A scathing report into the United Kingdom’s £275-billion ($441-billion) defined contribution pension sector by national watchdog the Office of Fair Trading that lambasts high charges and complexity could have gone further say modern, low-cost pension providers. The OFT has agreed a range of reforms to the workplace pension market after its study found millions of savers weren’t getting value for money. “We do not feel they have been sufficiently radical in their approach,” says Jamie Fiveash, director of customer solutions at B&CE, a provider of workplace pensions with more than $3 billion of defined contribution assets under management in schemes that include The People’s Pension, a super trust set up in 2011 ahead of auto-enrolment. “It should be much easier to make pension transfers from old and poorly governed legacy schemes into large scale, modern and well governed schemes.” Secondly, he argues policy makers should introduce an industry-wide charging structure to allow for informed choices. “This will ensure competition on products and service delivery rather than on obscure charging mechanisms, inevitably leading to the driving down of prices,” says Fiveash.

Morten Nilsson, chief executive of NOW: Pensions, a defined-contribution workplace pension scheme provider and UK subsidiary of Danish public pension plan ATP, adds: “To help employers select a scheme that is fit for purpose and is going to deliver on its promises to members, we support the OFT’s recommendations. The success of auto-enrolment will depend on the ability of providers to build trust and earn confidence among their members. If members don’t trust their provider and see their hard-earned pension pot being eaten up by high charges and their fund performing poorly, the motivation to stay enrolled with be sorely tested.”

The OFT’s findings, gathered from a six-month investigation into the defined contribution market, raised concerns around older schemes set up before 2001 in which savers are paying charges of 1 per cent or more. It is estimated that $48 billion is locked in these schemes run by insurance firms and trust boards. They account for around 190,000 savers, who could be losing around 20 per cent off the value of their pensions. Such charges contrast with the new wave of defined contribution providers, which include government-backed scheme, the National Employment Savings Trust (NEST), whose charges gravitate around 0.5 per cent of a saver’s pot. Auto-enrolment is expected to see 9 million extra people joining defined contribution schemes over the next five years.

Mea culpa

In response to the criticism, the Association of British Insurers (ABI), whose members offer many of the criticised schemes, has agreed to carry out an audit of the larger schemes, some of which are charging up to 2.3 per cent in annual management fees. Elsewhere, Legal and General has recently introduced caps on charges for auto enrolment workplace pensions at 0.5 per cent, a price cap that will not apply to members who want more investment choice than the default fund.

The report also highlighted a lack of competence among trustees responsible for running some schemes and raised concerns about savers in 3,000 smaller pension schemes, collectively worth about $16 billion and with 1,000 members or less, who may be at risk due to poor governance. Active member discounts (AMDs), which hike charges when an employees move jobs but don’t take their pensions, also came under fire. “We welcome the OFT proposal that all schemes, including contract-based ones, should have governance committees to help serve consumers’ interests. We have found that consumers are particularly reassured by NEST’s independent governance, which has members’ interests at heart, and the fact we are run on a not-for-profit basis,” says NEST chief executive Tim Jones.

Stand and deliver

But pension experts also believe the OFT was right to stop short of recommending a cap on charges levied by providers, and that charges will continue to fall. “There has been a slow reduction of charges through market pressure in the defined contribution world ever since 2001, when stakeholder pensions where introduced,” says Alan Morahan, principal at Punter Southall DC Consulting in London. “If the government had set a cap at 0.7 per cent, it would abate the downward movement. On the other side of the coin, a 0.3 per cent charge might be too low for schemes to be viable.”

The closure of defined benefit schemes and the introduction of auto-enrolment is expected to bring a “tsunami of money” to defined contribution schemes, warns Morahan. “Unless they get charges right, and also investment performance, administration and saver engagement, there is a danger they won’t deliver.”

The Robert F Kennedy Centre for Justice and Human Rights and Columbia University’s Earth Institute will run a series of high-level courses on sustainable investment focused on environmental, social and governance approaches as well as human and labour rights this autumn.

