Good governance critical for retirement funds

By Bart Heenk, Managing Director of UK-based Avida International

Good governance critical: Retirement funds should run like a business

Structural changes to the global investment environment require retirement funds to adopt far more stringent governance procedures and risk management practices, as the industry becomes increasingly regulated and much more complex, according to Bart Heenk, Managing Director of UK-based Avida International.

Speaking at the recent Sanlam Investments Institutional Insights conference in Sandton, Heenk said that retirement funds should be run like a well-oiled business. This did not mean, however, that pension fund boards had to be dragged into operational investment decisions.

To the contrary, in fact.

Outsourcing is the new trend

“If there is a need for more complex portfolios to mitigate against risk — for example the use of derivatives such as options — the task should be outsourced to the experts,” he said. “Instead of wasting their time trying to add value to the investment process, trustees should rather focus their efforts on how to improve their members’ benefits.”

This is where the trend of outsourced models such as investment consulting (also known as ‘implemented consulting’) and fiduciary management have become so popular in recent times, as they free up trustees to focus on their members’ outcomes.

Because increased complexity requires expertise at fiduciary, managerial and operational levels, most trustee boards are now delegating the decision making to the experts: investment committees, investment consultants and fiduciary managers.  However, it is essential that they still remain part of that investment decision making purpose.

Heenk said the onus was on trustee boards to look at the big picture with regard to benefits and tailor their governance and oversight frameworks according to strict “fit for purpose” guidelines. This would require fund custodians to extract maximum value out of supplier relationships in order to achieve the long-term financial goals of their members.

Risk management to be stepped up

Retirement funds worldwide face stiff headwinds in the form of rapidly reducing workforces and rising longevity, which puts an immense strain on dependency ratios — the number of contributing workers required to sustain pension payout obligations. This was becoming increasingly unaffordable, and pension deficits were fast becoming a reality.

Coupled with this, members received fewer tax incentives during their accrual phase and were being hammered by higher taxes on their benefit payments.

In terms of investment, the global macro-economy was likely to remain in a protracted period of low interest rates. This meant asset managers were forced to take on more risk in the search for yield. Boards of trustees were therefore compelled to jack up their monitoring and administrative functions to keep an eye on the big picture, which was their members’ benefits.

Good governance is crucial

“There has been a loss of trust in financial institutions, including retirement funds. Boards now have to prove their value for money as custodians. It is up to them now to improve their transparency and demonstrate that better governance translates into better returns.”

Heenk said boards need not worry that they would dilute their fiduciary responsibility by outsourcing complex investment decisions to experts. “Boards remain legally and morally responsible for their members’ assets, yet operational functions such as compliance and manager selection could conceivably be delegated to specialists  — particularly if the board lacks experience in such matters.”

Diverging views surround the issue of whether the costs involved in outsourcing would be better spent on internal investment teams. Heenk said pension funds in Scandinavia preferred the in-house option, cutting out the middlemen and their fees, while those in the Netherlands outsourced hundreds of billions of euros to outside partners, reducing internal operational risk.

“Whichever option is taken, the key is to establish a framework for permanent governance and oversight. On a rolling basis, boards must evaluate performance, identify gaps and objectives, and set targets for rewards. Only in this way, by running as a fit-for-purpose business, can pension fund trustees consider themselves proper fiduciary managers.”