Fiduciary Management

Fiduciary Management offers an in-depth explanation of every facet of this fast-growing approach to organizing the management of an institutional investment portfolio. Expert author Anton van Nunen begins by outlining the historic shift that has brought this strategy to the attention of the investment community and quickly moves on to illustrate fiduciary management in practice; giving advice in terms of asset-liability modeling and financial markets, constructing portfolios, selecting and overseeing investment managers, benchmarking and performance measurement, and reporting.

Foreword xi

Preface xiii

Chapter 1 The Pendulum Swings Back in Asset Management 1

The Forces of History 1

The Rise of Modern Portfolio Theory 3

Support for Shares 4

The New Paradigm 6

The Rise of Indexing 9

Discontent with the Paradigm 10

The Need for Fiduciary Managers 12

Chapter 2 Pension Plans: The Principal Setting for Fiduciary Management 15

The Historical Idea of Pensions 15

A Patchwork of Pension Provisions 18

Organization and Regulation of the Pension System in several OECD Countries 23

Denmark 23

France 25

Germany 26

The Netherlands 27

Marking to Market 28

Sufficiency Test 29

Sweden 30

Switzerland 31

United Kingdom 31

The United States 32

Australia 33

Similarities and Differences 34

Commonalities on the Asset Side 36

Chapter 3 The Role of the Fiduciary Manager as Chief Advisor 39

The Asset-Liability Study 39

Thinking through Risk and Return 41

Portfolio Construction 42

Selecting and Overseeing Investment Managers 43

Measuring and Benchmarking 43

Education 44

The Trusted Counselor, the Fellow Fiduciary 46

Chapter 4 Shaping the Fundamental Investment Policies 47

Liability-Driven Investments 51

Choosing an Active Investment Policy 52

Integrating Active Policy in the Overall Portfolio 55

Completion Account as a Necessary Adjunct to Active Policy 58

The Fiduciary Platform to Integrate Active Policy in the Overall Investment Portfolio 59

A Special Case: Bridging the Duration Gap 67

What a Fiduciary Manager’s Report Looks Like 68

Chapter 5 Asset-Liability Modeling and the Fiduciary Manager 73

The Role of the Fiduciary Manager 74

The Asset-Liability Model (ALM) 75

Policy Instruments Used in Asset-Liability Modeling 78

Calculations to Cope with Uncertainty 80

The Crucial Role of ALM 81

Asset-Liability Modeling in Practice 82

Prognosis of Future Reserves without Policy Changes 84

Future Financial Situation with Flexible Premium Levels under the Regime of a Fixed Compound Rate 85

Future Financial Situation with Flexible Premium Levels under the Regime of Compound Rates Equal to Market Interest Rates 88

