As companies struggle with underfunded defined-benefit pension plans, more are deciding to offload the chore of investing their plan assets.
Russell Investments, which has been providing such outsourced investment management, which it calls fiduciary solutions, since 1980, said it received 31% more completed requests for proposals (RFPs) for investment outsourcing last year than it did in 2011. And a recent survey by Asset International’s Chief Investment Officer Magazine showed 55% of companies with pension plans did some investment outsourcing or plan to do so within the next 24 months.
“The interest level has increased quite a bit,” said Eric Macy, managing director of fiduciary solutions at Seattle-based Russell. “People talked about it for a few years, but last year we really started seeing it.”
Macy linked the pickup in interest to the financial bind in which many corporate pension plans find themselves. While equity markets rose last year, interest rates remain low, which boosts pension plan liabilities. Actuarial firm Milliman estimated that the 100 largest U.S. pension plans faced a total funding deficit of $412 billion at the end of last year, which was $74 billion higher than the deficit at the end of 2011, and had an average funded ratio of just 76.4%.
“The great majority of pension plans are underfunded,” Macy said. “Plan sponsors are saying, ‘We need a plan to get us fully funded and keep us there.’”
The situation is a painful one for corporations. Regulatory changes mean pension plan finances now filter through to the company’s balance sheet. And a number of large companies have had to make sizable contributions to their underfunded pension plans over the last couple of years.
Companies traditionally have employed investment advisers to help them decide on asset allocation and select investment managers. When a company outsources the investment of its pension plan assets, it gives the outsourcer the authority to select investment managers.
This fits with the “more dynamic approach” to investment management companies are adopting, according to Macy. Rather than having the investment committee assess the performance of the plan’s investments and discuss possible changes to those investments at its periodic meetings, companies see an advantage to monitoring the markets on a daily basis for investment opportunities
“That’s a new segue into the need for a more outsourced CIO approach,” Macy said. “They don’t have someone to do it in house, they need someone who can look at opportunities on a daily basis and take advantage of opportunities.”
Companies are also questioning whether investing their pension assets in-house is the best way to spend their time and energy, he said. “Companies are saying, ‘Things haven’t gone that well, we’re a tire company, we need to focus senior management’s attention on the core business. So if there’s a governance model that can help us focus on the high-level issues of the pension plan and outsource the more day-to-day issues to seasoned professionals, that’s a good approach.’”
Agreeing, Debra Woida, head of delegated investment services for the Americas at Towers Watson, said that interest in outsourcing among companies with defined-benefit pension plans has grown over the last several years. In fact, these days even RFPs for investment advisory services often include a request for more information about investment outsourcing, said Woida, pictured at right, adding “I think in the current environment, everyone is feeling they at least need to feel they understand what it is.”
Some companies, even those with internal investing expertise, adopt investment outsourcing to handle more complex investments, such as real estate, hedge funds or distressed debt, Woida said. “Picking and monitoring an equity manager is very different from the due diligence to pick a hedge fund manager.”
Woida also links the interest in outsourcing to the decisions by many companies to freeze or close pension plans. Once the pension plan is no longer part of the company’s benefits package, it becomes less strategic. And the company may be less interested in targeting a certain return on their assets and more focused on limiting the risk involved in the plan and possibly preparing to shutter the plan completely and get it off the balance sheet. Those goals involve tactics that go beyond traditional investment selection, like devising a lump sum buyout or an annuity purchase.
Companies also like investment outsourcing because it allows them share the fiduciary liability for the plan. The company does not eliminate its responsibility and shares it with the outsourcer, Woida said. “Instead of being responsible for each and every decision, they’re responsible for seeing that the person they selected as their [outsourced chief investment officer] is a prudent selection and has the proper resources.”
As interest in investment outsourcing has grown, many new players are entering the field. Woida cautioned that companies should make a careful selection. “What position would you be in if they’re not in the business in a year?
“The level of due diligence around selecting a provider needs to be carefully thought out,” she said. “It is more than just advice so you need to be sure to document that it’s a prudent selection and this provider has the proper resources, the proper staff, the proper commitment to the business to provide you with that.”