Trustees from European pension funds continue to be tested by the increasing complexity of the investment decisions that they must make, in order to secure future long-term growth for their funds. Whether it is valuing mispriced assets or providing further programmes to 'get risk off the table', trustees and their advisors recognise that much closer attention is needed in terms of managing assets and liabilities. Pension fund trustees based in Germany, the Netherlands and the U.K. have started to appoint advisors. These advisors include traditional consultants offering a fiduciary management type of service, as well as boutique solvency and fund managers. One of the reasons why the appointment of advisors is growing is the limited pool of in-house investment talent at the underlying pension funds. This is particularly prevalent for mid-size pension funds, where sponsors struggle to devote further resources to this pursuit.

For these reasons, trustees continue to grapple with understanding 'best practice' and the levels of delegation they should consider, while ultimately knowing that in many countries they will retain the overall fiduciary responsibility for their pension fund plans.

In the last few years, the concept of fiduciary management has begun to take hold in the Dutch pension market. Fiduciary management represents a delegation of services along the investment chain ranging from strategic asset allocation (through an asset liability modelling exercise) to manager selection, to monitoring and reporting. This has been highly successful in the Dutch market. Blackrock estimates that up to £300 billion could be outsourced to fiduciary managers by U.K. pension managers in the next three years.1

The concept is also beginning to take hold across other countries in Europe, in particular the U.K. and Germany, albeit the terms used may differ, for example 'implemented consulting' or 'solvency management'. The term 'fiduciary management' is somewhat confusing, since in many countries trustees of pension funds cannot legally outsource their fiduciary responsibility to a third party.

The Fiduciary Management Model
So what does a fiduciary management model look like and what impact has this change in governance had on the role of custodians? The chart below shows how the relationships between an underlying pension fund, fiduciary manager and custodian could work.

In a fiduciary management mandate, the custodian would become an integral part of the relationship and would provide the necessary information to all parties to help the trustee measure and monitor the overall investments.

While fiduciary management mandates can vary, many trustees employ a fiduciary manager to efficiently manage the overall solvency of their pension fund and/or help them implement a manager structure. Part of managing the solvency could mean implementing a liability matching strategy through the use of derivatives, such as inflation and interest rate swaps. Monitoring such strategies and managers often forms a critical part of the fiduciary manager's responsibilities.

The custodian's role in providing services such as performance measurement, accounting and independent valuation of OTC derivatives is just as important when a fiduciary manager arrangement is in place, but the custodian needs to be able to interact with the fiduciary manager. The custodian's role and the services it needs to provide are unlikely to change in the near future, except that there is an additional relationship to manage (i.e., the fiduciary manager in its capacity as the agent of the pension fund).

Our Findings
At this year's J.P. Morgan's EMEA Pension Fund and Charities Summit, held in London and themed "Effective Governance-Focusing on the Key Issues," a key finding was that the advisory concept is here to stay, given the increasingly challenging and complex world pension funds now face, exerting strong pressures on their own governance models.

To garner further insight, we surveyed our audience, a significant proportion of which were U.K. pension fund trustees. The key results are shown below.

The survey showed that the concept of fiduciary management is gathering momentum in the U.K. market, with 27% of respondents already having a mandate in place and another 26% considering such a mandate for their funds. The chart above shows some true versatility in a fiduciary management mandate and its adaptability to suit individual pension funds needs. Within the U.K. there is a marginal preference for this type of mandate to be applied across the entire fund (58% in favour) rather than part of the fund.

Summary
Fiduciary management is an outsourcing approach to pension fund management which involves appointing an external organisation to provide investment advice, implementation and oversight, subject to the instruction of the fund's trustees. Fiduciary management is a significant trend that is likely to continue within Europe, which is significant as such trends are usually seen coming from the United States and not Europe.

J.P. Morgan is well positioned to partner with trustees as they evolve the governance models of their pension funds and implement new solutions. Our practical experience of working with fiduciary managers in the key European markets—the Netherlands and the U.K.—has given us invaluable insight into the working of fiduciary management which, we believe, will benefit our clients.

1. Source: Professional Pension, 6 Nov 2008