One of the selling points for fiduciary management is that it enables trustees to make better investment decisions more quickly. In what continues to be a volatile investment world, this is an attractive prospect for trustees chasing returns or seeking the right opportunities to de-risk. However, fiduciary management is not without risks and Ian Devlin examines the legal issues this investment model poses for trustees.
What is fiduciary management?
Fiduciary management, also known as implemented consulting or outsourced investment, involves trustees delegating some aspect of their investment responsibility to a fiduciary manager. The scope of what is being delegated in each case may vary but under the fiduciary management model, consultants or fund managers not only help trustees define their investment strategy but also implement, monitor and manage scheme investments in line with that strategy.
This contrasts with the more traditional pension investment model where consultants advise, trustees execute that advice by taking investment decisions, and fund managers implement those decisions.
What issues does fiduciary management seek to address?
The difficulty many pension trustees find themselves with is that they are tasked with the management and operation of what is in effect a mini-financial institution.
As with any complex institution, there are a range of risks which need to be managed. These risks may include:
- setting the scheme’s funding objective and investment strategy
- deciding what asset classes to invest in
- deciding if and how to dynamically manage the portfolio to take advantage of opportunities and protect against emerging risks, and
- monitoring investment risk and performance and adjusting the investment strategy accordingly.
Trustees rightly ask how can they be expected to devote sufficient time to these responsibilities when they may have day jobs to get on with? The answer in many cases is that they simply cannot; they do not have the time or lack the specialist expertise and internal resources to manage the many different aspects of their investment duties as trustees.
Fiduciary management seeks to address these gaps in trustee skills and resources by enabling them through the fiduciary manager to implement their investment decisions on a real time basis.
What legal risks does fiduciary management create for trustees?
While fiduciary management should, once properly implemented and monitored, improve investment performance for trustees, it is important that trustees understand what legal risks are associated with it.
Delegation and monitoring
From a legal perspective, fiduciary management involves trustees delegating aspects of their investment decisions to a third party. Therefore, one of the key issues for trustees in considering a move to a fiduciary management model is deciding on what tasks they wish to delegate and how to monitor the appointed manager.
At its most basic, fiduciary management may simply involve delegating the selection and replacement of investment managers. At the other end of the spectrum, it could involve the delegation of an entire investment strategy to the appointed fiduciary manager. Being able to offload this responsibility to a service provider is an attractive proposition from a trustee perspective. However, from a legal perspective, it does not mean that the trustees are relieved from responsibility for the investment of the scheme assets. Instead, they remain legally responsible for the investment of the scheme assets in accordance with the terms of the scheme’s governing trust deed, the requirements of the Pensions Act and general trust law.
As a result, it is important that trustees have obtained the necessary legal advice to satisfy themselves that any arrangement they may be entering into with the fiduciary manager is one which is within the investment powers conferred on them by their trust deed, complies with Pensions Act and general trust law requirements on investment by trustees and has adequate controls in place.
Given that the trustees’ legal responsibilities concerning investment cannot be delegated away, it will be important for trustees to put arrangements in place to monitor the fiduciary manager’s ongoing performance. This can prove challenging as there is no ‘one size fits all’ fiduciary management model. This makes benchmarking one fiduciary manager’s performance against another difficult, as they may be providing very different services.
At a minimum, trustees should be agreeing performance indicators with the fiduciary manager which it will be periodically assessed against. Doing so is critical from a legal perspective as it ensures trustees are fulfilling their responsibilities as trustees in actively monitoring the performance of any functions they may have delegated to the fiduciary manager.
Limitation of liability
As with any investment manager, fiduciary managers will seek to limit the level of liability they assume on being engaged by trustees. The question trustees need to ask themselves is whether any proposed limit is reasonable and in line with market norms?
Even where a manager is willing to accept unlimited liability for certain issues, is the manager in a position to pay should a claim arise? If trustees have concerns on this front, they will need to assess the strength of the manager’s financial covenant or seek details of the level of insurance cover it has in place.
Warranties and indemnities
Certain types of investment products may require investors to enter into subscription or other types of agreement with counterparties. The risk this poses for trustees is that the fiduciary manager may be required to give counterparties representations and warranties and agree to indemnities on behalf of the trustees when entering into those agreements. These could be representations or warranties that the trustees would not be willing or in a position to give if they were contracting directly with the relevant counterparty. As a result, the agreement with the fiduciary manager should include provisions that seek to address these legal risks.
Trustees should also address the fiduciary manager’s potential conflicts. These can arise in various ways. Most obviously, if the fiduciary manager is investing in the fiduciary manager’s own products, who is checking to ensure that this product is the most appropriate for the relevant pension scheme?
Different fiduciary managers take different approaches to investing in their own products, and this is something the trustees should investigate.
Much of the focus in appointing a fiduciary manager will have been on the services they are agreeing to undertake, the fee they will charge for doing so and how the services are to be delivered. What is equally important, and what can often get overlooked, is what would it cost and how difficult would it be to exit from that arrangement?
For instance, will the type of funds the fiduciary manager directs scheme investments towards be illiquid or subject to the consent of other investors were the trustees to decide to exit? Also, what notice period will apply where the trustees decide to terminate and is any such notice period appropriate?
These are important issues for the trustees to consider in putting in place any fiduciary management arrangement.
Fiduciary management is a useful option available to trustees who are looking to improve the quality and speed of their investment decisions. However, it is not without risk, and trustees would be sensible to consider some of the following issues before deciding whether to adopt it:
- Does the trustee board consider that it has insufficient investment expertise or resources to act swiftly to respond to investment or de-risking opportunities?
- What are the costs associated with the fiduciary management model and is there another alternative available which achieves a similar result at a lower cost?
- Do the trustees have sufficient resources to manage the risks associated with it?
- What type of fiduciary manager should the trustees choose and what tasks should be delegated and to what extent?
As ultimate responsibility for investment of the scheme assets rests with trustees, even where a fiduciary manager is appointed, these are issues trustees need to consider carefully in weighing up whether a fiduciary management model is the right fit for their scheme.