its investment objective reduces you would be taking less risk because you are in a position to seek less return. The mechanism for how this works can be complex. Where performance is being measured against liabilities, the benchmark will be a function of the liability profile and the increasing ratio of liability risks being hedged. You need to be sure there are processes in place to ensure you rather than the fiduciary manager own the benchmark, and also that you will be given sufficient support in its construction. All of these elements should never feel like a cookie cutter approach that doesn t allow you sufficient input to ensure the solution is tailored specifically around your scheme. 10 11 12 13 14 15 16 17 Will we be invested in your in-house funds and / or externally managed funds, and will we understand the impact on total fees? If you use external managers, a) are you remunerated by them in any way (directly or indirectly), and b) are all fee discounts you achieve passed through to us in full? How flexible can you be in terms of our preferences on what asset classes you invest in on our behalf? We have just appointed a manager(s) and want to keep them, are you able to integrate this within the solution? We are worried about liquidity as we have regular pension payments to make. How liquid will my investments be (both now and in the future) and are there any income generating assets we could use? What investment tools, decisions and levers would you use to re-risk or de-risk our scheme? How do you manage the level of protection provided by the liability-matching assets, and, in particular, how do you manage any leverage in the liability-matching assets? How would you work with us to design our flight plan and any funding level and / or yield level de-risking triggers? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 9

18 19 20 How frequently will you monitor our scheme s funding level and / or yield levels against any agreed de-risking trigger points? When we hit a de-risking trigger, a) do you check with us first before making any changes to our portfolio and, b) how quickly are changes implemented? Could you deliver us the same results / service under a traditional advisory approach? These 20 questions are fundamental to helping trustees compare providers, ensuring they understand the key principles of the solution they are buying into. However, trustees also need to understand the more subjective elements of a fiduciary provider s offering and will therefore still need to ask further questions in addition to these. This will include, but not be limited to, questions around gaining an understanding of how the provider constructs the portfolio, their investment process and beliefs, views on active vs. passive management, key drivers of return, and ability to include illiquid or alternative investments in the solution. 3. Trustee involvement, client service and reporting A successful fiduciary management relationship is fundamentally built on trust. The scheme s trustees have delegated day-to-day decision-making to another entity that they are trusting to stand in their shoes and make the right decisions on behalf of the scheme s members. Part of building this trust and long-term relationship is knowing exactly who is responsible for each element, as well as clear accountability at all levels. To maintain this trust over time, the provider must be completely transparent and provide all the management information its clients need to ensure they have effective oversight of the decisions being taken. Part of building this trust and long-term relationship is knowing exactly who is responsible for each element, as well as clear accountability at all levels. It is important that all the scheme s trustees understand the level of involvement required from them, both at the outset and throughout the journey. Similarly, it should be clear how much trustee time needs to be invested and whether this is more or less than is currently being spent on investment decisions and where this time would be focused. Gaining an understanding of the levels of client service and reporting that you can expect is vital, and key to your duties as a trustee. Seeing specimen reporting material from the provider is essential to establish if it works for you, as well as checking if there is sufficient flexibility to tailor it to your individual needs. As your needs will be different to all other schemes, you should understand how the fiduciary provider structures their ongoing client service, and how that is split between essential administrative services and broader relationship and reporting services. The key questions 1 2 3 4 5 6 7 8 What level of input and time commitment will you require from the trustees and scheme sponsor, both at the outset and at each stage of the relationship? Will we be spending more or less time on investment issues than we do currently (we currently spend X hours per quarter on investment issues)? What level of delegation do you feel is most efficient for us? What can we delegate and what can t we delegate? Do we have any power of veto on your investment decisions before you implement them? Do we input into the managers you can use within our solution? Are we able to use our own funds? Do we have any input into the asset classes incorporated into the solution you create for us? What level of input do we have into the strategic benchmark and investment objective? Who will assist us with this? How often would you meet with us, and will it be the people we have met so far that will attend these meetings? 