LONDON — Hermes Pensions Management Ltd., one of the U.K.’s last remaining in-house pension fund investment arms, is trying to ensure its long-term survival as a money manager.
To that end, Rupert Clarke, who earlier this month was named chief executive of Hermes, the in-house money manager of the BT Pension Scheme, London, is splitting the firm into two units so the asset management business can attract more third-party clients. One group will be dedicated to managing the £40 billion ($80.7 billion) BT Pension Scheme, while the second, and larger, team will concentrate on overall business development as a ‘multiboutique’ fund manager. Hermes runs £55 billion in total assets,
“We were primarily a captive (asset manager) with a bit of extra third-party on top,” said Mr. Clarke, who replaced Mark Anson in the post. “What we want to do is extend and structure our asset management business into the third-party market as a multiboutique. We looked at all other options and this created the best solution for our clients, owner and staff.”
While the BT plan accounts for nearly three-quarters of the firm’s assets, the Royal Mail Pension Plan, London — a former co-owner of Hermes — provides another £7 billion. To better diversify Hermes’ client base and ensure its long-term viability, Mr. Clarke wants to double third-party assets to £30 billion in the next three to five years.
Among the products Hermes officials believe are well placed to compete: Hermes Focus Funds, which invest in underperforming companies with the aim of creating value by active shareholder involvement; Hermes Equity Ownership Services, which provides responsible investment screening advice to investors; and Hermes Absolute Return Fund, a hedge fund of funds designed for pension funds by focusing on diversification.
Other strategies Hermes plans to market to third-party clients include private equity, commodities, real estate and specialist fixed income and equity. For example, the firm added U.K. midcap equity capabilities to its U.K. small-cap strategy, boosting capacity so the firm can offer a smidcap strategy to third-party clients.
Real estate is another key area, although in the short term, the U.S. subprime mortgage crisis coupled with global credit concerns have helped to create a “challenging environment” to market real estate strategies, said Mr. Clarke, who was chief executive officer of Hermes Real Estate.
Mike Webb, head of business development at Hermes, said the firm is in a good position to benefit from a shift by investors into alternatives. Three out of five U.K. pension funds will reconstruct their investment portfolio to better separate beta and alpha in the next five years, he said, citing data from CREATE-Research, a research consultancy based in Turnbridge Wells, England, focusing on the financial sector. The Netherlands is among other targets for asset inflows because institutional investors there have embraced the separation of beta and alpha, he said.
“The key is performance, that they do what they say on the tin, and that’s what we will continue to offer,” Mr. Webb said.
While Hermes will be focusing on gaining more third-party clients in Europe, the firm may also target U.S. investors with specific strategies, Mr. Webb said. Hermes already counts the $250.4 billion California Public Employees’ Retirement System and the $180 billion California State Teachers’ Retirement System, both of Sacramento, as clients.
Model for others
If successful in achieving its target for third-party assets, Hermes could become a model for other in-house pension asset managers that have considered similar moves, consultants said.
For example the Blue Sky Group, Amstelveen, Netherlands, and New York-based General Motors Asset Management have both tried to bolster third-party assets under management. However, assets for both firms remain dominated by their respective parent companies.
Blue Sky has e11.9 billion ($17 billion) in total assets under management as of the year-end 2006, of which e10.5 belongs to the three main pension funds of KLM. GMAM has been more successful. Of the $165 billion in global assets under management as of Sept. 30, about $30 billion comes from third-party clients, according to Carlos Rosa, vice president of marketing and business development.
“Much of the difficulty comes down to culture,” said Glenn B. Davis, partner at Eager, Davis & Holmes LLC, a consultant to fund managers based in Louisville, Ky. “The staff of a firm established to run money for one captive client — like an insurance company or one large pension fund — may have an internally focused culture. They may not have experience and skills in the asset-gathering side of the business.”
U.K. consultants said that third-party clients might find it difficult to accept that their interests are aligned with the BT Pension Scheme’s goals. Another setback might be Hermes’ ability to compete for the most talented portfolio managers on compensation.
“There is a dilemma,” said George Henshilwood, partner at London-based investment consultant Hymans Robertson LLP. “On the one hand, there must be a desire to grow the asset base and reduce the cost in order to make (the business) affordable (to the parent company). But the difficulty is aligning the business objective of the principal shareholders to that of the external clients.”
Long-term investment
Mr. Clarke believes Hermes’ asset management capability must be strengthened to win new clients.
BT Pension Scheme has agreed to invest £50 million out of Hermes’ profits to shore up investment teams and support infrastructure over the next five years. Although Hermes will also be altering its salary packages under the new business development plan, Mr. Clarke declined to detail specific changes.
Under the restructuring plans, Nigel Labram, who was appointed head of Hermes pension fund management in December, will lead the team managing BT Pension. Hermes will provide more services to BTPS such as additional resources to monitor external managers. As of the end of September, about half of BTPS’ portfolio is outsourced, according to data provided by Hermes.
Furthermore the firm wants to put more emphasis on pension liabilities as part of the overall asset allocation strategy, Mr. Clarke said. “We’ll be looking as much at liabilities as assets,” he added. “Historically, that hasn’t been the case, and we believe the liability side is much more of an issue now.”
Hermes officials in July decided to outsource about £17 billion in index-tracking assets to London-based Legal & General Investment Management Ltd. A pioneer in index-tracking strategies 20 years ago, Hermes concluded it no longer was able to compete on cost against other passive managers.
The decision was made under the leadership of Mr. Anson, who left in September to join Nuveen Investments, Chicago, as president and head of investment services. The move allowed the firm to dedicate more resources to shareholder-activist and higher alpha strategies.
“This is a measured plan over the next three to five years, rather than a 100-meter sprint in the next one to two years,” Mr. Clarke said. “The primary focus will be to invest in our business and make sure it’s robust.”
