Too many hats? A look at pension fund advisors and conflicts of interest

Who or what is a pension fund advisor? In broad terms one could consider a number of entities as being advisors to a pension fund. The description could include the fund’s auditors, its lawyer, its actuary or its measuring service. This discussion will primarily deal with those organizations that at one time were referred to as “measuring services” but more recently have become commonly referred to as pension fund advisors.

This group deserves attention because their mandate has had a much more significant change than those of the other groups.

Evolving role

It wasn’t many years ago that most pension funds had only one or two money managers who were responsible for the investment of the fund’s assets. The money manager usually had a mandate to invest in fixed income and equities to the extent spelled out in the fund’s guidelines, often 50 per cent in each asset class. The manager frequently was given some discretion to increase or decrease holdings within any one class but such decisions were to be kept within some fairly narrow parameters.

During this period, the company that was hired to measure performance had a relatively simple and limited function. It reported to the pension fund sponsor or to the board of trustees on how the money manager(s) had performed in comparison to other money managers. This report would usually show the asset sectors and classes in which the money manager performed well or poorly.

The primary hiring criteria for a measuring service was the size and breadth of its universe and the quality of its presentations both graphically and orally. The latter depended to a large extent on the inter-personal skills of the presenter.

After it became obvious that some money managers had better relative performance doing fixed income investing versus equity investing (and vice versa), a new approach emerged with a movement away from “balanced” managers to specialist managers. Initially this meant hiring a fixed income manager and an equities manager.

The question arose as to how a fund sponsor or board of trustees should undertake this recruiting task. Since the time spent on pension fund business was a miniscule part of most sponsors’ time, their knowledge of the availability and performance of alternative managers was lacking.

This then raised another question: Who should be given the task of identifying potential managers? In some cases, the fund’s actuary was given the task of coming up with the names of possible money managers. However the bulk of the “searches” for new managers went to the “performance measuring firm” (soon to become the pension fund advisor).

The decision to select these companies to conduct the search seemed logical because they had the comparative data of money manager performance. Who better therefore to know which managers were performing best in each asset class?

This was the start of a changing role for the performance measurement firms that has led to today’s environment where many fund sponsors and boards of trustees have abdicated much of the decision-making relevant to asset allocation and manager selection, as well as other issues relating to funds.

Since the changing role of the measuring service cum pension fund advisor was evolutionary rather than revolutionary, little attention has been given to the competencies of the pension fund advisor to handle the expanded mandates that have developed.

An example would be whether the skill set needed to be successful as a presenter of reports is sufficient to analyze changes in capital market conditions. The effect that such changes will have on the management of money both in the short term and the long term will impact on the kind of money manager needed.

In many cases, fund sponsors and boards of trustees have put great faith in their pension fund advisor. However there are seldom benchmarks established to determine the quality of their performance. In many cases, sponsors or trustees tend to “rubber stamp” the recommendations of the advisor on the basis that this is expertise that the fund has hired and therefore it should follow the advisor’s advice.

This has led to some cases of questionable conduct and cases of conflict of interest.

The more decision-making that is abdicated to the “pension fund advisor” the greater the chance of duplicity.

Manager selection

After the concept of balanced management of assets was displaced by the move to asset class specialists, it did not take long for funds to move to sub-specialists (value versus growth, large cap versus mid cap, foreign versus domestic, U.S. versus non-North American).

In many, if not most cases, the decision to move to a sub-specialist led to another manager search. In some ways these searches were similar in nature to executive searches. The pension fund advisor looked for managers who excelled in investing in the market niche that the fund was looking for expertise in. The advisor also factored in the need for the prospective money manager to fit with the fund’s personnel — trustees and administration.

Over a number of years, these searches have become relatively expensive. As the “pension fund advisor” becomes more sophisticated in the way that searches are conducted, costs increase and thus the cost for searches increases.

Inherent conflicts of interest

Potential conflict #1. Given that the advisor charges a substantial amount for a search, there seems to be a tendency on the part of some advisors to be protective of the money manager(s) that they have proposed to a fund sponsor. Undoubtedly this defensive or protective reaction emanates from a combination of professional pride and concern for their own credibility. They often seem loathe to criticize the performance of managers that they have recommended even when managers are not achieving the mandates they were given.

Pension fund sponsors and boards of trustees need to be more critical of money manager performance and selection. It is all very well to measure managers against indices and inflation but equal attention needs to be directed to relative performance.

Ignoring relative performance, as some pension fund advisors seem to encourage, may lead to a board of trustees tolerating performance below the level of that of many other managers.

Potential conflict #2. If pension fund advisors are the prime source of identifying candidates to take on the roll of money manager then it becomes very important for money managers to get on advisors’ lists.

The fund sponsor or board of trustees should ask the pension fund advisor how the advisor develops the list of money managers. The question should be raised as to whether the money managers that the advisor recommends pay any type of commission or other financial consideration to the pension fund advisor either in hard currency or soft dollars.

