6 March 2001
MYNERS REVIEW SETS OUT PROPOSALS FOR NEW APPROACH TO INSTITUTIONAL INVESTMENT
The Myners review of institutional investment published its final report today. It identifies a series of distortions to effective decision-making, and makes proposals to tackle them. Paul Myners said:
“Our funded pensions system, our highly-developed equity culture and the professionalisation of investment in the UK are an enviable success story. I pay tribute to the commitment and dedication of institutions and their advisers in bringing this about.
“Nevertheless, the industry and its decision-taking structures face forbidding challenges: an ageing population, unrecognisably different labour markets, shifting employer attitudes. In the world we now face, an ever-higher premium is likely to be placed on efficiency and flexibility.
“The review finds that savers’ money is too often being invested in ways that do not maximise their interests. It is likely to follow too that capital is being inefficiently allocated in the economy.
“The review sets out a blueprint for change, to drive clearer incentives and tougher customer pressures throughout the savings and investment industry.”
The main distortions identified by the review are:
- pension fund trustees are being asked to take crucial investment decisions, yet many lack resources and expertise. They are often unsupported by in-house staff, and are rarely paid;
- as a result, they rely heavily on a narrow group of investment consulting firms for advice, whose performance is not usually assessed or measured;
- fund managers are often set objectives which give them unnecessary and artificial incentives to herd. So-called “peer group” benchmarks, directly incentivising funds to copy other funds, remain common. And risk controls for active managers are increasingly set in ways which give them little choice but to cling closely to stock market indices, making meaningful active management near-impossible;
- vagueness about the timescales over which fund managers’ performance is to be judged creates unnecessary incentives for short-termism;
- fund managers are reluctant to intervene in companies where they own substantial shareholdings, even where this would be in their clients’ financial interests;
- an important cost for institutions, namely broking commission, is subject to insufficient scrutiny.
The review also looked at life insurance. It found that competition in the industry, though intense, tends not to focus directly on investment performance. This raises issues beyond the review's remit, but which need to be tackled if stronger incentives to efficient investment decision-making in the industry are to be created.
The review has a number of proposals to help bring about change.
Principles of institutional investment
The central proposal of the review, closely modelled on the approach taken on corporate governance by the Cadbury (and subsequent) Codes, is a short set of clear principles of investment decision-making. These would apply to pension funds and, in due course, other institutional investors. As with the Cadbury code, they would not be mandatory. But where a pension fund chose not to comply with them, it would have to explain to its members why not.
The full text of the principles is attached. The main elements include:
- Trustees should set out an overall investment objective for the fund, in terms which relate directly to the circumstances of the fund, and not to some other objective, such as the performance of other funds.
- Trustees should normally be paid.
- The attention devoted to asset allocation decisions should fully reflect the contribution they can make to achieving the fund’s investment objective.
- Decision-makers should consider a full range of investment opportunities across all major asset classes, including private equity.
- The fund should be prepared to pay sufficient fees for actuarial and investment advice to attract a broad range of kinds of potential providers.
- Trustees should give fund managers an explicit written mandate setting out the agreement between them on issues such as the investment objective, and a clear timescale for measurement and evaluation. Fees paid to managers should include the costs of information, research or transactional services used by the manager.
- In consultation with their investment manager, funds should explicitly consider whether the index benchmarks that they have selected are appropriate. Where they believe active management to have the potential to achieve higher returns, they should set both targets and risk controls that reflect this, allowing sufficient freedom for genuinely active management to occur.
- Trustees should arrange to measure the performance of the fund and the effectiveness of their own decision-making, and formally to assess the performance and decision-making delegated to advisers and managers.
- In defined contribution schemes, when selecting funds to offer as options to scheme members, trustees should consider the investment objectives, expected returns, risks and other relevant characteristics of each such fund. Where a fund is offering a default option to members through a customised combination of funds, trustees should ensure that an objective is set for the option, including expected risks and returns.
