Selecting A Fund Manager Guide

Issue date

19 Dec 2004

Introduction

Why pension fund investment is important

Pension funds exist in order to pay pensions to their beneficiaries - the millions of working people who are saving money to ensure that they can look forward to a decent life in retirement. Therefore pension funds invest in order to ensure that they can make those payments. The underlying function of investing is to help people provide for and enjoy their retirement.

The process of investment is a long-term business. Although many pension funds are increasingly ‘mature’ (meaning they have more retired than active members) few are anywhere close to the day when the last pension will have been paid out. This means that logically pension fund investment should have a long-term perspective to it.

And, although it might not often appear so, pension fund investment is also very much about people. Those ‘liabilities’ your actuary describes are the schemes’ beneficiaries, real-life people with aspirations for their retirement. And the ‘assets’ your schemes hold, particularly equities, are typically a slice of ownership of companies whose success is dependent on the skills, effort and management of the people who work for them.

It is important to remember these things because your experience as a trustee, and the advice you will be given, may lead you to think in quite different, and surprisingly narrow, terms. You may have been encouraged in the past to focus on the relative returns generated by your fund managers over periods of time that are remarkably short when viewed against the expected lifetime of the pension scheme. It addition it is very likely that there will be little discussion of the human side of the job that you are tasked with carrying out.

Simply focusing on short-term performance figures does not actually tell you much about the health of the fund, and may lead you to miss other important factors at play. The TUC believes that member trustees should always try and remember that pension fund investment is ultimately about helping beneficiaries enjoy their retirement over a very long period of time.

Finally trustees must also be aware that their role is extremely influential in the fund management market. Your decisions will send clear signals to fund managers about what clients expect.

In the past only a small number of fund managers showed a real commitment to issues that union members are interested in such as corporate governance and social responsibility. This is changing and if managers realise that their abilities and actions in these areas will affect their potential to win business it will be in their interest to ensure they are up to scratch.

It therefore cannot be stressed enough that member trustees should make maximum use of their influence during the manager selection process. If member trustees ensure that issues like governance and social responsibility have an impact on fund manager selection this could help bring about significant changes to the way investment management is undertaken.

This guide is intended as a simple run-through of some of the elements and issues that are involved in selecting managers. We hope it helps trustees through the business of reviewing and appointing fund managers, and provides information that will enable you to take a wider view during the process.

Background

The background to this guide

One of the most important decisions you will make as a trustee is who will take on the day-to-day management of the scheme’s investments - who will be its investment managers. This will be an organisation you are putting in charge of millions or even billions of pounds of scheme members’ money. You will want to be sure you have the right company for the job.

This short guide is intended to help trustees through the selection process and ensure that they are using it to its full potential. It will look at:

How trustees should go about choosing an investment manager

The methods available

How to ensure members’ interests are properly reflected in the process

The influences on fund manager selection

The qualities you could look for in an investment manager

Before we get started on the actual business of selecting fund managers it is worth exploring two issues that are closely connected to it. First, why member trustees must be involved in the process and second some important background information about the investment review process.

The need for member trustee involvement

Whilst trustees can delegate the day-to-day investment decisions of the scheme to the investment manager, the ultimate responsibility for how the fund is invested and how it performs rests with the trustees. It is vital that they choose an investment manager who is capable, that the trustees trust and can work with, and who will carry out their instructions.

Member trustees must be involved in the decision over who is to be chosen as the fund manager. Many employers and employer trustees have in the past taken the view that decisions about a scheme’s investments are not the concern of trade union members or member trustees and that in any case, trade unionists do not understand these issues. We know this is not true and the case for member participation must be made.

It is also important that member trustees are involved in choosing fund managers in order to ensure that members’ longer-term interests are properly reflected. Trustees will want to ensure that the managers they choose are properly committed to promoting high standards of corporate governance and social responsibility in investee companies. You will be in a highly influential position when selecting managers and can ensure that those chosen do take these issues seriously. If member trustees do not raise these issues they may not feature at all in the selection process.

