Also in the UK, the Pensions Regulator recently published a report (4 November 2010) by the industry-led Investment Governance Group19 (IGG) which looked at the governance of DC pension funds. The report contains the IGG’s best practice guidance for defined contribution (DC) pension schemes, reflecting the growing importance of DC provision and that good governance is at the heart of a well-run pension scheme. In addition to this, the Pension Regulator released a report of the National Audit Office on the investment governance in the UK Pension Protection Fund. The six principles released by the IGG cover the key areas of investment decision making and governance that are important to the health of a DC scheme.
The stages of investment governance can be categorised as follows:
Stage I: Governance structurePrinciple 1: Clear Roles and Responsibilities
Principle 2: Effective Decision Making
Stage II: Investment choices and monitoring
Principle 3: Appropriate Investment Options
Principle 4: Appropriate Default Strategy
Principle 5: Effective Performance Assessment
Stage III: Communications
Principle 6: Clear & Relevant Communications
We have included the principles as quoted from the Pension Regulator’s site, these are listed overleaf:
Principle 1: Clear roles and responsibilities
Principle rationale
This Principle aims to help decision makers lay firm foundations for the process of investment governance. It advocates that schemes have defined and documented roles and responsibilities for each element of the investment governance chain, ensuring each party, including members, are clear as to the role they are expected to play in the process.
DC Principle
Principle 1: Clear roles and responsibilities
Roles and responsibilities in relation to investment decision making and governance are clearly defined and communicated to interested parties
‘Best practice’ guidance for DC decision makers
- are those responsible for investment governance and they must decide which responsibilities are allocated to which roles within the operation of the pension plan. A decision maker can be an employer, trustee, provider, adviser or member representative
- should record the roles and responsibilities of each stakeholder, including delegations of responsibilities, in an investment governance plan or as part of the Statement of Investment Principles (where one exists)*
- should make all decision makers and scheme members aware of the allocation of responsibilities among the decision makers , particularly those responsibilities which members must take on in relation to their own pension planning
- should identify and document any conflicts of interest together with a plan to manage those conflicts where appropriate
- should agree a policy on responsible ownership, to the extent that it is practical in the context of the funds offered or under consideration, monitor its implementation and report on it to interested parties, including members and member representatives
Principle 2: Effective decision making
Principle rationale
This Principle builds on Principle 1. It aims to ensure the process is effective through sound decision making based on quality and timely information and reference to relevant regulatory requirements and guidance.
It also advocates decision makers adopt a proactive approach to their decision making, building in regular assessment and reviews of the people and processes within the decision making structure, and making improvements where appropriate.
DC Principle
Principle 2: Effective decision making
Decisions relating to investment governance are taken on a fully informed basis and the investment governance processes are sound.
‘Best practice’ guidance for DC
Decision makers should:
- have or acquire the relevant knowledge, understanding and skills to take decisions, which may be based on advice from those reasonably expected to have the necessary expertise
- make available sufficient time and resources for making investment governance decisions
- develop an investment strategy and options which are within their governance capabilities
- exercise sufficient control to allow them to adapt and develop their strategy as circumstances and market conditions require
- be sufficiently familiar with scheme documentation, regulatory requirements and supporting guidance to enable them to observe these principles and carry out their duties in accordance with the requirements set out in these documents
- regularly assess the effectiveness of the investment decision making and governance process with reference to investment performance including net of fees, make improvements to the process as appropriate and report to interested parties (including members)
- regularly review the management of any external investment advisers, their contracts and their remuneration
- produce guidelines for the selection and removal of investment managers and for any alteration to the range of investment options/funds and apply them consistently
Principle 3: Appropriate investment options
Principle rationale
This Principle requires decision makers to provide investment options that take account of a range of risk profiles and needs within the pension scheme membership. It also aims to ensure pension scheme members receive the appropriate level of fund choice to meet their needs, without being overwhelming or restrictive.
DC Principle
Principle 3: Appropriate investment options
The investment options provided take account of a range of member risk profiles and needs and are designed appropriately
‘Best practice’ guidance for DC
Decision makers should
- offer an appropriate default strategy (see Principle 4)
- consider the number of funds (as components of the investment options or as standalone entities) to be made available and how the number on offer might impact the ability of members to make effective investment decisions
- offer an adequate range of investment options given the expected risk tolerances and requirements of scheme members, including the likely format and structure of their retirement benefits, and consider how these options may change as they approach retirement
- consider:
- the way investment options are classified and described with a view to making it easier for members to make appropriate choices (eg through the use of a core fund range or listing funds by risk rating of asset type)
- the operational characteristics of funds including dealing frequency and liquidity
- the costs, including management fees and other fund expenses
- the security and stability of the firm(s) providing investment management services and products
- ensure that the investment options/funds offered have appropriate names, clear investment objectives and relevant benchmarks ensure that investment fees/costs are reasonable and competitive given the performance expectations of the fund
Principle 4: Appropriate default strategy
Principle rationale
This principle determines a sound investment strategy principally for those members who prefer not to take an active investment decision.
