To Outsource or Not To Outsource? Assessing the In-House Alternative

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To Outsource or Not To Outsource? Assessing the In-House Alternative

  1. 1. Redington13-15 Mallow StreetLondon EC1Y 8RDT. 020 7250 3331www.redington.co.ukIn-House ProfessionalismTo Outsource or Not To Outsource?Assessing the In-House Alternative16th March 2011The Second Annual Conference onFIDUCIARY MANAGEMENTANDIMPLEMENTED CONSULTING
  2. 2. 2...multiple issues?To Outsource or Not To Outsource?Multi Dimensional Problem
  3. 3. Key Trustee DecisionsSchemeObjectivesRiskAppetiteAssetAllocationInvestmentStrategyManagerSelectionSponsorMembersLegalCustodianActuaryConsultantReportingMonitoringRiskManagementAccountingRegulatorAdministrationPerformanceMeasurementAssetManagersTo Outsource or Not To Outsource?Complex Decisions
  4. 4. 4GovernanceHigh LowTo Outsource or Not To Outsource?The Governance ChallengeSource: NAPF 2010 BlueBook
  5. 5. 5•Trustee Board (TB)•Investment Committee (IC)•Investment Consultant/ActuaryGovernance• TB/IC• Investment Consultant/ActuaryObjective Setting• IC• Investment ConsultantInvestment Strategy• IC• Investment ConsultantDetailed AssetAllocation• IC• Investment ConsultantPortfolio Structure• IC• Investment ConsultantManager Research• Investment Consultant• Fund ManagerImplementation• IC• Investment ConsultantOngoing Monitoring(Strategy & Managers)Traditional Advisor ModelTrustee Board /Investment CommitteeIn-HouseProfessionalism(CIO)Outsource:FiduciaryManagementTo Outsource or Not To Outsource?The Governance Challenge
  6. 6. 6Fund Manager(s)• LDI/Gilts•Credit• Property• Equity• AlternativesBoard /InvestmentCommitteeSetting strategy ImplementationInvestment Consultant• Work with trustees board to• Establish framework/risk budget• Contextualise Investment Objectives –return goals vs. balance of risks• RoadMap and ALM analysis of existingportfolio• Investment strategy design• Investment & Portfolio Management• Implementation of framework• Ongoing MonitoringGovernance and Investment StrategyTraditional Investment Consultant Model
  7. 7. 7Board /InvestmentCommitteeSetting strategy ImplementationFiduciary Manager• Investment strategy design• Investment & Portfolio Management• Implementation of framework• Strategic and Tactical Implementation ofassets• Monitoring & ReportingGovernance and Investment StrategyFiduciary Management• Establish framework/risk budget• Contextualise InvestmentObjectives – return goals vs.balance of risks e.g. Contributionsat Risk• RoadMap and ALM analysis ofexisting portfolio• Propose new investment strategy
  8. 8. 8Board /InvestmentCommitteeSetting strategy ImplementationIn House Executive/ CIO• Investment strategy design• Investment & Portfolio Management• Implementation of framework• Strategic and Tactical Implementation ofassets• Monitoring & ReportingGovernance and Investment StrategyIn House Executive• Establish framework/risk budget• Contextualise InvestmentObjectives – return goals vs.balance of risks e.g. Contributionsat Risk• RoadMap and ALM analysis ofexisting portfolio• Propose new investment strategySpecialistConsultant (s)SpecialistConsultant (s)Investment Bank (s)InvestmentManager (s)Investment Bank (s)
  9. 9. OverallObjectiveRiskTargetsAspirationalTargetsSchemeConstraints9The pension risk management framework is a market consistent, transparent and actionable tool which is key for any trustee, sponsor or memberObjective Triggers Performance IndicatorsWhat is the overall objective? To reach full funding on self-sufficiency basis By 2020 on a Swaps +75bps with £50m ofcontributions p/yrHow will we measure the objective? Using the required return on the Scheme’sassetsRequired Return of assets is Swaps +160bpsWhat are the primary risk targets? Required rate of Return at Risk (RRaR)Contributions at Risk (CaR)RRaR should be no more than 300bpsCaR should be kept below £50mWhat is the secondary risk target? Value at Risk (VaR) VaR should not exceed 20% of the liabilitiesWhat are the primary aspirational targets? To increase interest rate and inflation hedgeratiosHedge ratios equal to funding levelWhat is the secondary aspirational target? Dynamic de-risking Based upon regular monitoringWhat is the primary Scheme constraint? Liquidity Enough liquidity to pay pension paymentsWhat is the secondary Scheme constraint? Collateral Requirements Enough eligible collateral to cover the 1yrderivative VaR95Regular monitoring allows a call to action that enables trustees and sponsors to anticipate and recalibrate the investment strategyGovernance and Investment StrategyPension Risk Management Framework (PRMF)“‘If a man knows not what harbour he seeks, any wind is the right wind’”Seneca
