Tuesday, 28 June 2011

A Trustee’s role in a Fund’s investment strategy

A not uncommon reaction from friends when it emerged that I was a candidate to be a Pension Fund trustee was “I didn’t know that you were interested in investment, Paddy?” The implication was that the big deal for a trustee was involvement in the management of the Fund’s Asset portfolio – that’s where the action was. A couple of slightly cynical acquaintances even said when I was elected “Well that should help you sort out your personal investment portfolio” and when I said that I didn’t have such a thing they looked at me with amazement – must be the friends I keep! That maintaining and increasing fund value is a key role of a trustee I happily accept but for me to immerse myself in the minutiae of investment tactics - I don’t think so.

So what is the role of a non-professional trustee on a DB scheme’s Board with regard to investment? I think that above all it is to look at the subject from a fairly high level strategic perspective. The liability side of a Fund’s standing at any one time changes fairly slowly and is very assumption based. For example longevity and discount rate assumptions are just that – assumptions. Because they deal with future events, and because by definition the future is uncertain, they cannot be seen as factual - but all too often they can become unrealistically regarded almost as hard data. So, for example, discount rates based on bond yields can steer pension fund asset allocations towards bonds in an attempt to reduce volatility and improve the future prospects of the funding level - however this can be at the cost at the cost of potentially producing much lower long-term asset returns. The risk is that assumptions, which are very soft data, can distort asset allocations which can even lead to a delusionary perspective of the health of a fund. We all operate in the present and for some Trustees there may be a bias towards caution. If a Fund’s valuation at any one time can be seen to be more predictive of a healthier future by increasing the proportion of the liability driven element in the asset side this can be attractive to a risk-averse Trustee.

So in looking at investment strategy the Trustee does need to understand liability assumptions and not be over-influenced by them. Clearly a vehicle which locks in returns with a high degree of certainty - for example by using bonds with their dependable cash flows - can be useful for part of the portfolio. If this part of the asset base is notionally allocated to the meeting of current and short and medium term pension payment obligations that can be enticing. The rest of the fund can be allocated to investments with a longer time horizon - principally Equities in most cases. It is at this level of abstraction that I think Trustees should be operating – the principles of portfolio structuring taking due regard of the actuary’s liability forecasts. But it is worth remembering that every pound that is locked up in a liability driven investment vehicle is a pound that is not available, except at a cost, for other asset classes. There is a trade-off between on the one hand locking in returns and on the other hand keeping all the investment options open. And as is always the case the Actuary should be challenged – not to disagree with his assumptions but to request him to disagree with himself by running sensitivity analyses!

The Trustee’s role then is to avoid the detail of investment decisions, to try not to second guess the investment managers and to review performance at a fairly high level of summation. This means, ironically, that although Pensions conferences can be valuable for Trustees (more should go to them) many of the exhibition displays at these conferences by the investment community are not really for them. Trustees should not really be engaging in conversation with the earnest investment managers in their smart suits and with an impressive City addresses on their business card! What is, however, in my view firmly in the domain of the Trustee is to reflect that he is not only concerned with the metrics of the Fund’s investment but also with its integrity. The difficulties that some big name DB schemes have got into in recent years has tended to disguise the fact that most DB schemes remain adequately funded with good sponsors and reasonable prospects of discharging their liabilities over time. These funds are very significant players indeed in the world of finance and investment and they can also be a force for good in it. So for funds to invest ethically and especially to make investments in the new “social investment” asset class is something that Trustees should in principle support.

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