9 How is the team that will be looking after us structured? Will we have a dedicated team looking after us and 10 11 12 13 14 15 16 17 18 19 20 responding to any day to day enquiries (for example, short notice requests for cash for member payments)? If so, who will this be and can you provide references for them? Will we have a dedicated investment specialist and / or client account manager? If we have any concerns regarding the solution or service that you are providing, or need to escalate any issues, is there a senior member of the team we can contact? Do you have standard processes in place to deal with any requests our auditors have regarding our solution with you? What regular performance monitoring and reporting will you provide to us? When would we receive these? How are these reports broken down, i.e. what are the key aspects that are included? Can we see some examples of the reports we would receive from you? To what extent could we influence the style and content of the reports you would send us? Are there any costs attached to creating bespoke reports for us? Will we receive any other regular communications from you? What training will you offer us in order to get comfortable with fiduciary management, and will you provide any ongoing training? What documents or information will you require from the trustees, sponsor and scheme actuary, both before we appoint you and on an ongoing basis? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 10

4. Fees and performance measurement Fee structures can vary significantly between fiduciary providers. There is no right or wrong approach, trustees just need to understand how different providers structure their fees (including a detailed breakdown of the component elements) and take a view on the approach they prefer. Fee structures can vary significantly between fiduciary providers. However, some providers may be unwilling to give a detailed breakdown of their fees as, for example, fees may have been negotiated with external fund managers and are therefore confidential, and so those providers may be unwilling to break-out external manager costs. If this is the case, trustees should focus on the total fees when making comparisons across providers including, where relevant, those paid to external or internal fund managers, fiduciary management fees and other administration or custody fees. It is important to compare fees on a like for like basis, as the exact solution being offered will have a significant impact on fees. Some providers will wish to charge a performance-related fee in addition to base fees. The key considerations here are to ensure this fee rewards the fiduciary manager for exhibiting skill, that it does not create any perverse incentives for the fiduciary manager to take unnecessary additional risk, and that it vests over a long enough timeframe that the fiduciary manager is incentivised to take the same long term view of success as the trustees. Even where the fiduciary manager provides a breakdown of some (or all) of its fees, actually comparing fees can be extremely difficult. It is important to compare fees on a like for like basis, as the exact solution being offered will have a significant impact on fees. The service and elements incorporated within the fiduciary solution will impact the level of fees charged, as well as the overall asset allocation between the growth seeking and liability matching components. For example, a 75% growth-seeking allocation targeting high long-term returns alongside a highly-leveraged liability-matching component will command higher fees than a 50% growth-seeking allocation targeting more modest returns combined with a more basic bond portfolio for the matching component. The instruments and tools used, as well as the actual underlying investments / asset classes invested in, will also have an impact. For example, passive equity strategies have low management fees whereas an allocation to hedge funds will tend to increase management fees. Trustees should also be aware of how they can measure the performance of the fiduciary solution to judge if the provider has been successful. The appropriate performance metrics will correspond to the precise mandate under consideration, which will itself reflect the governance challenge the trustees and sponsor are aiming to solve. If it is full fiduciary management being considered where the trustees set the overall strategy and then delegate all investment decisions to their fiduciary manager performance should be measured against a liability benchmark. If the trustees want to delegate the management of their hedge fund or emerging markets portfolio, then an asset class-specific benchmark should be used. If it is a strategic de-risking mandate a solution where the fiduciary manager is asked to implement the (typically funding level driven) de-risking triggers that form part of the trustees ongoing strategic plan then a liability benchmark which adjusts as de-risking occurs is most appropriate. The trustees should ensure their fiduciary manager understands the need to construct a performance benchmark which reflects their precise objectives. The key questions 1 2 3 4 5 6 7 What are the total fees or expense ratio we will expect to pay in a typical year? Is this based on assets under management or some other basis? Do you quote your fees separately from any external fund manager fees (ie, unbundled), or bundle these elements together into one total fee? Can you provide a full breakdown of your total fee, and list the services included in this fee. Please provide details on any fiduciary management fees, underlying investment manager fees and other fees such as custody, administration and legal fees. Why is the fee higher (or lower) than my current investment strategy / approach? Will your fee change over time - for example as the scheme de-risks and progresses through our flight plan, or as you make changes to the investment portfolio? Do you charge a performance fee? If so, how is it structured and can you give me an illustration of how it works? Do you have a minimum fee, and will you allow us to include any caps or hurdles in the fee? 8 Are your fees aligned with our interests? If so, how? 9 Are you able to negotiate with any external managers to reduce management fees? Please provide an example of this and the magnitude of the reductions you typically achieve. 10 To what extent do you pass on any underlying manager fee discounts / savings directly to us? Can you show us examples of this? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 11

