2. What is driving change today?
Unintended Consequences
Today's asset owners are faced with a unique - and in many cases unprecedented - range of external pressures. From policy holders to regulators, asset owners' constituents are looking to see change. But the longer term consequences of this change are perhaps less understood.
A global basket of localised pressures
The pressures that asset owners face globally are enormously diverse - depending heavily on where in the world they find themselves and their current scale. But regardless of the nature of the pressures, the challenges faced by asset owners today are significant and hard to address without driving fundamental change.
Amongst the strongest pressures felt globally today are the regulatory and governmental changes impacting Australian superannuation funds - through the "Your Future, Your Super" initiative (see below). Still mostly unique in the pension funds world, the enforcement actions that continue to be carried out by APRA are radically reshaping business models and market structure, with the aim of ensuring consistent value for end investors.
Shifting westwards, the governance and board pressures embedded in the wider ESG agenda dominate the European agenda. European policy-holders and end-investors today are demanding to see tangible evidence of diversity, governance and sustainability from their pension providers - Encouraging industry to replatform and restructure their investment cycles.
Continuing the governance theme, investors and regulators in South Africa and Kenya are pressuring pension fund managers to have clear transformation plans to ensure representation for black fund managers or indigenous populations.
Against this backdrop of significant change drivers, North America stands apart in its continuing focus on the nuts and bolts of investment performance due, in a large part, to its mature regulatory infrastructure.
Regulation and hidden outcomes
Managing the 'nest-egg' of entire professions, regions or countries is a highly sensitive and politicised activity.
Yet pension and superannuation funds face significantly different levels of regulatory pressures around the world - depending on the regulatory framework of their home market. At one end of the spectrum is a codified, principles-based regulatory framework (such as ERISA in the USA) and at the other end is a dynamic, rules-based regime backed by active regulator enforcements (such as in Australia).
Our research highlights a significant difference in the longer term consequences of these two regulatory models...
The ERISA model: North Americans focusing on fundamentals to drive long-term growth?
For North American funds, the luxury of a relatively stable regulatory environment with regulatory enforcement delivered by a robust civil legal system is the backdrop to a strong focus on the fundamentals of growth.
Although it has evolved continually, the US's Employee Retirement Income Security Act (ERISA) has been in existence since 1974, meaning that US pension funds are almost unique in not facing any particular "shock" regulatory events today.
Left largely to set their own strategic agenda, North American asset owners are spending more on transformation projects (targeting efficiencies of >20% vs only 15% in Asia Pacific); they are spending on core investment drivers (such as Operational Risk and Investment diversification); and they are spending with a longer time horizon.
On the other hand, the total volume of transformation project activity is significantly lower in North America than in any other region - raising questions about innovation and continual improvement.
Freedom to decide their roadmaps but equally freedom to take no action at all.
The Australia model: a dynamic regulatory environment aimed at realising 'safe returns'?
At the opposing end of the regulatory spectrum, Australian asset owners are heavily preoccupied by the volume of regulatory enforcement today.
With the aim of maximising value for end-investors, APRA's transparent benchmarking of superannuation funds is driving more transformation project activity than in any other market globally. But this is also triggering a range of intended and unintended consequences including:
An increase in the use of short-term technologies (such as Excel) to support requirements for regulatory reporting and disclosures.
A significant increase in the volume of consolidations, as funds seek to gain scale through inorganic means.
A reduction in the risk appetite for superannuation funds, with investments tending towards tracking bluer-chip stock performance in an effort to avoid unnecessary downside risks (which may trigger future regulatory actions if unsuccessful). Better to deliver safe beta with no downside than to risk the house on alpha.
'If you're in the bottom 28 in Australia and you can't demonstrate value, you need to consolidate' Super Fund CIO
ESG: from Europe to the world?
European asset owners face an entirely different challenge. While getting the basics around managing risk, continues to be a top three priority across all markets, the role of individual pension holders and the ESG agenda is also continuing to shape asset owners’ priorities. Globally change is being driven by pension holder demands for greater board diversity, commitment to climate and environmental goals and wider transparency and social responsibility. Not only do these drivers dominate the strategic agenda for European asset owners, but they are being felt more acutely in Europe than anywhere else in the world.
This is not to say that ESG is only a European phenomenon - as it occupies a Top three place in the priorities of every region globally and several Canadian pension funds lead international progress in this space. Anecdotally however, the intensity of pressure being felt from policy holders and the need to be driving fundamental change in the diversity of board appointments and in the entire ethos in which investments are managed is more acutely felt at a grass-roots level in Europe than elsewhere.
For asset owners, the impacts of these pressures continue to evolve. It is no doubt a driver behind significant organisational restructuring - but it is also triggering a fundamental re-fit of the ways in which investment performance can be measured. Beyond simple pre-trade visibility, ESG pressures are driving change in investment analytics, mandate compliance monitoring and board-level reporting - across every asset class.
ESG has added a new dimension to the way we manage portfolios.
'ESG is not just a theme in Europe - it is a deeply felt responsibility at the individual level'
Inputs or outcomes? Fund models drive the tech agenda
Faced with ultimate accountability for outcomes (i.e. investment returns), defined benefit plans are driving a strikingly different change agenda versus those who are focused in inputs (i.e. defined contribution plans).
Their investor accountability is clearly a driving force for defined benefit funds, who mark this out as a core priority alongside the need for operational agility. This need to build a scalable operating model (that can support the right outcomes today and tomorrow) is manifest in the amount of technological change that DB funds are driving today (26% of DB funds are running technology transformation programmes vs 19% of DC funds). It is also evident in their choice of investments - focusing on asset allocation management and performance reporting as core priorities and in the scale of the projects that they are running (with the average project length of 12 months vs 4 months).
Perhaps surprisingly, those accountable only for inputs (i.e. defined contribution funds) have a visibly more short-term agenda. Rather than looking to do the right thing from a long-term perspective, DC funds are focused primarily on cost management and on ESG - both shorter term considerations that focus on the production process rather than its outputs.
Earnings pressures evidently influence pension funds' priorities - with major variance in the strategic agenda.
