SPECIALREPORT

PensionsInsight / June 2010www.pensions-insight.co.uk

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The investment solutions availableto pension funds have come along way since the days when

‘balanced’ mandates were the mainstayof portfolios. But with increased sophistication comes increasedcomplexity, in particular in the field ofperformance measurement.

From equity funds with specificstrategies to whole new classes ofinvestment such as hedge funds and nowmulti-asset funds behaving like a wholeportfolio in one basket, the challenge fortrustees and advisers is how to assess theirperformance. Have performancemeasurement tools kept up withthe pace of innovation?Measuring theperformance of the fund manager formany of these newer types of strategiescan be tricky. For example, there maynot be an appropriate benchmark foran equity fund that seeks to benefit from‘European recovery opportunities’so how can one tell whether the fundoffers reasonable returns for the risk itposes?

Traditional index benchmarks arealso less useful and less timely for illiquidasset classes such as property and privateequity. The problem is compounded inmulti-asset funds as the balance of riskyand non-risky assets is constantly changing.

To get around this last problem, thetrend is for ‘absolute return’ productssuch as DGFs and hedge funds to be

measured against a performance targetsuch as Libor, or RPI – typically aimingto achieve around 3 or 4% above thatfigure. Richard Warne, global strategydirector of the institutional business atAviva Investors, says: “This form ofbenchmark is a much better way fortrustees to assess whether the assets’performance is matching the liabilityprofile and gives a much better way tocompare the performance relative toinflation and interest rate risk.”

Mike Allen, head of research atRMB Asset ManagementInternational, says that evaluating theperformance of multi-asset funds, suchas their own diversified target funds, isas much a qualitative as quantitativeprocess. “There is no quantitative magicwand to evaluate multi-asset funds.Pensions managers need to understandhow risk is managed in the fund. It is notjust the end number but how you getthere – reducing volatility is the key.”

Allen says that schemes should focuson outperformance net of fees and howwell the fund has coped with marketshocks in the past. “You have got tolook at the performance over a longerperiod – short-term performance doesnot tell you anything. You need to seehow a diversified target fund performsin a stressful environment.” Such fundsclaim to produce equity-like returnswith less volatility and downside: “it isabout testing those points. You need toassess how the fund performed duringthe Dubai crisis last year and the Greececrisis this year, for example.”

Risky businessThere are, however, many other risks to an investment than just its volatility.Chris Woods, managing director atFTSE group, says: “Volatility is a usefulbut incomplete measure of risk.”

Investors can be lured into a falsesense of security by an asset class withlow volatility. Phil Boyle, partner at LaneClark and Peacock, says: “There’s anold market adage that if something lookslike it is low risk it just means that youdon’t know what the risk is yet.”

The global financial crisis highlightedliquidity and counterparty risk. WhenLehman Brothers collapsed, pension

funds scrabbled to discover whetherthey had been a counter party to theswaps they had purchased to managetheir interest rate risk.

However, perhaps a more significantproblem to be exposed by the financialcrisis was a failure of liquidity, the abilityto trade assets. When the credit marketsdried up, many asset classes sufferedbut it was particularly difficult for hedgefunds and property – assets becameimpossible to sell so the fund managerscould not return money to investors.

Warne says: “Asset classes like hedgefunds and property are often highlyilliquid. If trustees decide to put moneyinto these investment strategies, theymust ensure that they are getting goodreturns for giving up their liquidity.”

Measured and managedSo what should pension trustees do toaccurately assess all these different risksof their pension portfolio and see howwell their investment managers wouldcope with a crisis?

Pension consultants are advisingtheir clients to carry out much moresophisticated tests. Boyle recommendsbuilding a correlation matrix ofdifferent asset classes to capture theextent to which different assets movetogether on an ongoing basis.

To get the best possible picture,however, Boyle says that pension fundsshould undertake a scenario analysis oftheir portfolio. Scenario analysis entailsidentifying possible outcomes for theeconomy and considering how each ofthe scheme’s investments would beaffected. It can highlight that, forexample, a scheme may be particularlyvulnerable to a sharp increase ininflation and allow them to dosomething about it. “Funds can takedifferent types of historical events orpossible future events and considerwhat impact these would have on theirasset/liability profile,” says Boyle.

Timely informationIn the wake of the financial crisis, thereis an increased appetite among trusteesto monitor their portfolio beyond theboundaries of quarterly boardmeetings. New tools and services are

evolving to support thosedemands.

Paul d'Ouville, head ofNorthern Trust's global productmanagement group for asset servicing,offers a service that gives its clientsaccess to real-time information on theirportfolio. “We’ve seen an increaseddemand from our clients to accessinformation on their portfolio to seehow volatility is impacting its value andto provide information on how theirmanagers are performing relative tothe benchmark.”

For the last 18 months SummitGlobal Investor Services has beenoffering an alternative platform wherepension managers can monitor theperformance of their fund managerson a daily updated basis. Itautomatically produces reports, toparameters bespoke to the scheme, thatthe trustees can read prior to meetings.“The aim is to empower trustees andpension scheme managers to deal withinvestment managers and consultants,”says Andrew Caird, managing directorof Summit. “If they can see what ishappening then they can make betterdecisions.”