11 12 13 14 15 16 Does the solution use your own internal funds, or funds of entities affiliated to your organisation? If so, what percentage of assets is invested internally and how are internal managers paid? Will you earn any additional revenues, or other remuneration, from this relationship other than the fiduciary management fee we will be paying you? What information will you provide us with in our performance reporting? For example, will this show funding level changes, performance versus our liabilities, underlying drivers of return and our asset allocation? Can we tailor these reports? How do you measure the underlying asset managers investment performance? How will we measure your investment success? Is it compared with our current strategy, liability benchmark, multi-asset composite benchmark, or other providers? How can we measure you to ensure you are delivering from an investment, operations and client service perspective? The appropriate performance metrics will correspond to the precise mandate under consideration, which will itself reflect the governance challenge the trustees and sponsor are aiming to solve. 17 Are you happy to be monitored by a third party? 18 19 20 What is your performance track record over one year, three years and since inception for mandates similar to the one we are investigating? What have been the key drivers of this performance? Where do you typically expect risk / return to be derived from? Does the remuneration of your key staff have any direct link to the performance of my solution? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 12

5. Operations, risk and the transition Understanding the operational processes that support the fiduciary provider s offering is essential. This is an area for particular focus while you are at the initial stages of the selection process, as it is likely to contain more immediate deal breakers than some of the other areas. For example, knowing where your assets will be held is vitally important. In some solutions you have a segregated mandate with an independent custodian; in others you invest in a suite of the provider s pooled funds, or it may be a combination of both with you having both segregated assets and pooled funds held in independent custody. It is also important to understand what constraints to exit the provider may be able to impose, should you wish to terminate the relationship. The likely costs of exiting the solution should also be investigated. While this may be difficult for the provider to answer precisely, they should be able to give you examples of orders of magnitude. The approach to custody will be key an independent custodian will give you much more flexibility on exit; however it may also leave you with an extremely complex portfolio to manage if your assets are segregated. Understanding how the provider plans to manage your transition, what the costs would be, and how any risks are managed, is crucial. The external verification and auditing of performance and risk controls / processes is a core aspect of fiduciary management that needs to be clarified and understood by trustees. The processes required to run a fiduciary management business are both broad in scope and complex in nature. As a relatively young industry, encompassing providers with very different heritages and approaches to solutions, there are no standard protocols or benchmarks of best practice. You should therefore ensure that your provider either has already had, or is planning to have, their processes reviewed by an external party. There is no sensible way of constructing a peer group or standard benchmark for performance measurement of fiduciary solutions, as they should all be unique to each individual scheme s circumstances. It is therefore extremely important that the provider demonstrates to you that the performance it is quoting is rigorously calculated and independently verified. Transitioning from your current strategy / portfolio to a fiduciary approach can be complex. The approach to initial transition varies not only between providers but depends on the solution being offered and the scheme s current investments / holdings. Understanding how the provider plans to manage your transition, what the costs would be, and how any risks are managed, is therefore crucial. The key questions 1 Are there any lock-ins with your fiduciary offering? 2 3 4 5 6 7 8 9 What would be the costs of exiting the solution in the future? What would happen to my assets if your fiduciary business shuts down? How financially secure is your organisation, and how well capitalised is your fiduciary business? Do you have contingency plans in place for business continuity in the event of any incidents? When was your business continuity plan last tested, and can we see the test results? Where will my assets be held? Do we have to use your custodian or can we use our current provider? Do you independently verify your performance and reporting? Is this external or internal verification? Does an external specialist review your risk and control framework? Are your key risk controls fully documented? Please provide details, including how your risk control processes are audited. 