DC Principle
Principle 4. Appropriate default strategy
An appropriately designed investment strategy is offered for members who prefer not to make a choice
‘Best practice’ guidance for DC
Decision makers should
- ensure the default strategy meets the requirements described in Principle 3
- allow appropriate time for design, review and monitoring of the default strategy as compared with other investment options
- ensure there are clearly defined strategic objectives for the default strategy in terms of the levels of risk and returns inherent in achieving the desired outcomes for members
- ensure the membership data on which the default strategy is based is as robust and detailed as is practical
- ensure the design of an appropriate default strategy considers, as far as is possible, the needs of the broad membership, including:
- risk and return (net of fees/costs)
- its position in relation to all other investment options
- members’ expected term to retirement
- members’ attitude to risk
- the expected format and structure of their retirement benefits
- ensure that investment fees/costs are reasonable and competitive given the performance expectations of the strategy
NB: The Department for Work and Pensions' guidance on 'Offering the Default Option for Defined Contribution Automatic Enrolment Pension Schemes' will be published in 2011. This will set out further detail for design and monitoring of default options in DC arrangements
Principle 5: Effective performance assessment
Principle rationale
The aim of this Principle is to ensure decision makers monitor the performance of investment options, including the default strategy, and take appropriate action where necessary
DC Principle
Principle 5: Effective performance assessment
The performance of investment options is monitored.
‘Best practice’ guidance for DC
Decision makers should
- regularly assess the default strategy against its strategic objectives
- regularly assess the performance of each investment option, and the constituent components of the default strategy, against its stated performance objectives
- consider removing any investment option which is not expected to perform well against its objectives
- spend an appropriate amount of time and resources reviewing and managing each investment option
- monitor the suitability of any investment wrapper and be prepared to swap to other arrangements when appropriate
- report performance including net of fees, risks and any alterations to members (expanded in Principles 1 and 6)
Principle 6: Clear and relevant communication
Principle rationale
The aim of this Principle is to provide pension scheme members with clear, relevant and timely information so they can:
- make an informed choice relevant to their circumstances about which fund(s) to invest in
- understand their personal responsibility for their pension plan, the choices they have available and how these affect the value of their fund and retirement income.
DC Principle
Principle 6: Clear and relevant communication to members
Clear information on the investment options and their characteristics that will allow members to make informed choices is provided
‘Best practice’ guidance for DC
Decision makers should ensure scheme members receive effective and relevant communications. Such communications should
- be tailored to the expertise of the members, using plain language and an appropriate format to engage their interest and further their understanding
- state the investment objectives, benchmarks and fees for all funds together with the risk/return characteristics of each fund in such a way as to enable members to make a meaningful choice between them (including explanation of the risks and implications of making these choices)
- provide or signpost tools, seminars and further information that can help members to understand the basic tenets of investment strategy including, most particularly, the interaction between risk and return
- provide or signpost tools to help members to appreciate that the contribution levels, term to retirement, net investment returns can all affect the size of the fund which will be available to them to provide a retirement income
- provide members with regular and consistent performance reporting, net of fees, on the investment options available to them
- provide members with timely investment information relevant to their term to retirement and the decisions they will need to make to secure an income
- set out clearly the options which will be available at retirement emphasising the importance of shopping around and how members can seek advice and guidance
- provide members with access to the scheme’s Governance Plan, or equivalent document
Innovation in the Face of Crisis...
The financial crisis has revealed innovative ways in which funds are now dealing with their challenges, these include:
- The adoption of rigorous Trustee selection procedures with market-based compensation. This allows for the close scrutiny of Trustees’ performance and is aimed at enhancing professional competency of Trustee boards. You will recall that we discussed Trustee remuneration at our last Hot Topics session20; it is still a contentious topic in South Africa as well as the UK. However, recognising the constraints that many Trustees face in respect of time, expertise and collective commitment, it is thought that this process of Trustee selection enhances the governance budget.21
- “Funds have been introducing decision protocols involving greater clarity of the fund’s mission and strategic goals; an appropriate resource budget for each element in the investment process; the application of a priori beliefs; the discipline of a risk budget; and a fit-for-purpose line-up of managers with ‘ buy and sell ’ thresholds for appointment and retention. By this assessment, UK best-practice funds have recognised the merits of matching their governance budgets with their risk budgets. This has been accomplished in a variety of ways, with rather different models of trustee responsibilities and the composition of boards. In a couple of cases, best practice has involved the use of a two-tier decision-making structure, with a highly competent investment function headed by a CIO tasked with clearly specified responsibilities and accountable to the investment committee.”22
- In their study of the UK pension fund environment, Clark and Urwin (2010)23 found that the following four responses by best-practice pension funds deserved recognition:
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- Intensification – increased board attention and the mobilisation of additional resources to deal with exceptional circumstances;
- Priority setting – using ‘ dashboards ’ to signal (green, amber and red) the importance of issues and hence the time that should be devoted to those issues inside and outside of board meetings;
- Risk management – quantitative discipline, qualitative overlay and greater independence of risk assessment from the investment management process;
- Expansion of the belief structure of the board and its management team – where more complex market conditions can only be coped with more complex (deeper) beliefs.
Some of the other trends we found from the international research conducted will be set out in question 9, where these are applicable to SA and how they can be practically applied. Having now looked abroad at some of the trends/events taking place in respect of improving the governance of pension funds, let’s now turn our attention to our local environment.