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To Outsource or Not To Outsource? Assessing the In-House Alternative
1. Redington
13-15 Mallow Street
London EC1Y 8RD
T. 020 7250 3331
www.redington.co.uk
In-House Professionalism
To Outsource or Not To Outsource?
Assessing the In-House Alternative
16th March 2011
The Second Annual Conference on
FIDUCIARY MANAGEMENT
AND
IMPLEMENTED CONSULTING
5. 5
•Trustee Board (TB)
•Investment Committee (IC)
•Investment Consultant/Actuary
Governance
• TB/IC
• Investment Consultant/Actuary
Objective Setting
• IC
• Investment Consultant
Investment Strategy
• IC
• Investment Consultant
Detailed Asset
Allocation
• IC
• Investment Consultant
Portfolio Structure
• IC
• Investment Consultant
Manager Research
• Investment Consultant
• Fund Manager
Implementation
• IC
• Investment Consultant
Ongoing Monitoring
(Strategy & Managers)
Traditional Advisor Model
Trustee Board /
Investment Committee
In-House
Professionalism
(CIO)
Outsource:
Fiduciary
Management
To Outsource or Not To Outsource?
The Governance Challenge
6. 6
Fund Manager(s)
• LDI/Gilts
•Credit
• Property
• Equity
• Alternatives
Board /
Investment
Committee
Setting strategy Implementation
Investment Consultant
• Work with trustees board to
• Establish framework/risk budget
• Contextualise Investment Objectives –
return goals vs. balance of risks
• RoadMap and ALM analysis of existing
portfolio
• Investment strategy design
• Investment & Portfolio Management
• Implementation of framework
• Ongoing Monitoring
Governance and Investment Strategy
Traditional Investment Consultant Model
7. 7
Board /
Investment
Committee
Setting strategy Implementation
Fiduciary Manager
• Investment strategy design
• Investment & Portfolio Management
• Implementation of framework
• Strategic and Tactical Implementation of
assets
• Monitoring & Reporting
Governance and Investment Strategy
Fiduciary Management
• Establish framework/risk budget
• Contextualise Investment
Objectives – return goals vs.
balance of risks e.g. Contributions
at Risk
• RoadMap and ALM analysis of
existing portfolio
• Propose new investment strategy
8. 8
Board /
Investment
Committee
Setting strategy Implementation
In House Executive/ CIO
• Investment strategy design
• Investment & Portfolio Management
• Implementation of framework
• Strategic and Tactical Implementation of
assets
• Monitoring & Reporting
Governance and Investment Strategy
In House Executive
• Establish framework/risk budget
• Contextualise Investment
Objectives – return goals vs.
balance of risks e.g. Contributions
at Risk
• RoadMap and ALM analysis of
existing portfolio
• Propose new investment strategy
Specialist
Consultant (s)
Specialist
Consultant (s)
Investment Bank (s)
Investment
Manager (s)
Investment Bank (s)
9. Overall
Objective
Risk
Targets
Aspirational
Targets
Scheme
Constraints
9
The pension risk management framework is a market consistent, transparent and actionable tool which is key for any trustee, sponsor or member
Objective Triggers Performance Indicators
What is the overall objective? To reach full funding on self-sufficiency basis By 2020 on a Swaps +75bps with £50m of
contributions p/yr
How will we measure the objective? Using the required return on the Scheme’s
assets
Required Return of assets is Swaps +160bps
What are the primary risk targets? Required rate of Return at Risk (RRaR)
Contributions at Risk (CaR)
RRaR should be no more than 300bps
CaR should be kept below £50m
What is the secondary risk target? Value at Risk (VaR) VaR should not exceed 20% of the liabilities
What are the primary aspirational targets? To increase interest rate and inflation hedge
ratios
Hedge ratios equal to funding level
What is the secondary aspirational target? Dynamic de-risking Based upon regular monitoring
What is the primary Scheme constraint? Liquidity Enough liquidity to pay pension payments
What is the secondary Scheme constraint? Collateral Requirements Enough eligible collateral to cover the 1yr
derivative VaR95
Regular monitoring allows a call to action that enables trustees and sponsors to anticipate and recalibrate the investment strategy
Governance and Investment Strategy
Pension Risk Management Framework (PRMF)
“‘If a man knows not what harbour he seeks, any wind is the right wind’”
Seneca
10. 10
Flight Plan – Projected Cashflows
This 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 Strategy
Pension Risk Management Framework (PRMF)
11. 11
Chairman
Employer nominated
CIO
Employee nominated Independent
Actuaries
Lawyers
Investment
Consultants
Asset Managers
Corporate
Sponsor
Trustee Board
Investment
Banks
Regulator
Product
Providers
To Outsource or Not To Outsource?