Finally, if your scheme has followed the recommendations of the Myners review and established a separate investment sub-committee it is vital that there is member representation on it. If there is no such committee member trustees should consider advocating that the scheme set one up.

A few words of caution about beauty parades

Trustees need to be aware that the selection of fund managers is actually a very small part of the job of investing fund assets. The investment strategy, particularly asset allocation, is fundamentally more important. Hence whilst the manager selection process needs to be taken seriously, it must be seen in the context of wider scheme strategy.

You should also bear in mind that the selection process is an imprecise one. It appears to be very hard, if not impossible, to accurately predict which fund managers will outperform over a set period. In fact efficient markets theory argues that it should be impossible for any investor to outperform over any prolonged period of time. This suggests that it will be very difficult to pick a 'winning' fund manager in an investment review.

What is more there is also evidence that for these reasons pension funds have been poor at choosing fund managers in the past. According to research by The WM Company they have tended to pick strongly-performing managers at the point when they begin to under-perform, and conversely fire under-performing fund managers at the point when they begin to improve.

And always bear in mind the timeframe within which you are investing. The typical scheme will, you would hope, be expecting to pay out pensions for beneficiaries for decades to come. You of course need to keep a close watch on the funding of the scheme and as such performance is important. However a few quarters of underperformance may be ultimately relatively irrelevant in terms of the fund’s long-term objectives.

There is concern that pension funds may be too short-term in their approach to investment performance. This matters because of the signals it sends through the capital markets. If fund managers are hired, or fired, based on short-term performance they will seek to ensure that they generate short-term returns. This in turn may lead them to encourage the companies they invest in to embark on short-term activity that boosts the share price regardless of the long-term impact on the company. Or they may invest in companies that they do not really believe in simply because they expect the shares to go up, as was the experience in the recent TMT bubble.

None of this is to suggest that you should not review and consider replacing a fund manager if you have performance concerns. In fact your scheme’s rules may stipulate that you must review on a regular basis. However you must be aware that it may not address the issue of performance in the way you expect. You should also note that the Myners review recommended that trustees make it a principle that they do not terminate an agreement with a fund manager in less than the agreed timescale of the mandate on performance grounds alone.

As a result of such issues a number of pension fund are starting to appoint their fund managers for much longer-term mandates. This may be an issue you want to raise with your consultant.

Finally the process of an investment review and fund manager appointment is not cheap. So be sure that you really need to change your arrangements before you agree to carry out an investment review.

Getting started

Why choose an investment manager?

These days all but a few of the largest pension schemes in the UK contract out the investment management of their assets to external fund managers. Therefore it is essential that the process of initial and periodic review of fund managers is a rigorous one.

So why would scheme trustees typically need to choose an investment manager for the assets of their fund?

If the scheme wanted to change its investment strategy and award new mandates.

If the relationship between the scheme and the existing investment manager had broken down. This might happen for a number of reasons:

i) a breakdown in the chemistry of the relationship between the trustees and the representative of the investment management company

ii) the investment manager could be failing to administer the investment process adequately - for example not reporting back to trustees properly

iii) consistently poor performance - the investment management company could be failing to achieve the performance targets or benchmarks set by the fund

iv) a change in personnel at the investment management firm dealing with the fund, perhaps through a takeover or staff changes

Re-read the Myners principles

To aid the process of manager selection the TUC would strongly recommend that you read through the Myners principles. These principles should be at the heart of how you carry out your investment duties. The principles themselves are not long but they contain some important guidance to trustees making investment decisions such as the need for:

Effective and informed decision-making

Clear investment objectives

Explicit mandates

A focus on asset allocation

Shareholder activism to be included in mandates

It will only take a few minutes of your time to refresh your understanding of the Myners principles, but it could remind you of some important issues to bear in mind. For convenience the principles are included at the end of this guide.

The role of the consultant

Most schemes will use an investment consultant to help them in selecting a fund manager. The consultant might be the scheme’s existing actuary. Alternatively the fund might appoint a separate investment consultant. You should note that the Myners review recommended that where practical funds should at least tender separately for actuarial and investment consulting advice.

