Unlike fund trackers that rank investment funds based on past performance, a fiduciary rating is supposed to forewarn investors about the reliability and organizational ability of a manager, in terms of providing a consistent level of performance. And while a credit rating assesses the risk of default by a borrower, a fiduciary rating evaluates a manager’s ability to protect and enhance the value of assets entrusted to it by clients.
Some managers break fiduciary risk down to market risk, liquidity risk and credit risk. But Swiss-based fiduciary rating agency RCP& Partners, for example, groups a manager’s fiduciary profile under two families of risks: structural risk and performance risk.
Structural risk focuses on a manager’s capital adequacy and control, compliance standards and the level of client services. Performance risk examines the manager’s investment process and philosophy, the quality of products offered and the experience of its investment team.
Sounds crucial enough for trustees to take the issue seriously. But why is there little demand for the service from the investors’ end?
Shane Norman, research director at RCP& Partners, says the situation reflects a “mixture of circumstances”.
Exeception rather than rule
“First, I would say it’s an exception rather than the rule that trustees of pension plans are full time. Most are unpaid. They sit there as good-hearted people who are given responsibilities for defining investment strategies and selecting the manager. But because they are usually short on useful information they rely on outside sources entirely, particularly on pension consultants,” he says.
Pension consultants themselves do not necessarily have very wide coverage of the investment industry, according to Norman. When a plan sponsor requests a consultant to appoint a manager to a particular portfolio, for instance, more often than not, the consultant would recommend a list of perhaps between 25 and 35 managers, who tend to be the larger and better known firms. But the actual number of managers capable of doing the job is probably 10 times that, says Norman.
“Pension consultants make most of their money through asset liability modeling and human resources consulting for major pension plans. Their role in asset liability modeling is to model the mixture of investment and allocation that helps trustees decide what level of return they’ll need to meet the future liabilities.”
So far so good. But once the decision on asset allocation is made, there follows the need to select managers who can provide the desired level of return against a particular risk profile.
“This side of pension consultation – the research and selection of managers – is almost like something that is forced upon consultants, something that they have to do,” says Norman. “For them it is a cost, the cost of doing research on many managers, especially when the market is changing so much so quickly with all the mergers, alliances, new products and new services going on.
“It’s an immense task to keep up with all those changes and many of the pension consultants just don’t have the resources to do that. And that’s why they confine themselves to a relatively small universe of managers.”
Friend or foe?
Norman admits some consultants may have seen RCP as a threat to their business in the beginning but he believes that concern is starting to fade away.
“Any service that can broaden their coverage of managers is basically helpful to them. And I don’t think they see our service as anything other than that. The proof is that in Germany we are operating a joint venture with that country's largest consultant. So I don’t think they see us as being a threat to their core business.”
According to Norman, the key distinction between the marketing of fiduciary rating in Asia and the West is that, whereas in Asia the approach is primarily “bottom-up”, in other markets such as the US and Europe, the marketing strategy has been “top-down”.
“In Asia, we focus our effort on, first, the investment management firms. Elsewhere, we have aimed at the buy-side, such as pension plan sponsors and endowments. Although these two approaches have now merged to a considerable extent, it is probably still true to describe our Asian development as more bottom-up than top down,” he says.
Norman says the main reason for such an approach is that the buy-side in Asia is still relatively underdeveloped, with fewer and much smaller pension funds and other institutional investors than in Europe or North America.
