H.M. TREASURY

32/01

15 March 2001

PRINCIPLES OF INSTITUTIONAL INVESTMENT DECISION MAKING

CONSULTATION ON MYNERS PROPOSALS

Economic Secretary Melanie Johnson today announced a two month consultation to seek the views of the public and industry on the precise formulation of the principles for pension fund investment decision-making, proposed by Paul Myners in his review of institutional investment in the UK.

Addressing the annual investment conference of the National Association of Pension Funds (NAPF), Miss Johnson said :

“Paul Myners’ report sets out a clear and consistent package of proposals which will help the pensions industry respond to the challenges it faces, and which all of us - Government, the consumer, and the industry - stand to benefit from.

“Today we are launching a short consultation to provide the industry and others with an opportunity to comment on the precise formulation of the principles recommended in the report.

“The Government believes that these principles codify best practice for pension fund decision-making. We would welcome your views, and would be grateful to receive responses by 15 May.”

The review proposed separate series of principles for Defined Benefit and defined Contribution pension schemes. Both are attached for the views of respondents.

Mr Myners does not propose that the principles he sets out should be mandatory. Pension funds could choose not to comply with a particular principle; but where they do so, they should explain that decision to their members and to the public, in an enhanced annual Statement of Investment Principles.

The Government agrees that this approach - similar to that of the Combined Code of the Committee on Corporate Governance, and its predecessor, the Cadbury Code - should bring about real behavioural change in pension fund investment practices. The central tenets include:

decisions should be taken only by those with the right skills and expertise;

fund managers should be set clear objectives and timescales;

the performance of all advisers and managers should be measured, and trustees should assess their own performance; and

the investment strategy and returns of the fund should be reported annually to members and the public, as part of a strengthened Statement of Investment Principles.

In his Budget speech following publication of Paul Myners’ report, the Chancellor of the Exchequer said:

“Institutional investors are responsible for assets of 1.5 trillion pounds. To promote long term investment and to protect investors, I have accepted the recommendations of the Myners report.

“We will abolish the minimum funding requirement; through tax and regulatory reform make it easier for life insurers and pension funds to invest in venture capital; and we will ensure both a strengthened role for pension fund trustees and a clearer duty on fund managers to promote beneficiaries' interests.

“I support the challenge to the industry that Mr Myners has laid down and his proposal that we should be prepared to legislate as necessary to achieve the improvements that he prescribes.”

Following the consultation on the detail of the principles launched today, the Government will publish a finalised version that the industry will be able to adopt.

The Government will review the effectiveness of the code in bringing about behavioural change in two years time. The Government will also work with the industry over coming months to establish baseline data against which this can be assessed.

Within the context of the Government’s overall agreement to Mr Myners’ proposals, the consultation invites the institutional investment industry and others with an interest to comment on the precise formulation of the principles he recommended.

These are attached to this release, and set out in Chapter 11 of Mr Myners’ report ‘Institutional investment in the UK: a review’. The main text of the report sets out Mr Myners analysis and recommendations in more detail. Copies of the report are available from the Treasury Public Enquiry Unit on 020 7270 4558 or from the Treasury website at www.hm-treasury.gov.uk.

Responses should be sent by 15 May 2001 to:

Adrian Murphy

HM Treasury

Allington Towers

19 Allington Street

London SW1E 5EB

e-mail : adrian.murphy@hm-treasury.gov.uk

NOTES FOR EDITORS

Paul Myners was asked to carry out his review of institutional investment by the Chancellor in the 2000 Budget (Budget press release HMT1).

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.

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.

On 8 November 2000, Mr Myners wrote to Chancellor of the Exchequer Gordon Brown and Secretary of State for Social Security Alistair Darling in response to a joint consultation document on the MFR launched by the DSS and Treasury in September 2000. Mr Myners recommended that the MFR be replaced with a regime based on disclosure.
The letter also put forward proposals to make it easier for pension funds to invest in private equity, by lifting restrictions on pension funds investing directly in limited partnerships, the most common vehicle for private equity investment.

The Government published a separate document alongside the Budget (‘Security for Occupational Pensions: the Government’s proposals’) setting out its proposed way forward on the MFR. This is available from the Treasury, DSS and DMO websites at www.hm-treasury.gov.uk, www.dss.gov.uk and www.dmo.gov.uk respectively. Printed copies are available from the Treasury Public Enquiry Unit on 020 7270 4558.