In either case, the consultant will assess the size of the scheme, look at the fund's investment performance and investment portfolio and match the scheme with appropriate investment managers.

The advantage with this approach is that someone else carries out the due diligence for you ‑ you are not involved in the daunting task of sifting through many brochures from firms of investment management companies and weighing one up against the other.

The disadvantage is precisely that someone else is taking the decision for you. The trustees have less control over what is going on. Furthermore, the consultant might have a vested interest in promoting the virtues of one firm over those of another.

It should also be noted that to date there have been concerns that some consultants may not as yet have well-developed skills for advising pension funds on issues such as corporate governance and socially responsible investment. Indeed there is some evidence to suggest that they may be inadvertently acting as a block to pension funds developing their approaches in this area.

As such this may be an area where trustees will want other sources of information on fund managers. If you wish to make sure you are getting a full range of information on these issues when reviewing or appointing managers there is a list of suggested resources at the end of this guide. Alternatively you may wish to contact the TUC for information.

1.1 The selection process

Points to bear in mind

Point 1: make your RFP count

At the first stage of the process the consultant will send out a tender notice, also known as a Request for Proposals, or RFP for short. This is the document your consultant will circulate to fund managers to invite them to tender for your mandate. It is also one of the potentially most useful tools in a trustee’s toolbox. What goes into your RFP will have a major influence on which fund managers will even make it past the first stage of selection.

Put simply the RFP sets out the minimum requirements your fund has for any manager wishing to run the mandate you are tendering. It might typically stipulate a demonstrable competence running the mandate out to tender.

For example here is part of a recent RFP sent out by a local authority pension fund:

Information concerning the personal situation of the contractor, supplier or service provider and information and formalities necessary for the evaluation of the minimum economic, financial and technical capacity required:

Proof of FSA or equivalent registration.

Details of corporate structure and ownership.

Total market value as at 31.12.2002 of total assets under management, tax exempt portfolios managed to similar mandates and portfolios managed for local authority pension funds to similar mandates.

Number of professionally qualified investment management staff involved in the management of these funds.

Track record of (ideally GIPS compliant) past performance returns (with income reinvested) of tax exempt portfolios for at least each of the last 12 quarterly periods. Suppliers should show the returns on the benchmark against which each fund's performance has been measured (funds with the same benchmark may be aggregated). Source of return statistics should be indicated.

However there is nothing to stop trustees from adding further requirements to the RFP such as:

The manager will vote all shares where practical to do so and take a considered approach to voting.

The manager will have a commitment to shareholder activism to protect the value of investments and challenge poor corporate governance, and be able to demonstrate adherence to the ISC statement of principles on the responsibilities of institutional shareholders and their agents.

The manger must take proper account of issues of corporate social responsibility and have a demonstrable record of engaging with investee companies where such issues threaten the value of investments.

By putting requirements for fund managers to demonstrate commitment to activism in your RFP you will be preventing fund managers with no commitment to active ownership from being selected. As this will have an impact on the commercial success of fund managers it will send an important message to the fund management market - only managers who take their ownership responsibilities seriously can expect to be commercially successful. This will help strengthen the hand of those managers which do take such issues seriously, and put pressure on those which do not to improve their practice.

Point 2: Do your own research

Once the consultant has assembled a shortlist you may wish to carry your own research: look at the pensions press and trade union commentary and see how the various investment management companies are viewed. What reports have there been on the managers under consideration in the last year or so? Do they seem to be interested in issues such as corporate governance and socially responsible investment?

You might look at other funds' experiences. Which other funds does the applicant manage? Do they manage any money for trade unions? What sort of mandates do they seem to be awarded most often? If your scheme is a small scheme is the management company geared up to dealing with small schemes or does it only want small schemes for clients?

Point 3: Have a questionnaire ready

In order to provide a framework for interviewing fund managers it is advisable to have some questions ready to ask.

You will not normally have to write the questionnaire. The scheme actuary or consultant will normally be employed to do this. But the questionnaire must have the approval of the trustees. At the very least member trustees must be able to have their input into it ‑ for example, ask the prospective fund managers views on working with member trustees, socially responsible investment, corporate governance and so on.