  10. 10. 10Flight Plan – Projected CashflowsThis is the expected path of the liabilities over the next 20 years.Risk management, governance, markets and strategic asset allocation all play a part.Governance and Investment StrategyPension Risk Management Framework (PRMF)
  11. 11. 11ChairmanEmployer nominatedCIOEmployee nominated IndependentActuariesLawyersInvestmentConsultantsAsset ManagersCorporateSponsorTrustee BoardInvestmentBanksRegulatorProductProvidersTo Outsource or Not To Outsource?Case Study – In House Executive
  12. 12. To Outsource or Not To Outsource?Case Study – In House ExecutiveBarclays (UK) Retirement Fund• Tony Broccardo appointed CIO in 2008• 7 more investment professionals hired as part of the internal team• Oak Pension Asset Management launched in December 2010, formalisingthe centralisation of investment decisions at the FundRBS Pension Scheme• Robert Waugh appointed CIO after leaving as Head of UK Equities at ScottishWidows in late 2009• supported by in-house investment professionalsHSBC Bank Pension Trust• Lesley Alexander, previously of EMI Pensions, appointed as CEO in December2010• Phillip Bretnall appointed COO in December 2010• Mark Thompson appointed CIO in January 2011
  13. 13. Case Study: Barclays UK Retirement Fund (BUKRF)Scheme: Barclays UK Retirement FundAUM: £16bnCIO: Tony Broccardo, first appointed in 2008Previous Roles:• Executive Director and CIO for F&C Asset Management PLC• Global Partner and Institutional CIO for INVESCO Asset Management Inc• In both roles he chaired the Global Asset Allocation CommitteeIn 2008, BUKRF decided to appoint a CIO and delegate more of the key investmentdecisions. The reasons behind this were to make investment decision making:• More flexible and dynamic in volatile market conditions• Able to respond quickly to changing marketsSince then 7 more investment professionals have been hired. Their efforts arefocused on:• Tactical Asset Allocation• Hedging Strategies• Manager SelectionThe setting up of Oak Pension Asset Management (OPAM) in December 2010 formalised the centralisation of the investmentdecisions for BUKRF. This meant that the investment team was now an FSA regulated entity and able to provide investment advicedirectly to the Trustees without the involvement of external consultants or managers.OPAM continues to strengthen and further professionalise the schemes in-house investment capacity, while remaining 100%aligned to the interests of the Scheme.BUKRF CIO Key Responsibilities:• Deciding which capabilities should beoutsourced.• Deciding where the In-House team canhave most impact.Tony Broccardo, CIO BUKRFTo Outsource or Not To Outsource?Case Study – In House Executive
  14. 14. Process:• The fund doesn’t attempt to stock pick or manage the assets directly• Instead they utilize external asset class specialists• Focus their efforts on asset allocation, tactical investment decisions and manager selection• Conduct scenario analysis to try and understand all of the risks and opportunities within the fund3 key parts to OPAM:1. Dynamic Asset Allocation• Asset allocation overlay• Hedging mandates• Opportunities over shorter term horizons (< 1 year)• Use of derivatives to switch between markets2. Manager Selection• Dealing with large consultants and managers3. Implementation Team dealing with• Liquidity• Risk Analysis• Stress TestingResults:• Monthly Dynamic Asset Allocation Committee was established• Allowed the Fund to respond quickly in late 2008 to take advantage of an opportunity in leveraged loans• Over the past three years the active strategies overseen by BUKRFs investment team have added about £1bn tothe schemes roughly £16bn defined benefit portfolio.Consultants:• Less work with consultants than other pension funds, more done in house• Work with consultants on a specialist basisSource: Professional PensionsTo Outsource or Not To Outsource?Case Study – In House Executive
  15. 15. 15Board /InvestmentCommitteeSetting strategy ImplementationOPAM - Tony Broccardo, CIO BUKRF• Dynamic Asset Allocation• Asset allocation overlay• Hedging mandates• Opportunities over shorter termhorizons (< 1 year)• Use of derivatives to switchbetween markets• Manager Selection• Dealing with large consultants andmanagers• Implementation Team dealing with• Liquidity• Risk Analysis• Stress Testing• Establish framework/risk budget• Contextualise InvestmentObjectives – return goals vs.balance of risks e.g. Contributionsat Risk• RoadMap and ALM analysis ofexisting portfolio• Propose new investment strategySpecialistConsultant (s)SpecialistConsultant (s)?Investment Bank (s)?InvestmentManager (s)Investment Bank (s)?To Outsource or Not To Outsource?Case Study – In House Executive