The Compass Sustainable Investing Certificate program, designed for long-term investors, will have a solutions-driven focus showing investors how to mitigate risk and improve returns. Looking at sustainable investing across all asset classes, the course aims to correct the misperception that sustainable investment underperforms and offer ways to invest sustainably with tools other than negative screening. It will feature keynote speakers from a stellar faculty and networking sections in a participation-driven approach over two weekends.

The course takes place over six days on October 18, 19 and 20 and December 6, 7 and 8 at Columbia University, New York City. Email kaul@rfkcenter.org, call 646-553-4753 or go to www.RFKCompassEd.com.

Recent reflections on this month’s five-year anniversary of the Lehman Brothers collapse have focused on a variety of developments since the crisis: from reform to remuneration, sovereign debt to shadow banking, and from offshore tax to the Occupy movement.

However, one significant area that has been largely overlooked has been the rise of sustainable and responsible investment among the institutional investment community.

Since the global financial crisis struck, the responsible investment industry has grown rapidly into mainstream finance. For example, in 2008 the United Nations-backed Principles for Responsible Investment (PRI) had around 350 signatories. They’ve now tripled to over 1,200 signatories, who are estimated to manage around a fifth of the world’s capital. We’ve also seen the wide adoption of stewardship codes in the United Kingdom and elsewhere, along with voluntary and compulsory regulation to encourage transparency.

Even the banking sector has been working on its sustainability. EIRIS has extracted data from its Global Sustainability Ratings to compare the environmental, social and governance (ESG) risk management score of the banking sector and found that it has risen over five years from 2.79 to 3.06. This score is based on criteria that assess how well the board and senior management address company-wide ESG risks and opportunities at over 150 of the world’s biggest banking institutions.

That analysis is good news for institutional investors – it shows that reforms have helped make the banking sector safer and more sustainable – but it also needs to be put into context. The average sustainability score for all sectors is actually 3.3, which means that the banking sector still performs worse on sustainability than many controversial sectors such as pharmaceuticals or oil and gas. That may help to explain some of the continuing flow of ethical lapses that the sector has faced in the last few years, from LIBOR fixing to money laundering.

Another anniversary this month shows that the rise in responsible investment also needs to be put into context. That it is actually part of a longer term trend, which still has some way to run.

30-years old today

Thirty years ago today, EIRIS, the organisation I work for, was formed, helping give birth to the ESG research industry in Europe.

Back in 1983, responsible investment as we know it barely existed. Thirty years ago, we had just one asset management client (the Friends Provident – now F&C – Stewardship Fund) and it was a challenge to find any corporate information on sustainability. Now we serve 150 institutional investors and research around a million sustainability data points each year across 3,000 companies spanning 46 countries.

This sort of growth has not happened only as a response to the financial crisis. The global downturn, sparked by Lehman’s collapse, has been more of a catalyst than a creator for the boom in responsible investment.

As is the case with the banks and sustainability, there is also still a long way to go when it comes to institutional investors and responsible investment. Research by the PRI in 2011 showed that despite the large number of institutions it had signed up, still only 7 per cent of the global market was subject to ESG integration by its signatories. That’s a figure I’ll be attempting to drive up following my election to the PRI’s advisory council this month.

In the next five years responsible investment needs to make even faster progress. Rising global demand for food, energy, living space and water, as well as the challenge of dealing with climate change, mean sustainability issues will only become more material to mainstream investors in the years to come.

Banks and institutional investors alike still need to show that they can manage ESG issues in a way that makes individual portfolios, and global finance as a whole, much safer for the benefit of all participants in the investment chain.