You should tailor the questions to meet your own scheme's needs. Factors to consider when drawing up a questionnaire include the market value of the scheme (ie how much is it worth); the size of the scheme (how many members does it have; how many are currently receiving a pension; how many are contributing to the scheme?).

You could ask about how the manager work with your scheme's statement of investment policy and their attitude to issues like shareholder voting. Include questions about the fund manager's experience in dealing with schemes like yours. You will also want to find out what the fund manager will charge for managing your fund.

It is vital that member trustees make their feelings known in the manager selection process. Issues that trade unions are concerned about will only be taken seriously if they are raised. Remember that fund managers and investment consultants ultimately exist to serve the client - and the client is you.

If you feel that issues that you feel are important are not being properly dealt with in the selection process make your consultant aware of this as soon as possible. If the questions that are being put to the potential fund managers do not cover the areas you think they should, introduce your own.

A sample questionnaire is included in this guide.

Point 4: Passive investment

It is particularly important that trustees are thorough in the manager selection process when appointing manager for passive, or index-tracking mandates. Tracking an index means by definition that the fund is locked into certain stocks. The appointed fund manager cannot trade their way out of companies that are in trouble.

As such the only way the manager can protect the value of your investments is by engaging actively with investee companies and trustees must ensure that the appointed manager will be willing and able to do so.

The TUC’s view therefore is that trustees appointing passive mandates must take a close look at the resources managers devote to addressing governance and CSR issues. You should consider it part of your responsibilities as a trustee to do so. Trustees should appoint managers that are committed to defending and enhancing value through active ownership. And this should be one of the key differentiators at the beauty parade.

This is not to say that there is not an equal case to be made when choosing active managers. But the particular nature of passive investment does throw the responsibilities of ownership into sharp relief.

Making a decision

There are various ways you might decide to choose the scheme's investment manager.

You may be tempted to make your decision just based on how the fund management company comes across. For example, you could go with the one that has been around the longest, the one that manages the most funds or is the biggest. But while this might be the easiest way of choosing a fund management company, it is no guarantee that you will get the right fund manager for your pension scheme.

You may want to look at how the fund management company has performed recently. However as we have seen past performance is not a good guide to the future so this should not be the only information you base your decision on.

In reality once you have reached the shortlist stage all the managers you interview should be able to run the mandate you are awarding. As such there may be little to choose between them. Where this happens why not compare their voting records on corporate governance issues, or consider which you think is more committed to promoting high standards in investee companies?

Sample questionnaire

Set out below is an example of some of the questions that could be put to a potential investment manager.

1. Business

1.1 What are your longer term business plans in terms of both assets and clients, and how are these going to be achieved?

1.2 What is the ownership structure of the business?

1.3 How much experience do you have of managing a portfolio of this size?

1.4 Given your approach to investment, how much money do you believe that you could realistically manage in UK equities before it became a problem?

1.5 What performance-related fee scale would you propose for this mandate?

1.6 Are you prepared to work to tracking error guidelines rather than performance targets?

1.7 How many portfolios does a typical portfolio manager run in the UK equity team?

2. People

1.8 How do you retain and motivate people?

1.9 How do you align the interests of your staff with the interests of your clients?

1.10 How do you go about recruiting staff? What do you look for in potential recruits?

1.11 What are your current recruitment plans?

1.12 What succession plans do you have in place for key individuals?

1.13 How would you describe the culture of your organisation?

1.14 How important would the individual portfolio manager be to our return?

1.15 How many portfolios is our proposed manager responsible for? How many of these are managed in a similar way to the proposed mandate?

1.16 What relationship would you propose to have with the Investment Committee?

3. Process

1.17 What is the maximum tracking error that you would be prepared to manage the portfolio at?

1.18 What biases would you expect to find in one of your UK equity portfolios? Would these be different for a high-risk portfolio?

