Trying to draw inferences about fiduciary managers by comparing their growth funds grossly misses the point – to outperform liabilities – of these mandates, argues IC Select’s Anne-Marie Gillon.
However, this approach should be regarded at best as naïve, and at worst misleading. Using the performance of the growth assets of a fiduciary manager to assess their overall performance is akin to attempting to judge the weight of an elephant by measuring its tail.
There will probably be some relationship, but not one that is sufficient to draw any reasonable conclusions. It would be a lot more accurate to find an appropriate scale to weigh the elephant.
There is no standardised way to calculate growth fund performance data that is adopted by all managers
It is naïve to believe that the management of growth assets reflects the overall performance of a fiduciary manager, because effective fiduciary management is about the management of total fund assets against liabilities.
In this context, it is easy to identify three key reasons why comparing the performance of growth funds is not helpful.
Growth portfolios play different roles
First, some managers find it more cost-effective to implement their interest rate views through liability-matching assets rather than within the growth assets.
Where interest rate views are implemented in this way, it creates a distorted asset allocation for the growth assets, since fixed interest investments will not be included and, consequently, it will appear that there is a higher equity weighting and more volatility.
Second, fiduciary managers’ approaches to growth fund management vary, with managers trying to achieve different return objectives for their growth funds. This makes some managers appear higher risk than others if the growth assets are compared in isolation.
However, this difference in growth fund objective gets balanced out when the full portfolio is constructed. For example, a 50 per cent allocation to a growth fund objective of ‘cash plus 4 per cent’ would have the same impact, at the total fund level, as a 66 per cent allocation to a ‘cash plus 3 per cent’ target – both providing an expected total fund return of 2 per cent.
Third, in recent years fiduciary managers’ propositions have evolved to include cash flow-driven solutions. Where these are used, the assets provide both liability protection and return enhancement, further changing the requirement of the growth fund assets.
Assessing a fiduciary manager by focusing only on the growth fund returns misses this valuable part of the service.
Fund-level performance lacks standardisation
The above three reasons demonstrate why it is naïve to compare the growth funds of fiduciary managers. However, the following three reasons illustrate why it is misleading to compare the performance of growth funds.
First, there is no standardised way to calculate growth fund performance data that is adopted by all managers. Consequently, growth fund performance is calculated in different ways by each fiduciary manager.
Some present the performance of the growth assets by using a carve-out of the growth fund assets from one of their clients. Others use the performance of a model fund, while at some companies the managers rely on the performance of publicly available fund data. Some managers will use a composite of all client growth funds.
Depending on the method employed, costs may not be fully captured, illiquid investments may not be included in the growth fund return, and the manager may have the ability to cherry-pick the performance track record they share.
Second, the timing of the publication of recent growth data meant that revaluations of illiquid investments had not been completed before publication at all managers. Instead, historic pricing of illiquid investments, unadjusted for the impact of Covid-19, was used to determine performance. This would have had a significant impact on both the reported return and risk figures, making them unreliable.
Finally, extreme caution needs to be applied to the comparison of growth funds, as the objectives and the risk constraints vary between managers.
However, there is the equivalent of an ‘elephant’ scale for fiduciary management. At the end of 2019, the Competition and Markets Authority approved the Global Investment Performance Standard for Fiduciary Management as the recommended method for assessing the performance of fiduciary managers.
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This GIPS standard looks at the total performance of a fiduciary manager relative to liabilities and must be calculated by all managers according to the same methodology.
By looking at total fund performance, it avoids the problems associated with growth fund performance described above and – as it is calculated on a standardised basis, unlike growth fund performance data – provides trustees with directly comparable performance information to support fiduciary manager assessment.
By using this information, trustees can be confident they will not be misled by spurious information and can instead judge the full size of each fiduciary manager.
Anne-Marie Gillon is a director at IC Select