Peter Webster is chief executive of EIRIS, an ESG research agency dedicated to empowering responsible investment. For more information visit eiris.org or follow on Twitter @EIRISNews

The herd mentality of investors has been agonised over for as long as markets have been around. The dilemma is often raised of whether to participate in or shun market trends, but the DKK150-billion ($27-billion) Sampension has succeeded recently with a selective approach. It has fully embraced the institutional diversification movement by building a significant alternatives portfolio, but has been content to move in for some rich pickings as other investors fled the bonds of outcast European sovereigns.

The fund estimates it made over $180 million in 2012 by buying Italian sovereign debt instead of Danish – at a time when investors were treating government paper from Rome with disdain. Sampension calculated calmly that the market reaction was excessive, given that the country was introducing reforms it felt were genuinely beneficial in an effort to keep yields down – and the bonus returns seemed to prove the Danish fund right.

Chief investment officer Henrik Olejasz Larsen reveals that much of Sampension’s Italian debt exposure has this year been switched to another unfavoured European destination, Spain. “We have seen a rapid improvement in the economic conditions in Spain,” Larsen says.

Beyond getting extra returns or proving to be in a wise minority, Larsen explains that Sampension’s faith in the European periphery is also motivated by a desire to hedge against future interest rate rises. “Peripheral debt will hedge rising interest rates in Denmark and Germany if the situation in Europe stabilises,” Larsen argues.

A European stabilisation is indeed what Sampension expects, as was reflected in a recent decision by the fund to slightly upweight its European equity exposure. “We think there will be improvement beyond what is priced into the markets,” says Larsen. That indicates the foundations of the fund’s European enthusiasm – not a denial of the problems the continent faces, but a feeling that investors have over-reacted. “We don’t think the euro crisis is over, but there is political will to kick the can down the road and do whatever it takes to keep the currency together. There may be small surprises ahead, but we don’t see any great catastrophes,” he states.

Alternative bedrock

Sampension has also notably developed a 13 per cent alternatives allocation. Larsen says that its above-average stake in the asset class has been made possible by its large size bringing added capacity and also an unusually stable membership reducing liquidity needs. Half of the alternatives bucket is invested in real estate, with the remainder taken up by private equity, infrastructure, forestry and global macro hedge funds.

Larsen has found that Sampension’s alternatives portfolio has risk/return qualities common to more liquid assets, with the exception of private equity, which has been offering superior returns. He is confident that the broad scope of assets invested by Sampension’s alternative team gives it potential to quickly adopt promising new assets. That is something the fund will likely need to do too as it eyes a 20 per cent alternatives allocation to reflect an increased risk budget, resulting from the continued development of its new unguaranteed pension offering.

Like most Danish pension investors, Sampension is aiming to extend its infrastructure allocation, which currently amounts to a small exposure to listed infrastructure funds. It has been actively seeking unlisted funds and projects for direct investing without any success so far, as risk/return qualities have yet to appeal, says Larsen. He has pledged to intensify this effort, reflecting that “we were spoilt for choice for a long time with real estate and credit opportunities, but these are drying up now”.

Sampension has joined its fellow Danish funds in lobbying the government for greater public-private partnership opportunities. The supply of projects so far has been “disappointing” though, Larsen says. Another setback came as Sampension was part of a consortium offering to fund a real estate project on Copenhagen’s harbor front, only for the government agency in charge of the process to pull the plug due to a lack of other bids. Discussions about getting Danish institutional funds into infrastructure projects are ongoing though, and Larsen floats the possibility of national projects in the construction and maintenance of public buildings as a potential breakthrough.

Beyond infrastructure, Larsen reveals that Sampension is also looking into offering direct lending in lieu of banks. “We have been trying to find exposure by negotiating with banks, but nothing has come of this so far,” he says, although Sampension is now finalising a European senior real-estate-loan fund investment.

Sticking up for CLOs

Another way in which Sampension seemingly bucks majority thinking is in its continued enthusiasm for investing in AAA collateralised loan obligations (CLOs). Larsen thinks they offer a decent hedge against a rise in government bond yields. “CLOs’ bad reputation during the financial crisis is not reflected in our good experience of them,” he argues. In his view, solid internal processes helped Sampension avoid losses on these assets, but Larsen reckons the poor sentiment towards CLOs is fundamentally undeserved.