Case Study – In House Executive
12. To Outsource or Not To Outsource?
Case Study – In House Executive
Barclays (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, formalising
the centralisation of investment decisions at the Fund
RBS Pension Scheme
• Robert Waugh appointed CIO after leaving as Head of UK Equities at Scottish
Widows in late 2009
• supported by in-house investment professionals
HSBC Bank Pension Trust
• Lesley Alexander, previously of EMI Pensions, appointed as CEO in December
2010
• Phillip Bretnall appointed COO in December 2010
• Mark Thompson appointed CIO in January 2011
13. Case Study: Barclays UK Retirement Fund (BUKRF)
Scheme: Barclays UK Retirement Fund
AUM: £16bn
CIO: Tony Broccardo, first appointed in 2008
Previous 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 Committee
In 2008, BUKRF decided to appoint a CIO and delegate more of the key investment
decisions. The reasons behind this were to make investment decision making:
• More flexible and dynamic in volatile market conditions
• Able to respond quickly to changing markets
Since then 7 more investment professionals have been hired. Their efforts are
focused on:
• Tactical Asset Allocation
• Hedging Strategies
• Manager Selection
The setting up of Oak Pension Asset Management (OPAM) in December 2010 formalised the centralisation of the investment
decisions for BUKRF. This meant that the investment team was now an FSA regulated entity and able to provide investment advice
directly to the Trustees without the involvement of external consultants or managers.
OPAM continues to strengthen and further professionalise the scheme's in-house investment capacity, while remaining 100%
aligned to the interests of the Scheme.
BUKRF CIO Key Responsibilities:
• Deciding which capabilities should be
outsourced.
• Deciding where the In-House team can
have most impact.
Tony Broccardo, CIO BUKRF
To Outsource or Not To Outsource?
Case Study – In House Executive
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 fund
3 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 markets
2. Manager Selection
• Dealing with large consultants and managers
3. Implementation Team dealing with
• Liquidity
• Risk Analysis
• Stress Testing
Results:
• 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 BUKRF's investment team have added about £1bn to
the scheme's roughly £16bn defined benefit portfolio.
Consultants:
• Less work with consultants than other pension funds, more done in house
• Work with consultants on a specialist basis
Source: Professional Pensions
To Outsource or Not To Outsource?
Case Study – In House Executive
15. 15
Board /
Investment
Committee
Setting strategy Implementation
OPAM - Tony Broccardo, CIO BUKRF
• Dynamic Asset Allocation
• Asset allocation overlay
• Hedging mandates
• Opportunities over shorter term
horizons (< 1 year)
• Use of derivatives to switch
between markets
• Manager Selection
• Dealing with large consultants and
managers
• Implementation Team dealing with
• Liquidity
• Risk Analysis
• Stress Testing
• Establish framework/risk budget
• Contextualise Investment
Objectives – return goals vs.
balance of risks e.g. Contributions
at Risk
• RoadMap and ALM analysis of
existing portfolio
• Propose new investment strategy
Specialist
Consultant (s)
Specialist
Consultant (s)?
Investment Bank (s)?
Investment
Manager (s)
Investment Bank (s)?
To Outsource or Not To Outsource?
Case Study – In House Executive
16. Strength of Governance Structure
In-House CIO • Strong governance structure
• Emphasis is on Investment Strategy and Asset Allocation
External Fiduciary • Depends on level of delegation
• Final decision on Investment Strategy must rest with Trustees
Alignment of Interest
In-House CIO • Highly aligned
External Fiduciary • Must juggle interests of many clients
Market Opportunities
In-House CIO • Focused on finding opportunities for one client
External Fiduciary • Must juggle interests of many clients
To Outsource or Not To Outsource?
In-House vs. Outsourced Fiduciary
17. Investment Expertise
In-House CIO • Depends on size of governance/cost budget
• Team size usually smaller
External Fiduciary • If large fiduciary, should be strong
• Ability to hire investment professionals in many asset classes
Transaction Costs / Management Fees
In-House CIO • Size will determine savings
External Fiduciary • Large fiduciary can benefit from economies of scale
• Strong position to negotiate on fees
Key Man Risk
In-House CIO • If small team then risk may be high
External Fiduciary • Should be lower for large fiduciary manager
To Outsource or Not To Outsource?
In-House vs. Outsourced Fiduciary
19. Conclusions
Large Schemes (>£500m) – Should hire a Delegated CIO because it focuses attention on
investment strategy and help put in place a Pension Risk Management Framework
Depending 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 decisions
Small Schemes (<£500m) – If unable to justify internal option should look at the other
external options
Might be too small to afford In-House approach. If too expensive, should look for an external fiduciary. They will
benefit 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 management
The In-House Option
Conclusions
20. To Outsource or Not to Outsource?
Assessing the In-House Alternative
A 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 Strategy
4. Creates high alignment of interest between Delegated CIO and Trustees.
5. They had the necessary resources.
21. The In-House Option
Key Features of the Delegated CIO
Key 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 related
costs
Potential 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. 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 Fiduciary
Management?
Where is the Breakeven
Point for developing a
team of In-House
professionals?
The In-House Option
What is the Cost?
