It’s rough seas these days for plan sponsors. With pension plans investing in alternative assets such as private equity and real estate, sponsors are now taking on more onerous tasks as they attempt to navigate these investment choices. Similarly, with no foreign exchange limit for pension plans, global investing is on the rise, requiring a need for foreign exchange and a handle on complex tax treaties. Pension plan administration, in a sense, has become the proverbial tempest. How well are custodians responding to pension plans’ needs to keep plans from drowning?

More and more, pension funds are investing in alternative asset classes—real estate, hedge funds, derivatives, private equity—in order to attain greater returns. A 2005 Aon Consulting survey showed that of the 50 largest pension funds in Canada, approximately 20% were invested in hedge funds. According to Rob Baillie, president and chief executive officer of Northern Trust in Toronto, the number of over-the-counter derivatives transactions processed in Northern’s first quarter of 2006 was higher than the number of transactions processed in all of 2005. And its assets under custody for private equity have doubled in the last two years.

But whether transactions have doubled, tripled or quadrupled, these alternatives engulf plan sponsors’ precious time. “I’m told by a lot of clients that alternatives may only represent up to a maximum of 15% of their portfolios,” says Baillie. “But it’s taking 50% of their time.”

Time spent by sponsors is in understanding the proper procedures and providing more due diligence. With assets such as private equity, it’s research to find the opportunities and then analyzing them. “The challenge custodians will face is to develop experience with new types of alternative assets,” says Paul Owens, plan manager and chief executive officer of the Colleges of Applied Arts and Technology Pension Plan(CAAT)in Toronto.

“These investments could potentially and most likely add more risk to a [pension plan’s] portfolio,” says Annie Blouin, head, North America, corporate and institutional services at RBC Dexia in Montreal. “Our role as a custodian is to support the investment by providing ways to monitor and quantify these additional risks and by offering our expertise,” says Blouin.

A key area of investing in alternatives is risk reporting and compliance. “Plan sponsors want to understand how much risk should I take or am I willing to take for a certain level of return,” says Doreen Rigby, managing director, State Street Trust Company Canada in Toronto. Through tools that provide “what if ” scenarios, custodians are able to show plan sponsors what their risks are.

But not all pension plan sponsors are ready for hedge funds, real estate, derivatives or private equity. “Generally, alternative investments for the smaller plans really are just finding a good investment manager with a proven track record of returns for an international or global fund,” says Scott Scobie, managing director of Canadian Western Trust(CWT)in Vancouver. “The small plans don’t want overly complicated alternative investments,” says Scobie. “They really don’t usually require foreign exchange services that often as they tend to match assets with their pension liabilities.”

CWT focuses on the small- to medium- size pension plans, which it feels are generally underserviced by the larger custodians, which tend to cater to the larger pension plans. The smaller companies simply want to focus on their business at hand, Scobie says. CWT can partner with high-quality investment management firms to offer its clients what it calls a “no-choice” or “lifestyle” arrangement. The plan sponsor chooses the type of fund and CWT will be its custodian and recordkeeper. In this way, the plan sponsor can focus on the business instead of worrying about the pension plan.

Although smaller plans may not track U.S. and global markets, larger plans, with more global exposure, would. According to the latest survey by RBC Dexia Investor Services, 29.6% of Canadian pension assets were invested in global securities at year-end.

As global investment increases, foreign exchange plays an increasing role. Foreign exchange is about governance, says Baillie. “Pension plans want to ensure they’re getting best execution for their foreign exchange trades.” And one way to do this, according to Baillie, is to appoint the custodian to handle foreign exchange. “There is a great deal of foreign exchange volume run through custodians. The market is asking custodians to provide transparency and to help with benchmarking to demonstrate they’re giving clients best execution,” says Baillie. Northern Trust has worked with each of its clients to create a customized approach, which helps them meet their specific governance requirements.

