The majority of fiduciary managers outperformed their target return in 2024 – what do you attribute this success to?
The vast majority of mandates are fully hedged (or close to this level), and with equity markets returning 20%+ it provided a significant tailwind across the board.
That said, there is no universal strategy followed by FM providers, and so performance will have been driven by specific factors, considering different philosophies of the providers as well as portfolio make-up.
Individual FM providers did better or worse depending on the level of equity exposure, but even this is an oversimplification, e.g. exposure to the “Magnificent 7” stocks within equity allocations over 2024 also influenced outcomes.
Looking at longer track records, a key question trustees should be asking of their FM provider is: Should performance have been better in such a positive year, to offset worse performance in down years?
There was something of a clustering in performance outcomes. Could you break these down into strategies?
With recent shocks to DB schemes, not least those in 2020 and 2022, FM providers have sought to increase diversification, and not be so reliant on a single source of returns. While this means performance should, in theory, be steadier year-on-year, the result is that portfolios (in particular return-seeking portfolios) have become more defensive in aggregate – and arguably less inclined to take advantage of positive markets (i.e. going “risk on”).
It is worth noting this is not necessarily a bad thing for trustees and sponsors, who may be more willing to forego upside if it means reducing the chance of a deficit increasing or re-emerging. However, trustees need to be aware of how their strategy is set up, and how it might fare in different market environments.
Breaking down these strategy successes further, can you offer up any view and perspective on why they did so well?
In a year like 2024 where equities rallied, in general we would expect the composites with higher return targets to perform well – as was the case – with typically higher exposure to equity markets. Composites with lower-returning targets generally have less exposure to equities and so drivers of performance have been more driven by other asset classes. Credit tends to be a key component of many of these strategies and was a key driver of performance in 2024.
Probably most interesting from the 2024 data is seeing the relative spread of outcomes relative to liability objectives, with a much greater range in the lower-returning composites. This suggests there is a lot of structural differentiation in what a “de-risked” strategy looks like, and also highlights that “de-risking” doesn’t necessarily result in smoother returns.
Trustees who were well above targets in this context should equally be asking whether the reverse could happen in a different year – potentially with much greater ramifications should they be nearing an insurance transaction.
What was the reason in ESG performance lagging?
There are a few key themes in recent years which have acted as a headwind to ESG-tilted assets / strategies – with geopolitical events, energy crises, and a change in US Administration being key. Alongside this, traditional market-cap indices have been spurred on by a handful of large US technology stocks – not all of which would be classed as “strong ESG scorers”.
The combination of these factors means schemes with a greater desire to focus on ESG will likely have lagged against a traditional market-cap based approach. Of course what isn’t reflected here is the risk (and hence risk-adjusted return), or ‘impact’ of these approaches from an ESG perspective – Trustees may be willing to forego the absolute return because of these. But again, key for trustees is understanding the characteristics of your strategy up front, rather than being surprised after the fact.
Is this a concern?
Mainly for larger schemes, FM providers have flexibility to customise strategies to reflect individual aims, beliefs and constraints – this enables trustees to be able to impose constraints on their FM provider, for example to improve or enhance ESG characteristics. This is an active choice. Trustees, using advice from their FM provider, need to be aware of how this changes the risk / return profile of their strategy.
Equally, the more constraints imposed on the FM providers, the increased likelihood you will see performance diverging from their “best ideas”. Again not necessarily a bad thing, but something for trustees to be aware of to reduce the ‘regret risk’ should they see their peers perform significantly differently.
What are the lessons and stand out takeaways from the performance numbers overall?
The variability of returns within composites tells us that scheme-specific context is vitally important.
FM is not a product; it is multi-faceted and includes both advice and implementation. The GIPS data enables us to better understand performance of the industry but this needs to be done through different lenses.
As such, for an individual scheme the best thing you can do is consider your own circumstances, and ask yourself: Was my performance in line with expectations? If not, why not? Is my strategy still fit for purpose based on my goals? Can my FM provider articulate and justify the advice and decisions being made under their delegated authority? And finally, does it offer good value for money?
If trustees can get comfortable with these points, they are much more likely to be accepting of performance – good or bad.
Given half of mandates targeted their returns of liabilities of +0.5% to 1.5% – what does that tell us about manager strategies?
As is well-publicised, DB funding levels have improved materially, with correspondingly lots of de-risking in the market. This means the need for “growth” assets is lower on average, which is then reflected in FM’s underlying mandates. This tells us two things:
1. For schemes further along their de-risking journey, trustees need to better understand their portfolio make-up and how this might fare in different environments, to avoid negative surprises closer to their endgame; and
2. For the minority of schemes with higher return targets, trustees should be challenging their FM to ensure sufficient focus and resource is being given to growth strategies.
Given this small scale in differentiation, how can managers be separated?
As shown by the data the vast majority of the 500+ FM mandates are targeting returns within a relatively narrow band. However, in practice liabilities+0.5% p.a. on route to an insurance transaction is a very different target to liabilities +1.5% per annum, with some need for growth.
As you move lower down the return spectrum there are other factors which can influence performance outcomes:
- Differences in hedging accuracy, including frequency of recalibration, alongside hedging implementation approach can have a material impact.
- The extent and type of any return-seeking assets within lower-returning mandates needs to factor in the appropriate objectives and timeframes. Use of these assets can depend on the FM provider’s own philosophy and approach, which again can result in markedly different outcomes depending on the market environment.
FM includes advice and implementation. These considerations should be addressed by your FM provider, but given differing philosophies and approaches across the market, FM provider selection is key!
Regulation was also mentioned: What are the main points of regulation that stand out? Do these serve as an opportunity or challenge?
I think there are both opportunities and challenges.
We’re all aware of the changing, and challenging, regulatory environment, but clearly there are a couple of big items, as it relates to investment, in recent months: 1) surplus extraction – which may result in a boost to ‘run-on’ propositions and innovation in DB investment – i.e. a great opportunity for FM providers; and 2) investment in the UK. As FM providers are in control of vast asset pools on behalf of a large number of pension schemes, arguably any government intervention on investing in the UK could have significant impacts on how they construct portfolios for their clients.
From a trustee standpoint, we’re passing the five year anniversary of the CMA’s initial “re-tender” deadline. Alongside nudges as part of the General Code, we are seeing many trustees use this breakpoint as a natural period in which they will perform a review of their FM provider – to test whether they remain the best fit based on the scheme’s needs.
What are the key lessons to be learned from the findings of the review?
There is no single metric to assess an FM provider to say if they’re good or bad. Even with a vast amount of data, the end results could differ depending on what lens you are looking through. This means scheme-specific consideration is vital when performing an assessment of an FM provider.
It can be daunting to understand the subtleties of the FM market, and the complexities associated with underlying portfolios and strategies. Some FM providers and strategies work better in different environments and so FM provider selection, and strategy design, are key to achieving your investment goals. With most schemes seeing a material change in circumstances in recent years, we expect many trustees to be reviewing whether their FM provider continues to offer the right investment approach and value for money.
The Fiduciary Management Investment Performance Review can be downloaded here.
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