A typical dictionary definition of a fiduciary is “an agent obliged to act solely in the interest of his principle”. Pension fund trustees are fiduciaries, appointed to act in the best interests of participants and sponsors. However, in the Dutch market where the term “fiduciary management” originated, the meaning is more akin to “strategic partner”, an outside agent supporting the fund in executing a range of investment management duties.

A fiduciary manager supports the pension fund in the design, implementation and monitoring of its investment policy. Trustees, meanwhile, retain strict control over the setting and monitoring of investment objectives. The aim of delegating the day-to-day management of investments to an experienced and well-resourced organisation is to improve the overall risk/return profile of the portfolio, while reducing the strain on internal resources.

Although each pension fund can choose its own approach towards the delegation of duties to a fiduciary manager, in general they are made responsible for:

1. Developing a well diversified and dynamic investment strategy, explicitly linked to the liabilities of the fund.

2. Managing a team of best-in-class asset and overlay managers.

3. Controlling and monitoring the risk and performance profile of the overall portfolio and all its individual constituents.

Since delegation of such duties to a third party does not absolve the board of its investment responsibilities, a fiduciary manager is expected to justify their undertakings in integrated, transparent investment reports. In other words, a good fiduciary manager should be simply an extension of the internal pension fund infrastructure.

Pension funds are faced with an environment in which the design, implementation and monitoring of their investment policy is becoming ever more complex. The primary reasons for this include:

• New pension fund regulations and accounting standards, such as the FTK framework, which have increased the need to control risk and to match assets more closely with liabilities;
• An expanded universe of alternative investment opportunities, making it possible to generate more return per unit of risk by diversifying the portfolio over different asset classes and markets
• Increasing cognisance amongst trustees that, in order to generate stable and consistent outperformance, it makes sense to hire different specialist - rather than generalist - asset managers.

As a consequence, many trustees feel that more expertise and resources are required to achieve their stated investment objectives, even in cases where the actual investments have already been outsourced to external asset managers. Not all trustees (or their sponsors) feel that expanding their internal resource is the most effective or cost-efficient way to face these new challenges.

A good fiduciary manager should strengthen the governance model of a pension fund. The approach should also enhance a fund’s risk/return profile relative to liabilities. Funds are likely to benefit from lower costs, exploiting the economies of scale and buying power that a robust fiduciary manager can offer. Equally, employing a fiduciary manager may enable the fund to adapt faster to the changing investment environment. A combination of these benefits should leave trustees free to focus on arguably the most important strategic decisions a fund makes – establishing a robust set of investment objectives and a prudent strategic asset allocation.

Although the benefits of appointing a fiduciary manager seem evident, pension funds should also be aware of potential pitfalls. For example, a fund may lose control of the key decisions mentioned above, due to a lack of information from the fiduciary manager or through a lack of in-house expertise. Trustees should ensure that they retain an essential resource, such as an investment committee. In this regard, investment consultants also have an important role to play.

An important issue raised by consultants when discussing fiduciary management is the potential for conflicts of interest, particularly in cases where that manager operates a proprietary money management business. Arguing that no firm can guarantee objective scrutiny of their own in-house investment managers, some consultants believe that the advent of fiduciary management may lead to ‘conventional’ investment managers becoming wary of opening their shop for manager research. Fiduciary managers who do not manage money internally may therefore be better placed to act as a true fiduciary, from both a governance and alignment-of-interest perspective.

Most investment consultants, however, acknowledge that fiduciary management can play a useful role in improving the governance model of some of their pension fund clients. Some are even evolving their business models into fiduciary-manager-like designs, a trend we see manifested in the increased use of terminology like “implemented consulting”. Equally, some consultants have opted to develop a new service - the selection and monitoring of fiduciary managers. So while the remit of consultants may be evolving, their role remains relevant.

Henk Radder, director business solutions, Russell Investment Group.