Mr Myners published his report ‘Institutional investment in the UK : a review’ on 6 March 2001. He concluded that a number of distortions affect institutional investment decision-making:

trustees are the ultimate decision-makers for pension funds, but they are typically unpaid; many have limited investment expertise and a low level of support from in-house staff;

their investment decision-making, especially on asset allocation, is dependent on advice from a small number of advisory firms;

sponsor companies have insufficient incentives to encourage efficient management of pension schemes;

the objectives given to fund managers often do not align their interests effectively with those of their institutional clients, and there is a lack of clarity about the timescales over which they are measured.

fund managers are excessively reluctant to engage actively with companies in which they are invested;

the Minimum Funding Requirement (MFR) distorts investment behaviour without effectively protecting pensioners;

there are issues concerning capital and information flows around the personal investment products market; and

private equity investment is affected by many of these factors, but also raises specific issues as an asset class for institutional investors.

Copies of the report are available from the Treasury Public Enquiry Unit on 020 7270 4558 or from the Treasury website at www.hm-treasury.gov.uk.

The Chancellor of the Exchequer announced in his Budget speech on 7 March and the accompanying Economic and Fiscal Strategy Report ‘Budget 2001 Investing for the Long Term: Building Opportunity and Prosperity for All’ that the Government will take forward all of Paul Myners’ recommendations.

The speech and report are both available on the treasury website at www.hm-treasury.gov.uk. Printed copies of the EFSR are available from The Stationery Office (ISBN 0-10-284201-9 price £40.00).

Media enquiries should be addressed to Charles Keseru in the Treasury press office on 020 7270 5188.

Proposed Principles: Defined Benefit Pension Schemes

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.

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.

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.

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.

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.

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

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.

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.

Transparency

A strengthened Statement of Investment Principles 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.

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.

Proposed principles: Defined Contribution Pension Schemes

Effective decision-making

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.

Clear objectives

In selecting funds to offer as options to scheme members, trustees should:

consider the investment objectives, expected returns, risks and other relevant characteristics of each fund, so that they can publish their assessments of these characteristics for each selected fund; and

satisfy themselves that they have taken their members' preferences into account, and that they are offering a wide enough range of options to satisfy the reasonable return and risk combinations appropriate for most members.

Focus on asset allocation

Strategic asset allocation decisions (for example for default and lifestyle options) should receive a level of attention (and, where relevant, advisory or management fees) that fully reflect the contribution they can make to achieving investment objectives. Decision-makers should consider a full range of investment opportunities, not excluding from consideration any major asset class, including private equity.

Choice of default fund

Where a fund is offering a default option to members through a customised combination of funds, trustees should make sure that an investment objective is set for the option, including expected returns and risks.

Expert advice

Contracts for investment advice should be open to competition, and fee rather than commission based. The scheme should be prepared to pay sufficient fees to attract a broad range of kinds of potential providers.

Explicit mandates

Trustees should communicate to members, for each fund offered by the scheme:

the investment objective for the fund, its benchmark(s) and risk parameters; and

the manager’s approach in attempting to achieve the objective.

These should also be discussed with the fund manager concerned, as should a clear timescale(s) of measurement and evaluation, with the understanding that the mandate will not be terminated before the expiry of the evaluation timescale other than for a clear breach of the conditions of the mandate or because of significant change in the ownership or personnel of the investment manager. The management fee should include any external research, information or transaction services acquired or used by the fund manager, rather than these being charged to clients.

Activism

The agreement with fund managers should incorporate the principle of the US Department of Labor Interpretative Bulletin on activism. Managers should have an explicit strategy, including the circumstances in which they will intervene in a company; the approach they will use in doing do; and how they measure the effectiveness of this strategy.

Appropriate benchmarks

Trustees should:

if setting limits on divergence from an index, ensure that they reflect the approximations involved in index construction and selection;

Performance measurement

Trustees should arrange for measurement of the performance of the funds 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.

Transparency

A strengthened Statement of Investment Principles should set out:

who is taking which decisions and why this structure has been selected;

each fund option’s investment characteristics;

the default option’s investment characteristics, and why it has been selected;

the agreements with 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.

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 scheme members. The Statement should explain why a fund has decided to depart from any of these principles.