Paul Myners said:
“The principles may seem little more than common sense. In a way they are – yet they certainly do not describe the status quo. Following them would require substantial change in decision-making behaviour and structures.”
The review believes that it would be preferable for the industry to adopt the principles voluntarily, but is clear that if necessary the Government should legislate to require disclosure against them. The review recommends that the Government should examine after two years the extent to which the review’s proposals have been successful in changing behaviour.
Other proposals
The review makes a series of other proposals, listed on pages 21-26 of the report. The main ones are:
- A legal requirement for trustees to be familiar with the issues on which they make decisions, as in the US.
- The replacement of the Minimum Funding Requirement with a regime based on transparency and disclosure, already put forward by the review in November 2000.
- Incorporation of the US ERISA principle on shareholder activism into UK law quoted on p92 of the report, making intervention in companies, where it is in shareholders’ interests, a duty for fund managers.
- The Law Commission to be asked whether it can suggest greater legal clarity around the ownership of surplus pension fund assets, and reduction of the rate of tax on distributed pension fund surpluses
- A follow-on review of capital and information flows relating to personal investment products.
The review also looked specifically at private equity. Investment in private equity should benefit from the framework set out by the principles and from the replacement of the Minimum Funding Requirement. The review has also made a number of proposals which take account of the special nature of private equity as an asset class for institutional investors, including changes to the maximum number of partners in a limited partnership and changes to the taxation of investments in limited partnerships. It also calls for the British Venture Capital Association to take action to improve transparency and disclosure about issues such as investment returns and compensation.
NOTES TO EDITORS
1. Paul Myners was asked to carry out his review of institutional investment by the Chancellor in the 2000 Budget (HMT1).
2. Mr Myners published a consultation document on May 16 (Treasury press release 63/00) setting out the main issues which he was investigating and seeking views on them.
3. The consultation exercise closed in July. Over 200 responses were received. The main themes emerging from the consultation were:
- structural changes in the industries concerned
- the role of pension fund trustees and their advisers.
- the specific characteristics of private equity as an investment by institutions.
- the impact of benchmarking and performance measurement on institutional decision-making.
- the impact of regulation.
4. A consultation document on the MFR was launched by the DSS and the Treasury in September 2000. Mr Myners subsequently wrote an open letter to Ministers in November 2000, setting out proposals on two specific issues: the Minimum Funding Requirement and investment by pension funds in limited partnerships.
5. Mr Myners’ letter to Ministers and the text of the accompanying paper are available from the Treasury, DSS and DMO websites. Printed copies are available from the Treasury Public Enquiry Unit on 020 7270 4558.
6. This report is the final report of the Myners review - click on the link below for the full report (pdf). If you don't have a pdf reader you can download one by clicking on the link to Acrobat. Printed copies are available for journalists from the Treasury press office on 020 7270 5192.
7. A press conference is being held at 10.30am today at Trinity House, Trinity Square, Tower Hill, London EC3N 4DH.
8. Media enquiries should be addressed to Charles Keseru in the Treasury press office on 020 7270 5188.
The Myners Review is available below in Adobe Acrobat Portable Document Format (PDF). If you do not have Adobe Acrobat installed on your computer you can download the software free of charge from the Adobe website.
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Proposed 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 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 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 other than for clear breach of the conditions of the mandate or because of significant change in the ownership or personnel of the investment manager.
The mandate should not exclude the use of any set of financial instruments, without clear justification in the light of the specific circumstances of the fund.
The mandate should incorporate a management fee inclusive of any external research, information or transaction services acquired or used by the fund manager, rather than these being charged to clients.
6. Activism
The mandate 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.
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
- here 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.
- 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.
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 Principles1 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.
9. Regular Reporting
Trustees should publish their Statement of Investment Principles and the results of their monitoring of advisers and managers and send them annually to members of the fund. The Statement should explain why a fund has decided to depart from any of these principles.