Issue: December 2012 / February 2013
Questions that trustees commonly ask are answered. Best advice on how consultants should be used.
At the SIM-sponsored African Cup of Investment Management in Cape Town, a panel of consultants was put through its paces. The panel comprised Andrew Davison (Acsis), Mxolisi Mbekwa* (Selekane), Clive Eggers (Brockhouse Cooper) and Michael Prinsloo (Alexander Forbes).
Discussion was lively, so lively that the time constraint made it impossible not only to complete the series of intended questions but also fully to record all the answers. Here then is a summary of written replies subsequently received.
What services do consultants actually perform? How do they base their fees? Do they add value in relation to the fees charged?
AD: Key should be to empower the client’s decision makers, in this case the retirement-fund trustees, to make better decisions. Fees are either a rand retainer or a percentage of assets. If the consultant succeeds in helping better decisions, he can add substantial value.
MM: Services include advice on asset-liability matching, investment policy and strategy formulation, portfolio construction, asset-manager selection and monitoring of the programme.
CE: Yes, all these. But don’t forget trustee training and member communication too. You’re asking consultants whether we add value?
MP: Asset managers worry about only one half of the problem – to achieve a funding requirement of say cpi+5% – which misses many of the critical factors impacting on member outcomes. But funding targets/asset mixes constantly shift as liabilities shift. A better way of managing the assets to liabilities is a proactive liability-driven framework that ensures ongoing monitoring of the liabilities and managing all aspects of the fund to ensure that those liabilities are met. It opens a whole new world of consulting.
How would this value-add be measured? Do you quantify it and demonstrate it to trustees accordingly?
MM: It’s difficult to measure when the consultant uses transfer pricing, charging little for consulting and making more from providing other services to the fund’s asset or multi-managers for an asset-based fee. This can lead to interest conflicts that compromise the value-add. It should be measured against achievement of the client’s objectives.
MP: Trustees might well place as much emphasis on evaluating their ‘liability manager’ as they do their asset manager. It would probably be extremely difficult to demonstrate to a trustee the quality of a liability manager’s modelling capability. Proof will only be years down the line when members retire. Yet a highly reliable service can still be provided as long as the fund is being constantly monitored in its liability space.
CE: Measurement is quantitative (against long-term objectives) and qualitative (through the relationship with trustees and governance of the fund). It should largely be self-evident and quantified on request.
AD: We focus on the outcomes for members i.e. their replacement ratios, which we track. Many factors impact, not only the investment strategy.
Can you offer some rule-of-thumb guidance on what a medium-sized pension fund should reasonably be prepared to pay a consultant as a proportion of the fund’s total costs or total assets? At what point, in your opinion, would costs become too high to justify the service (e.g. for a fund of 1 000 members in comparison with a fund of 100 000 members)?
CE: Smaller funds cannot afford a full-service investment consultant. A fund should not pay more than around 15 basis points (0,15%) on the asset value and larger funds considerably less.
AD: Pure asset consulting is generally available only to large funds, but implemented consulting can be extended even to small funds. There’s no general rule.
MP: It’s dependent on complexity. My sense is that advisory fees are usually a fraction of the fund’s costs. Consultants would get only a few basis points on assets or payroll.
MM: Our estimate for consulting fees ranges from five to 10 basis points, depending on the size of the fund (not the number of members) and the level of work required. The larger the fund, the lower the basis points.
The fiduciary duties of trustees are exhaustive, diverse and complex. So too is the range of services that consultants offer. Should trustees and their funds therefore rely predominantly on consultants, possibly to the extent of making no important decisions without them; for example, on selection of asset managers or even on referring matters to lawyers? If so, might this not lead to funds becoming over-reliant on consultants in the sense of being discouraged from seeking other outside advice?
MP: The Pension Funds Act says that trustees should “obtain expert advice on matters where board members may lack sufficient expertise”. Yet they should not rely solely on consultants. They should have some level of trustee education whilst knowing their limitations.
AD: It’s critical that trustees don’t become reliant on consultants. Only once the trustees have applied their minds to the decision-making philosophy and objectives for their fund should they appoint consultants to advise within this framework. Ultimately, the trustees must own the process and the consultants should only provide guidance.
MM: Our role is to assist trustees in making informed decisions. It’s therefore important that consultants maintain their independence.
CE: We will clearly define what is and what is not within our area of expertise. Where we’re unable to assist, we encourage the use of other advice.
How do trustees oversee the performance of consultants? Is there any way other than employing another consultant for peer-review advice, adding to costs and delaying decision-making?
MM: The service-level agreement is supposed to include performance-measurement criteria. So trustees should be able to see when things are not working out or the fund is not doing well compared with its set objectives.
CE: It should be unnecessary to pay another consultant for peer-review advice.