Similarly questions should be asked why money managers that have outstanding records in the field are not included on the pension advisor’s list.

The sponsor or trustees should provide input into the search in order to ensure that managers who are not in favour with an advisor are considered when openings occur.

Fund sponsors should view pension fund advisors’ recommendations with a degree of skepticism when the advisor is in the practice of accepting consideration from prospective money managers.

Potential conflict #3. At times, advisors have multi-faceted businesses. Such situations provide the potential for conflict.

If a money manager is managing money for an advisor, and the advisor is not satisfied with the performance, what does the advisor do? Does the advisor continue to accept sub-par performance and thus fail to achieve good results for the funds they have under management or do they terminate the manager in favour of a better performing manager? If the latter path is taken, do they then have an obligation to recommend to all of their clients that they should do the same?

In a similar vein, what are the implications if an advisor is getting better performance from a given manager than that which the advisor’s clients receive?

Potential conflict #4. When an advisor is integrally involved with the development of investment policy, particularly when the policy calls for a multitude of managers, the chance for another conflict of interest arises.

It has already been pointed out that manager searches can bring significant revenue to a pension fund advisor. However this cost effect is frequently augmented by the fact that pension fund advisors build the case that an increased number of managers leads to greater complexity and the need for significantly more monitoring. This additional work is a consultant’s dream, since it supports the justification for increased fees.

Little work has been done establishing what is the optimum number of managers for a pension fund. If the advisor is playing a major role in determining a fund’s investment policy, there is always the risk that they will take the number of managers beyond the optimum for their own self-interest.

Potential conflict #5. In some instances, pension fund advisors offer the service of voting a pension fund’s proxies. They may perform this service for an additional charge or include the service in their basic fee schedule.

The justification for assigning this task to a pension fund advisor arises because in some cases, the fund’s money managers are voting in different ways on the same issue.

The argument is made that it doesn’t make sense that the fund is having its votes go two ways on the same issue so the task should be assigned to one entity.

Some advisors are diametrically opposed to the notion that the pension fund advisor be given the task of voting a fund’s proxies.It is the belief of this group that money managers should vote the proxies in the way in which they believe will best benefit the shareholder, in this case the pension fund.

The prime opportunity for a conflict of interest in this area is when a pension fund advisor has a political or social agenda that may not be in the best interest of the shareholder. The Centre for Working Capital in Washington, D.C., for example, has been set up by the AFL-CIO and publishes lists of how money managers and advisors have voted on AFL-CIO supported issues.


Pension fund management over the last couple of decades has become more sophisticated and complex. With this evolution the role of the pension advisor had grown both in breadth and impact. It continues to evolve as the size of pension fund assets continues to grow.

This article focuses on the aggregation of funds developed by defined benefit plans. We have not dealt with manager selection as it pertains to defined contribution plans. It is our premise that in the years to come, selection and retention of money managers for defined contribution plans will become a major issue.

This article’s objective is to challenge fund sponsors and trustees to investigate and review their management of pension fund advisors. Pension fund advisors are in essence consultants and as such should be monitored like consultants in other business functions. They need to have mandates and should be restricted to these. If it is suggested that they diverge from the mandate, there should be serious study given to the implications of making such a move.


There are several actions that a fund sponsor or board of trustees might consider when managing pension fund advisors.

1. A pension fund should ensure that all trustees receive training in pension fund management. This training should be updated from time to time as new developments occur in the field. The International Foundation of Employee Benefit Plans runs a series of courses on the subject.

2. Consideration should be given as to whether the fund’s advisor should conduct the searches for new money managers. If another party is hired for this mandate then the degree of objectivity increases and some of the potential for conflicts of interest disappear.

One of the first rules of control in business is to avoid having the doers and the checkers being the same parties. The logic being that the separation of duties removes the potential for conflict of interest.

3. If a fund has an external auditor, and it is recommended that such a entity be in place, then this party can be assigned additional duties in the area of due diligence. It would serve a pension fund well if its auditor was assigned the task of vetting the performance of the fund’s advisor(s) and determining if any conflicts of interest are occurring.

4. The most important recommendation is to have trustees and plan sponsors become more involved with the financial management of the pension fund that they have a fiduciary responsibility for. Advisors perform an excellent service for pension funds. Because of their exposure to a wide cross-section of plans, they have developed a level of expertise that a trustee generally could not hope to attain. However like any consultant, management needs to question the information that is presented to it. It is important that the views and recommendations put forth by an advisor are tested for necessity as well as conflict of interest.

If trustees and plan sponsors do not conduct a program of due diligence in this field they are not properly performing their fiduciary responsibility.

Fred Pamenter is managing partner with Pamenter, Pamenter, Brezer and Deganis Limited, a Toronto-based HR consulting and executive search firm. He may be contacted at (416) 620-5980 or [email protected]

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