1.19 Please give an example of both a successful and unsuccessful stock purchase, identifying -

Who came up with the idea

What process had to be followed to get it into the portfolio

How the weighting was agreed

Who was responsible for selling the stock

1.20 Where do you believe your competitive advantages lie?

1.21 What is your firm's biggest weakness?

1.22 How do your systems assist you in running portfolios?

1.23 How do your dealers add value for you? How has this changed as assets under management have increased?

1.24 How has your process evolved recently and how do you believe it is likely to evolve going forward?

1.25 How would you manage the particular demands of the mandate?

4. Corporate governance and corporate social responsibility

1.26 How do you comply with The Responsibilities of Institutional Shareholders and Agents - Statement of Principles issued by the Institutional Shareholders’ Committee?

1.27 How many dedicated staff do you have working on:

corporate governance issues

social responsibility issues

1.28 What access to governance and CSR research services do you have?

1.29 Do you vote at all UK company meetings? If not what proportion do you vote at and why do you not vote at all of them?

1.30 Do you make your voting record publicly available?

1.31 Approximately what proportion of votes do you vote for, against and abstain during a typical season?

1.32 Have you participated in the TUC Fund Manager Voting Survey?

1.33 Do you believe that issues of corporate social responsibility have an impact on company performance?

1.34 If yes, to what extent is analysis of CSR issues factored into investment decision-making? Are there any examples of where CSR issues have made you disinvest from a company?

1.35 Do you engage with companies over CSR issues/concerns? Do you have examples of successful engagement?

1.36 Are you involved with any investor coalitions on CSR issues - climate change, access to medicines, Burma?

1.37 Do you have a formal system for rewarding brokers for analysing intangibles? If yes, what percentage of your fee is allocated to this? If no, why?

Conclusion

Key things to remember:

Selecting a fund manager is a relatively small element of your investment duties, investment strategy and asset allocation are more fundamental.

The most important thing is to appoint fund managers that meet the needs of your scheme.

Pension funds invest over a very long period of time, do not focus undue attention on managers’ short-term performance figures.

Sacking a poorly-performing manager may not solve the problem.

Factors such as corporate governance and social responsibility may play an important role in protecting and delivering shareholder value over the long term, so it is important to question managers on their skills in these areas.

It is especially important to assess how passive managers address these kinds of issues as they cannot trade out of stocks where there are problems.

Online sources of information:

General websites

TUC trustee website www.tuc.org.uk/trusteenetwork

Hewitt Bacon & Woodrow http://www.hewittbaconwoodrow.co.uk

Hymans Robertson http://www.hymans.co.uk

Watson Wyatt http://www.watsonwyatt.com

William Mercer http://www.merceric.com

Fund manager information

TUC Fund Manager Voting Survey www.tuc.org.uk/fundmanagers

Investment Management Association www.investmentuk.org

Corporate governance and socially responsible investment

Pensions Investment Research Consultants www.pirc.co.uk

UK Social Investment Forum www.uksif.org

Manifest www.manifest.co.uk

Long-term investment

Information on the competition held by the Universities Superannuation Scheme on how pension funds could invest with a longer-term perspective.

http://www.usshq.co.uk/special_interest_groups_index.php?name=SPECIAL_INTEREST_GROUPS_COMPETITION

Media

Financial News www.efinancialnews.com

Global Money Management http://www.globalmoneymanagement.com

Pensions Week http://www.ftbusiness.com/product_pensionweek2.htm

Professional Pensions http://www.thepensionsite.co.uk

PensionsNet www.pensionsnet.com

PensionsPro www.pensionspro.com

Further reading:

How to be a responsible pension fund: a manual on how to evaluate your fund manager for pension funds who have a commitment to corporate governance and/or responsible investing - Universities Superannuation Scheme

This guide is aimed at trustees of larger funds with a greater level on knowledge about SRI and governance. It will be very useful to trustees of such funds.

http://www.usshq.co.uk/special_interest_groups_index.php?name=INVESTMENTS_HOW_TO_BE_A_RESPONSIBLE_PENSION_FUND

The Myners Principles

Defined Benefit Pension Schemes

1. Effective decision-making

Decisions should be taken only by persons or organisations with the skills, information and resources necessary to take them effectively. Where trustees elect to take investment decisions, they must have sufficient expertise and appropriate training to be able to evaluate critically any advice they take.