Owens says out of convenience, because plan sponsors don’t have the capabilities set up internally, a lot of plan sponsors use their custodians for foreign exchange. “That is an area we have to investigate. Custodians may not be the best vehicle for trading foreign exchange. I just don’t know how it’s done best at this stage or who would do it, whether it would be the custodian or somebody else,” he says.

Cost-cutting capabilities is another important issue for pension plans. First and foremost, custodians can help through their immensity. “Our size and scope allow us to have better cost structure both domestically and globally, so clients get the benefit of our scale,” says Blouin. “The securities lending revenue is an example of how clients can offset the cost without impacting [pension plans’] investment activities. There’s a lot more opportunity in global lending; the rates are better.”

Similarly, other services the custodian offers can help contain costs for, at least, the larger pension plans. On a smaller scale, transaction costs can make a difference. “Any type of transaction, whether it’s equity, bond, currency or other, the tools that help us to assess best execution are helpful. In the end, we’d like to know that we’re being charged appropriately,” says Charlie Eigl, vice-president, finance at the Ontario Public Service Employees Union Pension Trust in Toronto.

Nor do pension funds like to lose money, especially tax. “If there’s tax being withheld by a particular government and there’s a portion we’re supposed to get back, custodians have processes to manage,” says Eigl. Custodians can add value, he continues, by ensuring that the plan sponsor minimizes its global tax liability and receives any rebates as soon as possible.

Through transition management, custodians can help pension plans manage the trading costs and risks when they change investment managers. If the new manager sells off the stock, he may not always get the best price because perhaps he’s not being measured on his performance yet, says Baillie. “It’s not hurting them, but it’s hurting the plan. So a transition manager will look to transition the portfolio to the new manager in a more cost-effective manner, with lower risk.” Commission recapture helps return some of the trading costs that can be associated with research of a trade, says Baillie. And through securities lending, revenues from brokers/dealers are channeled back to the plan, thus helping to offset expenses.

Because pension plans have significant liabilities and cash flow requirements, says Blouin, their cash assets are typically invested in instruments that are very secure and liquid. “The trick with cash is knowing what your position is and getting it invested as early as possible,” says David Linds, senior vice-president, business development and client relationship management at CIBC Mellon in Toronto. “Having real-time access to cash positions is really important. That may sound like a simple answer,” says Baillie, “but it’s not necessarily the norm. Sometimes cash positions, depending on the provider, are only available in the morning as opposed to throughout the day. But as cash positions do fluctuate throughout the day, having a real-time view of your available cash will make you better equipped to ensure it’s invested.” Although CAAT does not use its custodian to manage the majority of its cash, Owens does agree that it’s an important issue. “If you don’t do something with it, you’re leaving money on the table.”

Of course, accuracy and expediency are ongoing concerns for plan sponsors. In a world where billion-dollar deals surface regularly, incorrect data, such as a transposition of numbers, could result in a faulty trade. “The major way you ensure [accuracy] is by automating as many of your processes as you can,” says Rigby. “If your technology is not leading edge and fairly current, you will be doing much more manual work,” she says. “If you’re doing much more manual work, you will, just by default, have more errors.” Scobie says CWT will spend “considerable dollars” this year on upgrading its data management system. “We cater to smaller plans with generally fewer complexities and reinvest our technology dollars specifically to this target group.”

But upgrading does not necessarily mean more complex. “We’ve been told by plan sponsors we deal with that they like our system, and they want us to keep it simple. So we are going to keep it very straightforward—without a lot of bells and whistles,” Scobie says. Baillie agrees. “If you need to spend a lot of time training clients how to use the online access system, that’s telling. But if you can make it intuitive—no different for them than surfing the Web—then it’s probably going to be a more useful tool.”

Despite all the issues facing plan sponsors, from alternatives to accuracy, what they are looking to have is their needs met in the most efficient way. “Custodians should have tools that demonstrate that they are looking after our best interests,” says Eigl. Calm seas ahead.

Brooke Smith is assistant editor of Benefits Canada.

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Copyright © 2021 Transcontinental Media G.P. This article first appeared in Benefits Canada.

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