The management of council pension funds is extensively devolved to investment managers and substantially comprises multi-manager portfolios. As a result, 75% or£75bn of day-to-day investment activity in the UK's council funds is controlled by external managers.
Professional relationships between pension funds and investment managers are critical to the success and integrity of the investment process, given the enormity of this delegation to the City. In response, the in-house council investment function has developed monitoring frameworks to help codify these relationships. The different pension funds might selectively review and check the process, standards and compliance of investment service providers. This is usually achieved through:
-- Effective co-ordination of investment activity across multi-manager structures
-- Reporting to councillors on the overall and key investment positions at regular intervals
-- Communication networks throughout the investment community - investment updates, training and development
-- Promoting external contacts to benefit from best practice in other funds, both public and private.
There is a high degree of consistency to budget monitoring across local authorities and it is a highly transferable skill. The common denominators are the identification of significant budget problems, pressures on spend and risk areas as soon as they become apparent. Prompt management action can be taken to control the use of resources, followed by modification to the level of services ensues.
Taking difficult budget decisions and then acting on them is thoroughly ingrained in local government culture. There is a common currency when it comes to understanding budgets and monitoring requirements among councillors and officers across all tiers of local government. After all, budgets touch on everything.
The same stylised approach to investment monitoring is more difficult to regularise across the 98 local authority
pension funds. Pensions and investments are specialist disciplines and, though important, are still by-products of council business, dealt with by just a few.
Investment monitoring horizons are also quite different. It is not just a matter of correcting for under or overspends while counting the months through the annual budget cycle. Distinguishing the difference between budget and investment monitoring is down to cultural differences in the local authorities, and is expressed in their dealings with external managers.
The monitoring ethos towards external managers and their investment decisions can perhaps be likened to three types of approach - the shadow boxer, the kick boxer and the spectator.
The shadow boxer tests the retrospective merits of
individual investment transactions. An element of rationalisation is not to be derided but persistently second guessing the professional may not be the most constructive and sustainable approach. For the monitor without portfolio,
to follow in the steps of another is to assume an overlapping role. Using this sort of rigour in the investment monitoring regime has the potential to interrupt, if not blur, the delegation.
The kick boxer carries the suggestion of precision to the investment monitoring rounds, but also implies some surprise strikes and point scoring. If so, how can this behaviour engender trust in the relationship? SAS70, FRAG21, the FSA, and IMRO provide seasoned gloves for investor protection.
The spectator, who takes his or her perspective from outside the ring, defines a more strategic setting for investment monitoring. But this is difficult to achieve because each relationship is unique and impacts on the combined fund.
The Unilever vs Merrill Lynch bout provided great spectator sport. The press relished reporting the details of an apparent collapse in communications and relationships, both important facets of effective monitoring. The minutiae of the breakdown were thoroughly exposed with neither side immune from bruised reputations and professional embarrassment.
Unlike budget monitoring, the Unilever case showed that things are not so clear cut in the investment monitoring arena. The strict right or wrongs of local government budget culture just do not translate to investment.
In the post-Unilever climate investment managers will go for belt and braces where practicable, notably tightening up investment agreements. For their part, pension funds might guard against the prospect of pursuing a less than open relationship with asset managers. Standing outside the ring does not mean becoming a bystander. Translating this strategic approach is about management not administration - managing the external manager not just administering his paperflows.
Each pension fund is unique but even with customised circumstances there are some very basic components to effective monitoring of external managers. These involve establishing procedures and processes to consolidate, review and report investment information from the different managers, together with qualitative and quantitative performance activity level indicators.
Within the system there need to be early warnings to promptly identify problems and overall portfolio risk areas. All information commissioned and received from investment managers should be reviewed, if only to ensure the validity and integrity of the information. Regular review and discussion with the managers is essential. Meetings or forums need to be in place, and monitoring should be firmly on the agenda.
But the in-house investment team has an important reciprocal part to play. The provision of accurate and timely feedback to managers is a priority. Advice, guidance and support on all aspects of the interface withcouncillors must be available to enable investment managers to function with full information, and not in a vacuum. As a focal point for internal management and councillor views, the investment officer should distil and manage the messages and make sure there are no surprises.
Successful monitoring tools can increase the awareness of the boundaries within which investment managers operate. The promotion of best practice among council funds is about ensuring high quality relationships and flows of investment information - especially given the enormity of the monies at stake.
Greater investment awareness and skill levels enable appropriate and responsive investment direction on the part of the pension fund client. In turn, this assists developments in monitoring with higher levels of satisfaction for both pension fund and manager.
Head of finance and investment, London Pensions Fund Authority