Trustees should ensure that they have sufficient in- house staff to support them in their investment responsibilities. Trustees should also be paid, unless there are specific reasons to the contrary.

It is good practice for trustee boards to have an investment subcommittee to provide the appropriate focus.

Trustees should assess whether they have the right set of skills, both individually and collectively, and the right structures and processes to carry out their role effectively. They should draw up a forward- looking business plan.

2. Clear objectives

Trustees should set out an overall investment objective for the fund that:

represents their best judgement of what is necessary to meet the fund’s liabilities given their understanding of the contributions likely to be received from employer(s) and employees; and

takes account of their attitude to risk, specifically their willingness to accept underperformance due to market conditions.

Objectives for the overall fund should not be expressed in terms which have no relationship to the fund’s liabilities, such as performance relative to other pension funds, or to a market index.

3. Focus on asset allocation

Strategic asset allocation decisions should receive a level of attention (and, where relevant, advisory or management fees) that fully reflect the contribution they can make towards achieving the fund’s investment objective. Decision-makers should consider a full range of investment opportunities, not excluding from consideration any major asset class, including private equity. Asset allocation should reflect the fund’s own characteristics, not the average allocation of other funds.

4. Expert advice

Contracts for actuarial services and investment advice should be opened to separate competition. The fund should be prepared to pay sufficient fees for each service to attract a broad range of kinds of potential providers.

5. Explicit mandates

Trustees should agree with both internal and external investment managers an explicit written mandate covering agreement between trustees and managers on:

An objective, benchmark(s) and risk parameters that together with all the other mandates are coherent with the fund’s aggregate objective and risk tolerances;

The manager’s approach in attempting to achieve the objective; and

Clear timescale(s) of measurement and evaluation, such that the mandate will not be terminated before the expiry of the evaluation timescale for underperformance alone.

The mandate and trust deed and rules should not exclude the use of any set of financial instruments, without clear justification in the light of the specific circumstances of the fund.

Trustees, or those to whom they have delegated the task, should have a full understanding of the transaction-related costs they incur, including commissions. They should understand all the options open to them in respect of these costs, and should have an active strategy - whether through direct financial incentives or otherwise - for ensuring that these costs are properly controlled without jeopardising the fund's other objectives.

Trustees should not without good reason permit soft commissions to be paid in respect of their fund’s transactions.

6. Activism

The mandate and trust deed should incorporate the principle of the US Department of Labor Interpretative Bulletin on activism [1] . Trustees should also ensure that managers have an explicit strategy, elucidating the circumstances in which they will intervene in a company; the approach they will use in doing so; and how they measure the effectiveness of this strategy.

7. Appropriate benchmarks

Trustees should:

explicitly consider, in consultation with their investment manager(s), whether the index benchmarks they have selected are appropriate; in particular, whether the construction of the index creates incentives to follow sub-optimal investment strategies;

if setting limits on divergence from an index, ensure that they reflect the approximations involved in index construction and selection;

consider explicitly for each asset class invested, whether active or passive management would be more appropriate given the efficiency, liquidity and level of transaction costs in the market concerned; and

where they believe active management has the potential to achieve higher returns, set both targets and risk controls that reflect this, giving the managers the freedom to pursue genuinely active strategies.

8. Performance measurement

Trustees should arrange for measurement of the performance of the fund and make formal assessment of their own procedures and decisions as trustees. They should also arrange for a formal assessment of performance and decision-making delegated to advisers and managers.

9. Transparency

A strengthened Statement of Investment Principles should set out:

who is taking which decisions and why this structure has been selected;

the fund’s investment objective;

the fund’s planned asset allocation strategy, including projected investment returns on each asset class, and how the strategy has been arrived at;

the mandates given to all advisers and managers; and

the nature of the fee structures in place for all advisers and managers, and why this set of structures has been selected.

