Tuesday, December 8, 2015

BT Pulling Billions From Its Own Manager?

Chris Newlands and Madison Marriage of the Financial Times report, BT pulls pension mandate from Hermes:
Telecoms group BT has pulled an £8.4bn investment mandate from Hermes, the asset manager it owns, in an attempt to reduce the costs of running its £40bn pension scheme.

BT’s decision will mean that total assets run by Hermes, the fund company BT created in 1983 to manage its pension scheme, will slide almost 30 per cent to £21.7bn.

The shift comes as BT struggles to plug the funding gap of its pension scheme. There is growing pressure on pension funds to reduce their costs of investment.

BT’s pension deficit increased from £5.8bn to £7bn in the 12 months to the end of 2014 and is the highest of any FTSE 100 company, according to consultancy LCP.

BT said in a statement: “We have made the decision to move the mandate . . . as this best meets the needs of the scheme and will be more cost effective going forward.”

The telecoms company will run the £8.4bn inflation-linked government bond mandate passively using a strategy that tracks the benchmark, rather than the more expensive active management strategy used by Hermes to beat the market.

John Ralfe, an independent pension consultant, said: “Index-linked gilts are by definition entirely inert. Therefore the idea that you pay anybody for managing them — even a passive manager — doesn’t make any sense.

“BT shareholders paying two people to sit around actively managing a gilt portfolio [is] just money down the drain.”

Mr Ralfe said it did not make sense to pay for active management of an inflation-linked gilt strategy as these tended to be buy-and-hold investments that did not require much trading.

He believed active management was too costly, and passive investments tended to outperform active equivalents on average.

Hermes’ main actively managed gilts strategy underperformed its benchmark by 47 basis points in 2014 and has underperformed since it was launched, according to the company’s annual report. Hermes said some accounts with that strategy — including BT’s scheme — performed better.

BT said in a statement: “Hermes has delivered strong performance for this mandate and across the portfolios they manage for us.”

Although the bond mandate made up almost 30 per cent of assets at Hermes, it accounted for just 3 per cent of revenues, according to the company’s chief executive Saker Nusseibeh.

He said: “When I joined the company in 2009, 92 per cent of revenues came from BT but that is now less than half. Fifty seven per cent of our revenues come from third parties. This loss absolutely does not affect our other mandates with BT.”

Mr Nusseibeh added that Hermes, which made a statutory loss of £8.1m last year but is forecast to make a £9.2m profit this year, had “entered into discussions” with Paul Oliver and Paul Syms, who were managing the bond mandate at Hermes on behalf of BT, about their future at the company.

The BT pension fund is likely to shift other active mandates into cheaper, passive alternatives, according to Mr Ralfe.

Around half of the scheme’s £40bn of assets are allocated to external fund companies, including active investment managers Ashmore, M&G and Wellington, as well as BlackRock, the world’s largest provider of passive funds.

Mr Ralfe said: “Over the years, [the scheme’s board] has moved some assets into passive. That may well continue. There’s a hell of a lot of money to be saved [in passive].”
Marion Dakers of the Telegraph also reports, BT pension fund pulls £8.4bn from its own investment manager:
Hermes, the investment manager set up by the BT pension fund, is losing 30pc of its assets after the telecoms giant decided to take part of its portfolio in-house.

Hermes said that the decision by its owner would affect its £8.4bn government bond mandate, which will be switched from active management to a cheaper, passive strategy that simply tracks the benchmark.

Saker Nusseibeh, chief executive of Hermes, said the BT Pension Scheme’s decision was expected and should not affect the rest of the firm’s mandates with the telecoms group. “We knew that our client was unusual in having an actively-managed gilt business. The performance of it had been stunning… but I wasn’t particularly surprised.

“The effect on our financials will be de minimis,” he added, noting that the mandate represented just 3pc of Hermes’ revenues.

Hermes will continue to manage between 30pc and 40pc of BT’s pension assets in future, BT said.

BT founded Hermes in 1983 and is still the group’s largest client, with a mandate to help fund retirement obligations for 320,000 workers. The telecoms firm, which uses several investment managers to run its pension holdings, said in early 2015 that it would inject £2bn into its pension funds over the next two years and reduce its costs in a bid to scale back its £7bn deficit.

Meanwhile, Hermes has recently diversified and increased revenues from third parties from 18pc in 2011 to more than 50pc this year. Its assets under management rose 9pc to £27.5bn last year, although the firm’s statutory losses widened to £8.1m.

The investment manager has also ventured into private equity and infrastructure deals, such as a joint venture with the Canada Pension Plan to acquire Associated British Ports, and has launched several new funds.
In early August, I covered CPPIB's big stake in British ports, a deal which included Hermes. As far as BT Pension's decision to bring its gilts strategy internally, it's a no-brainer and it should have been done a long time ago.

In a deflationary world, all public and private pension plans need to reduce costs everywhere and the number one place they're going to be looking at is external managers. This typically means bringing anything you can internally to be managed at a fraction of the cost.

In my last comment where I examined how the media is overtouting the Canadian pension model, I was careful to state that while there's some fluff and inaccurate information on what Canada's large public pensions are doing in terms of direct private equity deals, there's no question that they're increasingly managing more and more internally to lower costs significantly.

In fact, keeping fees at a minimum is the first lesson of how to invest like a Canadian. The best pension plan in the world, fully-funded HOOPP, knows this all too well which is why its does everything internally. Ontario Teachers is also a fully-funded world class pension plan but it's bigger than HOOPP and needs to allocate to external hedge funds and private equity funds. However, Teachers uses its size to negotiate fees down and it too goes direct in some asset classes (just not as much as they lead you to believe in private equity).

The key thing is to bring costs down and bring a lot of mandates in-house, especially anything which deals with indexing bonds or stocks.  If you're looking for alpha and want to allocate to private equity funds and hedge funds, make sure you negotiate hard on fees and have proper alignment of interests which at a minimum includes a  hurdle rate and a high-water mark in place in case your premier hedge funds get clobbered with their big bets gone awry.

And what if inflation comes roaring back and all these elite funds betting on reflation turn out to be right? Well, I wouldn't bet on it and neither are Canada's highly leveraged pension plans. More importantly, whether or not we get inflation or deflation doesn't change the fact that pensions need to reduce costs and lower external management fees (much more so in a deflationary environment).

But there are some pretty smart economists who do think inflation is right around the corner, I just don't agree with them. One of them is Martin Feldstein, Harvard University economics professor, who shared his thoughts on Federal Reserve policy, the U.S. economy and markets earlier today on CNBC (watch the clip below).

According to professor Feldstein, with core inflation now running at close to 2%, it's only a matter of time before U.S. inflation pressures pick up and he thinks the Fed will have to increase rates significantly (Fed funds rate at 4%) to tame the growing threat of inflation. The bond market obviously disagrees with his analysis and so do I but pensions with huge deficits would welcome such a scenario.

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