10 How do your fiduciary and risk teams interact? 11 12 13 14 15 16 17 18 Does your fiduciary team have clear segregation of duties in place between front office, middle office and operations? What is the minimum number of people required to process a trade instruction? What legal documentation or contracts are required? Please detail what these are and provide examples. How long will it take before our new solution is up and running? So, from us appointing you to our assets being fully on board, how long will that take? Will my flight plan and dynamic de-risking programme be in place immediately? From what date will the daily monitoring of my funding level commence? Would you use a transition manager? Would it be internal or external? If you use a transition manager, what experience do they have? How do you manage risks during the transition? If there is no specialist transition manager, how will the transition risks be controlled? 19 How do you manage costs during the transition? 20 Will I receive a transition report? Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 13

Conclusion Appointing a fiduciary manager is an exciting opportunity for trustee, sponsor and provider to work in partnership, creating a bespoke solution that addresses the increasingly complex challenges facing the pensions industry. Selecting the right provider is crucial and it is therefore important to follow a tender / selection process that works for your scheme and which engages with the fiduciary providers from the outset. The very best selection processes we ve been involved in have followed six steps (outlined at the start of this paper), run by trustees in partnership with their scheme s sponsor. We believe these offer trustees considering the fiduciary route a good starting point to work from. It is important to work closely with any fiduciary provider and ask questions at every step, ensuring all parties are comfortable. The aim of the latter part of this paper has been to outline the five areas of vital importance when selecting a fiduciary provider and arm trustees with the key questions within each to help them fully understand what it is they are buying. Some of these questions may appear challenging for a fiduciary manager to answer, but all are important from the perspective of a trustee (as we know from direct experience, having been asked them ourselves during selection exercises). Ultimately, these are the questions that will help trustees to identify the provider that is right for their scheme. All schemes are unique and therefore there is no one solution that fits all. Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 14

Contact Sion Cole Partner and Head of Client Solutions Delegated Consulting Services +44 (0)207 086 9432 sion.cole.2@aonhewitt.com Follow me on twitter @PensionsSion Working in partnership with our clients At Aon Hewitt we believe in working closely with our clients from the very outset to understand the challenges they face and their individual needs. Working in partnership with the trustees and sponsor, we create a bespoke solution to help address these issues and help them to meet their long term goals. No two clients of ours are the same and each have their own bespoke liability benchmarks, reflecting our truly tailored delegated offering. To talk to us about any of the points we have raised in this paper or to find out more information about our delegated offering, please do not hesitate to contact your Aon Hewitt Consultant or Sion Cole, Partner & Head of Client Solutions, Delegated Consulting Services, on +44 (0)207 086 9432 or at sion.cole.2@aonhewitt.com. aonhewitt.com/delegatedconsulting About Delegated Consulting Services Aon Hewitt s fiduciary offering (Delegated Consulting Services) is focused on helping trustees and sponsors achieve better security for their scheme members. We do this through helping you meet your unique long term objectives and, importantly, through improving your scheme s funding level. What makes us different? Only we ask the best questions and then really listen to exactly what our clients tell us. By working in partnership in this way we can then create a truly bespoke solution that is designed to meet your unique requirements. We don t just say bespoke, we live by it. Aon Hewitt currently holds fiduciary manager of the year awards from three of the industry s leading publications; Professional Pensions (2015), Pensions Age (2015) and the FT (2014). Our ability to create truly bespoke solutions has been cited as part of these award wins and is one of the reasons why our clients vary significantly in size and how we work with them. Examples of some of the solutions we can offer clients include full fiduciary with bespoke growth and liability matching portfolios and daily monitoring of triggers. We also offer single solutions (partial fiduciary mandates) such as hedge funds, alternatives mandates and flight planning with dynamic de-risking programme. About Aon Hewitt Aon Hewitt empowers organisations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organisational and personal performance and growth, navigate risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is a global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit: aonhewitt.com Follow Aon on Twitter: twitter.com/aon_plc Sign up for News Alerts: http://aon.mediaroom.com/index.php?s=58 Aon Hewitt A Comprehensive Guide to Selecting a Fiduciary Manager 15