Benefits and Pensions Monitor
Annual Report And Directory Of Global Custodians -
Custodians Learn To Deal With Alternatives
From the pension fundʼs perspective, this shift highlights the need for better transaction, operational, and risk management systems. These new asset classes can potentially add more risk to the portfolio. Itʼs important for them to be able to quantify those risks and manage them appropriately to ensure the best interests of the fund and its beneficiaries are front and centre. Custodians assist clients in monitoring these risks with tools such as compliance monitoring and risk management.
“To add maximum value, providers need to clearly understand their clientsʼ alternative investment strategies, objectives, and business model so that they can develop robust and reliable investment support services,” he says.
Placido says “we saw this shift coming and took the appropriate steps to prepare in order to provide our pension clients with the highest level of alternative investment support services possible.”
 Robert Baillie
President & CEO The Northern Trust Company, Canada
Northern Trust has been very much in tune with the increased allocation to alternative investments by pension funds and is doing a great deal to provide the best solutions for these clients. “While this really is a global phenomenon, the trend clearly has a presence in Canada and we are watching its evolution very closely,” says Baillie.
With a trend as dramatic as this one, there are bound to be operational difficulties as fund managers explore new territory at such a rapid pace. Baillie says three major issues come to mind when reflecting on custodian efforts around this shift in asset allocation:
- OTC derivatives processing
- Performance
- Risk measurement and private equity.
OTC derivatives processing is likely the number one issue to emerge from the increased interest in hedge funds, he says. Northern Trust processed more derivatives in the first quarter of 2006 alone than it did in the whole of 2005, and “weʼve seen 30 per cent average year-over-year growth over the past three years.”
In response to this trend, custodians must support a wide range of exchange-traded and over-the-counter (OTC) derivative products. They must perform settlement and processing and offer specialist services for OTC derivatives including independent pricing, and collateral management.
In anticipation of continued growth in this area, custodians must continue to make significant investments towards increasing the automation of OTC derivatives processing. “Weʼve bought specialist derivatives technology which weʼre integrating with our core accounting and performance measurement systems, and weʼre participating in the SWIFT FPML (Financial Products Mark-up Language) working group to help achieve STP.” Performance and risk measurement is an area where custodians can really add value for pension plan investors,” says Baillie.
Private equity is another ʻalternativeʼ asset class that is gaining momentum in the global investment community, almost to the point where it has become mainstream. “Our private equity assets under custody have doubled in just two years,” he says.
Everyone is struggling with this asset class. Baillie says clients say it is 15 per cent of their portfolio, but takes up 50 per cent of their time. “As a custodian, they come to us for help with automating the process and our efforts in this area are mainly on the front end. Weʼve looked into greater efficiencies for all clients and all asset classes, and private equity is a major part of that undertaking.”
 Doreen Rigby
Senior Vice-president & Head of State Street Investor Services Business in Canada
“We have clearly seen significant growth in the use of alternative investments throughout the industry. These products are being imbedded in existing investment strategies or mutual funds as well as being used in specific hedge fund structures,” says Rigby.
Hedge funds will continue to provide an opportunity for administrators as more pension funds and institutions increase their allocations. Currently, State Streetʼs existing operations that support the investment administration for these funds continue to deal with higher levels of transactions and new OTC instruments. These could be considered challenges, however, “we view them as an opportunity to provide even better service to our existing, and future clients.”
She says the year-over-year growth of hedge fund assets is expected to continue at a rate of 15 to 20 per cent.
 Adrian Mark Baker
Chief Operating Officer Canadian Western Trust
For Canadian Western Trust (CWT), custody of alternative investment assets is not an issue. Its sweet spot in the institutional custody world is pension plans with assets below $100 million, typically smaller, labour funded plans.
Because it has established a “nice little niche,” Baker says it gets asked all the time by consultants if it would issue a proposal on a $300 million portfolio. “It gives us a lot of opportunity to bid on large plans and itʼs an area we should investigate more.”
He says Canadian plan sponsors, if they have more than $500 billion, are served by excellent custodians with very sophisticated systems. However, this comes with a price. For example, the minimum fee is a lot higher.
“Being an alternative, weʼve focused on the needs of domestic clients. Part of the reason for our success is the fees, but it is also servicing.”
The development of CAP guidelines has created another opportunity for CWT. It is giving the custodian a multitude of offerings and “weʼve been promoting a limited choice or no choice plan.”
CWT is also looking to enhance its institutional custody business and offer segregated asset facilities, says Baker. It is working with a sub-custody partner to make an entry into the seg area.
“In 2006, we broke through $1 billion in pension assets and have seen some very good growth from Western Canada. Assets are up 17 per cent.” ■
Joe Hornyak is executive editor of Benefits and Pensions Monitor.
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