MP: It’s okay for trustees to get second opinions from time to time, but definitely not ongoing peer reviews. It will be like getting one asset manager to evaluate another, and to find ways for elbowing competitors out. Churn causes significant value destruction. You don’t what an added layer of fees, and delayed decision-making can also be costly.
AD: The service-level agreement should set out clear deliverables and encompass more than just performance, for the consultant to report and the trustees to evaluate. Adding another consultant would simply increase the fund’s costs. Trustees need to take accountability.
When consultants and professional trustees are paid by the hour, might they not be tempted to call lots of meetings and create complex structures so that their fee-earning capacity is maximised? What advice would you offer funds’ boards to guard against it?
CE: I would seriously advise against fee-per-hour agreements. They’re administratively impractical and inhibit an open, collaborative relationship.
AD: The reality is that incentives drive human behaviour. So far as possible, the consultant’s remuneration must be linked in some way to the outcomes that the fund is targeting.
MM: It’s always advisable to base hourly fees on the actual work done rather than attendance at meetings. An all-encompassing fixed fee, agreed upfront, is the best way to go.
MP: Generally, fees are negotiated and based on actual work. The market is too competitive to allow anything else.
It’s been suggested that consultants are funds’ “gatekeepers” i.e. that they make it virtually impossible for other service providers (such as asset managers and administrators) to approach trustee boards directly. What happens in practice, and why? What are the advantages and disadvantages in the “gatekeeper” approach?
AD: The advantage is that trustees are protected from making decisions in reaction to persistent salespeople who may simply be selling recent top-performance latest fad-type products. This is thus a defence against short-termism. The disadvantage is that the gatekeeper prevents the trustees from being exposed to possibly superior options.
MP: Most consultants are comfortable with service providers interacting directly, but try to avoid such problems as trustees being constantly distracted by managers’ beauty parades.
MM: Service providers should be able to approach our clients directly. Our role is to facilitate clients’ understanding, to narrow the information gap between the trustees and their asset managers.
CE: The advantage is that the trustees’ and principal officers’ time and resources aren’t wasted with unnecessary interactions. The disadvantage is that the fund’s best interests may not be served through an unscrupulous consultant. The key is trust. If you don’t trust your consultant, get rid of him.
If consultants are as good as they profess, how come we continue to have pension funds being ripped off?
MP: The bulk of the industry runs very well. This doesn’t excuse genuine cases where interest conflicts and governance failures have sometimes caused massive losses to individuals. In some cases, the consultant’s advice isn’t heeded. There are significantly more onerous requirements on consultants in terms of FAIS, giving funds and members more recourse.
MM: One issue is where the consultant has not properly performed a due diligence of the investment. Another is where the service provider has a business relationship with the consultant.
CE: Without specific details, it’s likely that there was some combination of not using a consultant, incompetence of the consultant, the consultant being kept in the dark, or perhaps even fraud or collusion on the consultant’s part. Consultants are best chosen through experience and referrals from trusted sources.
AD: Unless trustees and consultants agree upfront on whom is responsible for what, it’s possible the some decisions are made without a comprehensive process being followed.
Do you find problems with the ways in which you are briefed by trustees and/or the authority they give you? If so, what are these problems and how would you suggest they be remedied?
MM: There’s a need for trustees to be trained on how to use consultants.
AD: Trustees and consultants must together spend time on clarifying their roles before such confusion arises.
MP: If your role is not understood as the liability manager, you may be restricted to addressing problems only within the fund whereas they might demand that you negotiate with other parties including the employer.
CE: If a problem arises, we resolve it with the trustees before proceeding.
What should a consultant do if a fund fails to follow its advice?
AD: It’s not always possible to prevent such cases. When a decision is made which conflicts with the original advice, then highlight in a document the reasons for the alternative decision as well as the risks, concerns and implications.
CE: If legal or regulatory consequences exist and the fund still fails to comply after clear communication, the consultant must walk away and seek counsel on whether the authorities should be notified. If it is of a less serious nature, such as a decision to fire a manager, then communication and records of advice are critical. In practice, a fund is unlikely to retain a consultant with whose advice it repeatedly disagrees.
MM: The consultant must ensure that records of the decision-making process are properly kept, together with supporting documents of the advice provided.
MP: In terms of FAIS, there should always be a record of advice. Consultants must insist that clients document the exact bases on which decisions are taken.
For delivery to members, is a fund better off with the implemented-consulting model (e.g. Acsis) or advice model (e.g. Selekane)?
CE: It depends on fund size. Idealistically, pure advice is always preferable because it maintains independence and limits interest conflicts. In practice, implemented-consulting models allow for smaller funds to benefit from receiving lower-cost advice due to economies of scale inherent in multi-managed platforms.