Future Financial Situation with Changes in Investment Policy 100

Policy Changes 102

Where Does Fiduciary Management Fit In? 102

Chapter 6 Fiduciary Management In Practice—Portfolio Construction 105

Defining Appropriate Asset Classes 106

Hedge Funds: Weighing the ‘‘New’’ Alternative 106

Burrowing In: Defining Sub-Allocations 109

Thinking about Style 111

Apportioning the Fixed Income Portfolio 112

Measure for Measure 112

Formulating Mandates for Managers 114

Chapter 7 Horses For Courses—Selecting And Overseeing Investment Managers 115

Creating the Beauty Parade 116

Investment Performance 117

Investment Process and Philosophy 117

Investment People 118

Operational Risk 119

Managing the Beauty Parade 121

Managing the Transition 122

Overseeing the Managers 123

Chapter 8 Performance Measurement and Benchmarking 127

Why Has Benchmarking Grown More Important? 128

The Use of Different Types of Benchmarks 131

Liability-Driven Benchmarks 133

Strategic Benchmarks 134

Fixed Income 136

Equities 137

Real Estate 139

Detailed Benchmarks in the Context of Active Investment Policy 140

Active Overlay Management 143

Rebalancing 144

Measurement of Active Policy 145

Chapter 9 The Fiduciary Manager Experience in the Netherlands and Beyond 151

Changes in Investment Policy 152

Changes in the Role of a Fund’s Investment Committee 153

Changes in the Breadth and Depth of Discussions with Asset Managers 153

Changes in the Communication Process 154

Changes in the Level and Structure of Costs 155

Changes in the Importance of the Custodian 156

Overseeing the Fiduciary 157

Future Developments of the Market for Fiduciary Services 159

Beyond the Netherlands 165

Fiduciary Management Plus 165

Chapter 10 Summing Up Fiduciary Management: What It Is and Is Not 167

Goals, Policy, and Responsibilities 167

Fiduciary Management Can Enhance Productivity 173

What Fiduciary Management Is Not: A Simplification 174

Comparisons with Other Investment Management Models 175

The Concept’s Claims 176

Appendix: Suppliers of Fiduciary Services 181

Notes 259

Bibliography 265

Index 269

"Its key message is that fiduciary management is an idea whose time has come…Nunen provides good case study examples". (Investment & Pensions Europe, April 2008) Anton van Nunen, PhD, has headed Van Nunen & Partners, a consulting firm serving both institutional and individual investors, since 1998. His clients have included a number of major institutional investors in the Netherlands and beyond. Van Nunen has not only spelled out the concepts of fiduciary management, he has also implemented them at such institutions as VGZ-IZA, a major Dutch health insurance company, the Campina Pension Fund, and the Yarden Insurance Company. Van Nunen earned a PhD in economics from Tilburg University, where he went on to spend twelve years as an assistant professor.

Fiduciary management is an increasingly popular way of organizing the management of sizable investment portfolios. Much of the appeal for the concepts underpinning this idea is a response to the shortcomings that many investors see in the current approach to managinginstitutional portfolios—especially pension funds.

As the twenty-first century began, there was significant discontent among plan sponsors and other institutions regarding the prevailing investment management structure: too many people had a role while no one had overall responsibility. Fiduciary management came into being in response to such problems. Seeking to reunite expertise and responsibility, fiduciary management tries to ensure that those who oversee managers and consultants not only have the expertise to do this job, but also have close enough ties to the plan sponsor to do this job effectively.

Fiduciary Management: Blueprint for Pension Fund Excellence offers an in-depth explanation of every facet of this fast-growing approach to organizing the management of an institutional investment portfolio. Expert author Anton van Nunen begins by outlining the historic shift that has brought this strategy to the attention of the investment community, explaining the relationship between the theory and pension plans. Pension plan managers first set the scene for fiduciary management by limiting the number of players who were responsible for the funds. The theory soon spread beyond just pension funds to attract the interest of those who were responsible for all types of institutional portfolios. Van Nunen defines what is and what is not fiduciary management, details the principal functions of a fiduciary manager, and outlines the wide-ranging benefits of fiduciary management. Then he illustrates fiduciary management in practice, giving advice in terms of asset-liability modeling and financial markets, constructing portfolios, selecting and overseeing investment managers, benchmarking and measuring performance, and reporting.

Fiduciary management is a key mechanism for ensuring that a pension fund is able to have timely responses to changing market conditions while continuing to be focused on enduring investment principles. This book will help pension fund managers as well as all financial professionals to understand every aspect of this increasingly important concept.

Fiduciary Management

"Dr. van Nunen goes much further than to discuss governance. He discusses all aspects of what should be done in making a defined benefit plan successful, and expresses his views forthrightly. And he not only traces the history of pension arrangements, but supplements it with a fascinating chapter comparing arrangements around what I think of as the funded world. His ideas are relevant to fiduciaries around the funded world ... I hope you find his book as interesting, engaging, and useful as I did."
—From the Foreword by Don Ezra, Director of Investment Strategy, Russell Investment Group, and coauthor of Pension Fund Excellence

"Many pension funds are too small to ever become cost-effective pension delivery organizations. This book offers a solution to the serious 'too small' problem."
—Keith Ambachtsheer, Director of the Rotman International Centre for Pension Management, University of Toronto, founder of KPA Advisory Services Ltd., and author of Pension Revolution

"The topic of fiduciary management is now at the leading edge of assets and pensions management, which makes this book extremely timely. It manages to distill a wealth of practice and experience into a short and lucid discussion of the topic. A particular pleasure is that it avoids the trap of pages of obscure and usually irrelevant mathematics. For the many not following into this field, this is a 'must read.'"
—Con Keating, principal of The Finance Development Centre Ltd., London

"As is readily apparent from this book, Dr. van Nunen has thought long and hard about fiduciarymanagement and is one of the world's leading experts. He comprehensively describes how fiduciary management can improve plan governance, particularly as it relates to manager selection and the management of surplus risk. The book does an excellent job explaining how fiduciary management provides a robust framework and clear separation of duties for investment committee members trying to navigate an increasingly complex investment landscape."
—Bob Litterman, Managing Director and Head of Goldman Sachs Asset Management's Quantitative Resources Group, and author of Modern Investment Management: An Equilibrium Approach

"I found the book an interesting, engaging, and stimulating read. Fiduciary management is a very timely topic and is especially relevant for smaller pension plans that may lack in-house expertise. Such plans would benefit from outside help. The book covers a lot of ground. Dr. van Nunen shares with us his valuable insights and experience in his discussion of the pitfalls and complexities of asset management. Anyone who manages a defined benefit pension plan can benefit from reading this book."
—Josef Lakonishok, CEO and CIO of LSV Asset Management