On the whole, Sampension has some 69 per cent invested in bonds – although Larsen explains other asset classes are becoming more significant as guaranteed-liability products become less prominent in Sampension’s offering. While the equity allocation is low across the board, a substantial recent 10 percentage point increase in equities for young unguaranteed pension savers reflects Larsen’s future market outlook. “We will see a prolonged underperformance in low-risk bonds and a lower risk for a setback in equities,” he predicts.

Another key part of Sampension’s investment strategy has been interest rate hedging. While this helped the fund to huge returns of over 20 per cent for its traditional guaranteed offering in 2011, Larsen says this position has resulted in substantial investment losses in 2013. These investment disappointments have been fully compensated for by reduced liabilities, however.

A negative result for the guaranteed product can be expected at the year-end, Larsen reckons, with a healthier 3.8 per cent result coming for the first half of the year across the unguaranteed product. He remains optimistic that as Sampension’s unguaranteed offering becomes more important, there will be plenty of chances to explore new alternatives and make more shrewd investment calls within an increased risk budget. Given the fund’s recent success in judging market overreactions, there may well be other investors casting an interested eye on its future calls.

Roger Urwin, global head of content at Towers Watson and governance specialist, says most organisations don’t spend enough time on it, but transformational change is all about giving time to investment governance.

Culture and leadership, for example is so self-evidently important in people organisations and yet it is understated in asset owners, he says.

“The soft stuff really matters. You have to get the right people on the bus, but you also have to get the wrong people off the bus,” he says. “Culture and leadership, and talent and reward are not talked about. Why not? They are key to asset owner performance. This industry has strong managers, but not strong leaders. Leadership is principled, prioritised and very personal, and we need it in the community.”

Effecting change

Before a board embarks on investment policy work, Towers Watson’s transformational change model says mission, values and goals need to be established, and organisational effectiveness needs to be looked at. This includes culture and leadership, talent and reward and the value chain relationships.

Then investment policy work, including strategy, asset allocation, manager selection, and client delivery, can be honed. Execution, which includes actions and decisions, and measurement and review is the last step.

Urwin has recently worked with RailPen in the UK, CalPERS in the US and a large UAE sovereign wealth fund on transformational change and says execution plays a key role in success.

“These funds are all interesting to learn from. They all had big journeys and have come out feeling confident about their future. The key is execution; not what you did, but how you did it.”

This is all supported by a research paper conducted in 2007 by Urwin and Professor Gordon Clark from Oxford University that shows the key differentiator of the top performing funds was they were excellent in execution: whatever they did, they did well. But Urwin says it has to be self-generated change.

“We are living in a world of complexity and competition. There is a war for talent, it’s a low-yield environment and there is intense competition for returns. Also the bargaining power of external managers means large asset owners have an opportunity to do something different.”

The strength of differentiation, alignment of strategy and good execution are all part of this journey.

“Funds need to recognise the importance of investment governance, incorporating a new investment model, transforming organisational design and behaviours through top-down and bottom-up work.”

Super majority rules

Urwin works with boards, investment committees and the executives of funds to facilitate change.

He says investment beliefs have to be established at the board and executive level then brought together in a system that allows for the ambiguity within which investment decisions lie.

“Consensus is the lowest common denominator in boards, but it’s the dominant governance model,” he says. “There is a lot of inertia around the existing situation and not a lot of action. That’s a culture that’s grown up which should be challenged. A super majority is a good ploy.”

In establishing its investment beliefs, the CalPERS’ board recently used this strategy, with the votes requiring a two-thirds majority to be passed.

“Investment is decision making under uncertainty, so it is always marginal. A 3:5 vote is commensurate with that type of situation.”

The big elephant in the room, according to Urwin, is that investment committees tend to have many promising discussions, but few good decisions are actually made.