AD: The implemented-consulting model has the advantage of being an end-to-end solution that ensures clear accountability for various functions. It also allows decisions to be implemented quickly and cost-effectively. The advice model allows for more customised solutions and a greater sense of trustees’ involvement in the decisions.
MP: An implemented-consulting model might work so long as it has the power to go beyond the asset issues.
MM: The issue here is about remuneration of the consultant rather than the service delivered. The regulator should harmonise the remuneration of consultants regardless of the consulting model employed.
By law, trustees bear the ultimate fiduciary responsibility for management of their funds. But in practice much of the management responsibility is outsourced to consultants. Effectively, there’s a delegation of functions but not of fiduciary duty. Should there be? What recourse is available to funds against consultants should the fund or its trustees, acting on the advice of consultants, be sued for breaches of fiduciary duty?
AD: This is yet another reason to be clear, in the documentation, on the responsibilities of each party. The trustees will always bear the fiduciary responsibility but they in turn have recourse against consultants for poor advice, negligence or breach of agreement.
MM: It’s not true to say that consultants aren’t responsible for their advice. This became clearer with the introduction of FAIS. Consultants are required to keep insurance covering them against claims by clients.
CE: If it can be demonstrated that a consultant’s negligence, incompetence or wilful action has caused a breach, there is legal recourse. The consultant’s risk of reputational damage is another huge incentive to avoid this type of behaviour.
MP: Trustees delegate all the time. They have recourse to the Ombud and the FSB. It’s also important that service providers hold sufficient and appropriate insurance cover for liability claims against them.
Let’s discuss umbrella funds. Because they’re governed by professional trustees and principal officers chosen for their expertise, and sponsored by financial institutions, do they still need consultants?
MM: There might be individuals within the boards of umbrella funds who posses the expertise of a consultant, but they might not have the necessary resources to gather and process data used in the advisory process.
CE: It would depend on the complexity of the fund as well as the experience and expertise of its officials. The primary value of consultants is in the expert, independent advice they provide.
MP: If the umbrella is able to provide a capability that links directly to members needs, or liabilities to members, and can manage the assets accordingly, it doesn’t need a consultant.
AD: Even a skilled board may not have the necessary time, systems and analysis tools to adequately research and analyse the many options available to funds.
The revised Regulation 28 has opened a plethora of challenges for pension funds, notably investment in alternative assets (private equity and hedge funds) as well as investment in Africa north of SA. Trustees must consider environmental, social and governance criteria too. They require detailed knowledge of specific opportunities. Are consultants equipped to advise funds on what they should entertain and what they shouldn’t; what they should seek and what they should avoid?
CE: To varying degrees, the consultancy industry is equipped. We’d also use partnerships in niche areas where there is a clear value-add.
MP: This should be part of the due diligences that trustees start doing of their consultants.
AD: Consultants will have to develop or buy these more specialist skills, and be fairly remunerated to merit the addition of them.
MM: We have recruited the necessary skills to manage these new risks.
Then there’s FSB circular PF130 on good governance of pension funds. Is it really too complex for trustees to understand without using consultants? Or is the danger that trustees won’t bother to apply it unless consultants tell them how and insist that they do?
AD: It’s not too complex for trustees to understand. But there should be a few versions to deal with different sorts of funds. As it stands, the circular is most suited to large funds. Sections aren’t always applicable to smaller and medium-sized funds. This can often be confusing.
MM: The major problem is in the way the FSB communicates with trustees. There seems not to be a proper channel. PF130 seems to have been released to the industry that in turn uses it as a marketing tool. Almost every service provider offers some form of training on PF130. Consequently, the message has lost its purpose. Perhaps the FSB needs to establish a communication channel with trustees.
CE: Given the right training, it’s not too complex for trustees. Consultants add value through providing guidance, ensuring discipline and monitoring implementation.
MP: Consultants are close to the regulator and industry. This places us in the best position to guide trustees on PF 130 application. Otherwise, each board will be reinventing the wheel each time.
Finally, a curved ball. Don’t you prefer dealing with dumb rather than trained trustees, so that they’ll simply listen to everything you tell them and not attempt to act independently?
MM: It’s much better to work with trained trustees, or trustees committed to learning and doing right. They bring improved efficiencies in the quality and speed of decision-making.
CE: We prefer to work with trained trustees who act with independent thought. Particularly when it comes to fund governance, a lack of knowledge can be exceedingly dangerous.
MP: Trustees who understand the asset-versus-liability dynamic are more productive partners and able to make more optimal decisions.
AD: We add much greater value when the trustees are knowledgeable. They understand and appreciate what we do, so we aren’t at risk of losing our appointment for the wrong reasons. When astute trustees test us, it helps us to raise our game.
* Unfortunately, at a late stage Mbekwa had to withdraw from the conference. However, like the other panellists, he afterwards provided written replies that are summarised here.