10. Regular reporting

Trustees should publish their Statement of Investment Principles and the results of their monitoring of advisers and managers. They should send key information from these annually to members of these funds, including an explanation of why the fund has chosen to depart from any of these principles.

Defined Contribution Pension Schemes

1. Effective decision-making

Decisions should only be taken by persons or organisations with the skills, information and resources necessary to take them effectively. Where trustees elect to take investment decisions, they must have sufficient expertise and appropriate training to be able to evaluate critically any advice they take.

Where scheme members are given a choice regarding investment issues, sufficient information should be given to them to allow an appropriate choice to be made.

Trustees should ensure that they have sufficient in-house staff to support them in their investment responsibilities. Trustees should also be paid, unless there are specific reasons to the contrary.

It is good practice for trustee boards to have an investment subcommittee to provide appropriate focus.

2. Clear objectives

In selecting funds to offer as options to scheme members, trustees should:

consider the investment objectives, expected returns, risks and other relevant characteristics of each fund, so that they can publish their assessments of these characteristics for each selected fund; and

satisfy themselves that they have taken their members’ circumstances into account, and that they are offering a wide enough range of options to satisfy the reasonable return and risk combinations appropriate for most members.

3. Focus on asset allocation

Strategic asset allocation (for example for default and lifestyle options) should receive a level of attention (and, where relevant, advisory or management fees) that fully reflects the contribution they can make to achieving investment objectives. Decision-makers should consider a full range of investment opportunities, not excluding from consideration any major asset class, including private equity.

4. Choice of default fund

Where a fund is offering a default option to members through a customised combination of funds, trustees should make sure that an investment objective is set for the option, including expected returns and risks.

5. Expert advice

Contracts for investment advice should be open to competition, and fee rather than commission based. The scheme should be prepared to pay sufficient fees to attract a broad range of kinds of potential providers.

6. Explicit mandates

Trustees should communicate to members, for each fund offered by the scheme:

the investment objective for the fund, its benchmark(s) and risk parameters; and

the manager’s approach in attempting to achieve the objective.

These should also be discussed with the fund manager concerned, as should a clear timescale(s) of measurement and evaluation, with the understanding that the fund mandate will not be terminated before the expiry of the evaluation timescale for underperformance alone.

Trustees should not without good reason permit soft commissions to be paid in respect of their fund’s transactions.

7. Activism

The mandate and trust deed should incorporate the principle of the US Department of Labor Interpretative Bulletin on activism. Managers should have an explicit strategy, elucidating the circumstances in which they will intervene in a company; the approach they will use in doing so; and how they measure the effectiveness of this strategy.

8. Appropriate benchmarks

Trustees should:

explicitly consider, in consultation with their investment manager(s), whether the index benchmarks they have selected are appropriate; in particular, whether the construction of the index creates incentives to follow sub-optimal investment strategies;

if setting limits on divergence from an index; ensure that they reflect the approximations involved in index construction and selection;

consider explicitly for each asset class invested, whether active or passive management would be more appropriate given the efficiency, liquidity and level of transaction costs in the market concerned; and

where they believe active management has the potential to achieve higher returns, set both targets and risk controls that reflect this, giving managers the freedom to pursue genuinely active strategies.

9. Performance measurement

Trustees should arrange for measurement of the performance of the funds and make formal assessment of their own procedures and decisions as trustees. They should also arrange for a formal assessment of performance and decision-making delegated to advisers and managers.

10. Transparency

A strengthened Statement of Investment Principles should set out:

who is taking which decisions and why this structure has been selected;

each fund option’s investment characteristics;

the default option’s investment characteristics, and why it has been selected;

the agreements with all advisers and managers; and

the nature of the fee structures in place for all advisers and managers, and why this set of structures has been selected.

11. Regular reporting

Congress House

Great Russell Street

London WC1B 3LS

telephone 020 7636 4030

fax 020 7636 0632

www.tuc.org.uk

contact:

Tom Powdrill

020 7467 1201

tpowdrill@tuc.org.uk

[1] As an alternative trustees could consider requiring managers to demonstrate compliance with the Institutional Shareholders Committee principles on the responsibilities of shareholders

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