“It’s not time well spent on committees. There is too much oversight without insight. There needs to be more insight and engagement with executive teams who are increasingly senior people, so the investment committees need to be more like peer-to-peer relationships.”

 

The National Employment Savings Trust, NEST, the UK government-backed pension scheme set up a year ago with the introduction of auto-enrolment, developed a new allocation to real estate this summer. Now it is planning to add infrastructure to its illiquid allocations in a move reflective of a change of thinking to embrace more risk. NEST’s infrastructure foray is most likely to be via a blended infrastructure fund investing in both listed and direct infrastructure, explained chief investment officer Mark Fawcett at a recent National Association of Pension Funds (NAPF) investment strategies conference in London, where he urged defined contribution schemes to “break the mould” and push greater diversification. “We might add other illiquid assets and we are looking at infrastructure,” says Fawcett, who joined NEST from boutique investment manager Thames River Management. “There are good parallels between infrastructure and real estate. We are looking for growth-seeking and income-generating assets.”

With £11 million ($17.6 million) under management so far, NEST’s assets are forecast to reach $240 billion by 2050. Allocations in the Growth phase portfolio are divided between equities (50 per cent), real estate (20 per cent) and fixed income (30 per cent), where the portfolio includes corporate bonds and emerging market debt. Although NEST has been in talks with the NAPF’s Pension Infrastructure Platform (PIP), which says it is keen to have defined contribution investors, its need for continuous cash flow and the challenge of infrastructure being “lumpier than real estate and the cash flow varying” makes a blended fund a more likely model. The challenge is to now find the right low-cost manager, says Fawcett. “We are not in the business of paying 2 and 20.”

The property push

The push into infrastructure follows on from NEST’s 20 per cent real estate in the Growth phase allocation made last July. “It did raise eyebrows because it is a high allocation for a defined contribution fund, but it makes sense,” says Fawcett, adding that in Australia the allocation would “be double”. It’s an exposure that comes via Legal and General Property’s Hybrid Property fund in another blended strategy gaining exposure to listed and unlisted property. Here the hybrid structure comprises a 70-per-cent weighting to a UK direct property fund, with the remainder weighted to passively managed listed real estate via a global real estate investment trust (REIT) tracker fund. The addition of the global listed fund enables access in a daily priced, daily dealt manner with a greater amount of liquidity. The management charges are lower, the spread is reduced and there is international diversification, explains Fawcett. “We chose the hybrid because it is cash-flow positive and we thought direct real estate could be lumpy. We will think about a global direct allocation over time. We are aware of the leverage in REITs and that the shares are more volatile because of that leverage.”

Regulation and the members’ market

One of the biggest hurdles facing the pension provider’s new illiquid allocation is the daily dealing and pricing requirements placed on defined contribution schemes – that not the norm in defined benefit funds. These tend to rule out any type of unlisted property fund. One answer has come via NEST’s own internal market and its ability to trade illiquid assets between its own members, with older members selling assets to younger ones able to take on more liquidity. “We are doing this with real estate and are thinking about how to do it with infrastructure to ensure fair transfer between different members,” says Fawcett. NEST is currently working with another pension fund that has set up an everyday proxy to measure the price for infrastructure assets using an index which tracks the daily price movement.

Phase-sensitive allocations

Investment strategy at NEST, where Fawcett says the emphasis is “to get away from the peer group comparisons”, is honed for three distinct periods. For young savers in the Foundation phase, strategy is low risk, aiming for returns that match inflation and encourage saving. The Growth phase, typically lasting 30 years, targets returns of inflation plus 3 per cent in a diversified strategy. The final Consolidation phase invests in inflation-matching assets to de-risk. It seems that in the Growth phase, real inflation-linked assets are increasingly attractive over gilts and bonds. “Big defined contribution schemes should expand into other asset classes,” says Fawcett. “Defined contribution has not got to grips with what real estate has to offer.”