  16. 16. Strength of Governance StructureIn-House CIO • Strong governance structure• Emphasis is on Investment Strategy and Asset AllocationExternal Fiduciary • Depends on level of delegation• Final decision on Investment Strategy must rest with TrusteesAlignment of InterestIn-House CIO • Highly alignedExternal Fiduciary • Must juggle interests of many clientsMarket OpportunitiesIn-House CIO • Focused on finding opportunities for one clientExternal Fiduciary • Must juggle interests of many clientsTo Outsource or Not To Outsource?In-House vs. Outsourced Fiduciary
  17. 17. Investment ExpertiseIn-House CIO • Depends on size of governance/cost budget• Team size usually smallerExternal Fiduciary • If large fiduciary, should be strong• Ability to hire investment professionals in many asset classesTransaction Costs / Management FeesIn-House CIO • Size will determine savingsExternal Fiduciary • Large fiduciary can benefit from economies of scale• Strong position to negotiate on feesKey Man RiskIn-House CIO • If small team then risk may be highExternal Fiduciary • Should be lower for large fiduciary managerTo Outsource or Not To Outsource?In-House vs. Outsourced Fiduciary
  18. 18.  In addition... http://twitter.com/robertjgardner http://uk.linkedin.com/in/robertjgardner18© 2010 The Actuarial Profession  www.actuaries.org.ukDirect Line: +44 (0) 20 7250 3416Telephone: +44 (0) 20 7250 3331Redington13-15 Mallow StreetLondon EC1Y 8RDRobert GardnerFounder & Co-CEOrobert.gardner@redington.co.ukwww.redington.co.ukQuestions or Comments?
  19. 19. ConclusionsLarge Schemes (>£500m) – Should hire a Delegated CIO because it focuses attention oninvestment strategy and help put in place a Pension Risk Management FrameworkDepending on the governance budget available, should delegate investments decisions to CIO, benefiting from:• Ability to implement robust Pension Risk Management Framework• Ability to respond quickly to market changes• Delegated CIO focusing directly on the funding level of one scheme• Closer co-ordination between actuaries and asset managers• Responsive, pro-active CIO with authority to implement investment decisionsSmall Schemes (<£500m) – If unable to justify internal option should look at the otherexternal optionsMight be too small to afford In-House approach. If too expensive, should look for an external fiduciary. They willbenefit from:• Bargaining power and negotiating ability of a large fiduciary manager• Access to experienced professionals• Investment in wide range of asset classes• Manager that holistically assesses the risks in the assets and liabilities• Focus on funding level and risk managementThe In-House OptionConclusions
  20. 20. To Outsource or Not to Outsource?Assessing the In-House AlternativeA number of pension funds have already decided to employ Delegated CIOs including:This was the right option for these schemes because:1. Investment Complexity has increased.2. Trustees needed to implement a Pension Risk Management Framework.3. Trustees need to get the key decision for the Scheme right. Investment Strategy4. Creates high alignment of interest between Delegated CIO and Trustees.5. They had the necessary resources.
  21. 21. The In-House OptionKey Features of the Delegated CIOKey Features of a Delegated CIO• Small team of experienced professionals• Focused on one scheme instead of many Greater potential to spot de-risking opportunities First in line for new asset class opportunities• Work closely with Trustees and other Stakeholders• Maximum information flow on liability side• Easier to deal with changing actuarial considerations• Focus on Investment Strategy• Ability to control Tactical Asset Allocation• Interests highly aligned with the Trustees / Scheme• Elimination of some asset management and consultancy relatedcostsPotential Drawbacks• Key man risk• Quality of CIO depends on Governance budget available• Transaction costs – small scheme may pay more than large fiduciary• Cost – extra layer of Governance so extra layer of cost
  22. 22. What is the potential cost versus mandating an External Fiduciary?• Fees for Fiduciary Management can vary, a typical AMC is roughly 20bps.• Fiduciary Management adds an extra layer of governance to the investment process,this in turn can raise costs depending on the size of the Scheme involved.• But by spending an extra 20bps, is this cost outweighed by the benefits of FiduciaryManagement?Where is the BreakevenPoint for developing ateam of In-Houseprofessionals?The In-House OptionWhat is the Cost?

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