Such analytical tools allow schemesto assess the performance of theinvestment manager and also highlightwhere fees are being incurred – whichcan sometimes come as a surprise. TheSummit system, for example, allowsschemes to identify how much cashthey are losing through commission,the buy/sell spread, delays, custody feesand management fees but perhaps themost important factor is foreignexchange costs, which vary due tomarket timing. “Asset performance isonly one variable. Schemes need totake a more holistic approach and getthe bigger picture,” says Caird.

Whatever tools trustees use tomonitor the performance of theirfunds, synthesising that informationtogether to get an overall picture ofhow assets are performing relative toliabilities will increasingly be the focusof trustees’ measurementrequirements. That can ultimately onlybe tracked on a scheme-by-schemebasis. ■

Performancemeasurement needsto keep pace with thelatest investmentstrategies, saysCharlotteMoore

Illustrations by Evelina BeckersbenchmarkBeyondthe

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As a society we have grown quickly accustomedto information being instantly and widelyaccessible, from wherever we happen to be.Think how Google and the mobile internet havealtered the way we shop, travel and negotiateour lives. There is even mobile software thatallows a shopper to walk into a store, scan thebarcode on any item of interest with their phoneand see immediately where it could bepurchased more cheaply.

Few would deny that technology is improvingour daily lives. Yet, despite all the advances andbenefits of the internet, the breadth ofinformation and instantaneous access it offers –client reporting in the institutional investmentindustry has remained essentially static for thelast 15 years. Consider performance reports.They are fundamental to all investors, but howsignificantly have they evolved over the last twodecades?

The majority of investors are heavily reliant onperformance figures for measuring assetmanager effectiveness, and most receive thesereports in hardcopy. What’s more, these reportsarrive 15 days after month end, and only on aquarterly basis.

Modern technology that has made oureveryday lives so much easier could beharnessed to do the same for institutionalinvestors. It is commonly acknowledgedamongst institutional investors that traditionalanalytics suffers from lack of flexibility, delayeddelivery, questions over accuracy, littletransparency and high acquisition costs. Thisstate of affairs is all the more puzzling when youconsider the other trends that have affected ourindustry over the same period of time:■ Investment strategies have become vastly

more complex■ Many more asset managers are involved in

the average portfolio■ Pressure on resources has increased ■ Greater and more varied regulation.

From the perspective of an institutional investor,we can only conclude that the wheel isprofoundly broken, and a change to the statusquo long overdue.

Modern solutions for today’s investorsSummit Global Investor Services has developeda range of online tools targeted specifically atthe needs of institutional investors. Whereasmost analytical software is designed for assetmanagers and custodians, enabling them topush standardised reports out to theirinstitutional clients, Summit’s online frameworkis built for the investors themselves. With asingle analytical framework, incorporatingperformance, attribution, risk, transaction costs,FX monitoring, buy-and-hold comparisons andmore, Summit aims to put those bearing theresponsibility for investments back in control.

Investors can now replace traditional analyticswith state-of-the-art online tools that are notonly more intuitive and user friendly, but willprove vastly more economical and deliver realenhancements to their operational efficiency.This type of system greatly reduces timelinesbetween decision making and the resultinginvestment information being made available. It adds flexibility in reporting formats andfrequency, improves internal communication,delivers information to the specific depth andbreadth required by each user and greatlyenhances governance over invested funds. Inshort, the game has moved on, leavingtraditional performance measurement behind.

The use of modern tools unlocks vast amountsof detailed information, and enables investorsto analyse ever more data. But this approach isneither about micro-management nor neglectingthe long-term aspect of institutional investment,but rather about creating an open environment

where investors, asset managers andconsultants can come together and work fromthe same page. Where the investor has controlover their own reports and the level of detailcontained in those reports. Wherereconciliations and compliance monitoring iscarried out automatically on a daily basis andparties are notified only when required.

An iphone application is probably a step toofar at this point in time. But given the righttechnical architecture, there is nothing toprevent a trustee, after learning from theevening news that BA has reported record lossesthat day, from looking up their holdings andgaining immediate insight into the impact this ishaving on the investments they are responsiblefor. That same trustee, instead of receivingoutdated reports at meetings, should haveaccess to online tools enabling them to arrive atthose meetings already informed or even log into their investments while in the meeting. Thiswill allow them to ask pertinent questions onthe spot and, in the process, reduce the timedelay before making informed decisions.

In light of recent global events, governanceover institutional funds has become increasinglyimportant. Pension fund managers, trustees andplan sponsors who use this kind of technologywithin their scheme management process cansleep a little more soundly at night. They knowthat they have the tools to provide instantaccess to their holdings and trading information.They can take comfort from the fact that theiranalysis and reporting is being carried out in anautomated online environment, and that dailyinvestment activity is being continuouslymonitored through systematic checks andaudits. They know that they are in control.

Technology is finally catching up with performance reporting, says Andrew Caird

Expert view

The changing face ofinvestment analytics

PensionsInsight / June 2010www.pensions-insight.co.uk

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Andrew CairdManaging Director at

Summit Global Investor ServicesFor more info call 020 7877 0012

or email at andrew.caird@summit-gis.com

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