AN INDEPENDENT REVIEW OF SCOTTISH LIFE’S … · AKG has performed previous reviews on Scottish Life’s Investment Governance process in March 2009 and November 2010. In September

AN INDEPENDENT REVIEW OF

SCOTTISH LIFE’S INVESTMENT GOVERNANCE

PROCESS – INDIVIDUAL BUSINESS

JANUARY 2014

INDEPENDENT GOVERNANCE PROCESS REVIEW

AKG Actuaries & Consultants Ltd Page 2 January 2014

CONTENTS

1. INTRODUCTION ............................................................................................. 3

2. WHAT IS GOVERNANCE? .............................................................................. 6

3. THE INTERMEDIARY MARKET ................................................................... 7

4. THE ADVICE PROCESS .................................................................................. 8

5. THE REGULATORY/COMPLIANCE CONTEXT ........................................ 9

6. ATTITUDE TO RISK ....................................................................................... 11

7. THE GOVERNED RANGE ............................................................................. 13

8. REGULAR REVIEWS ....................................................................................... 17

9. INVESTMENT ADVISORY COMMITTEE ................................................... 19

10. OVERARCHING QUESTIONS ....................................................................... 21

11. CONCLUSION.................................................................................................. 23

APPENDIX 1 PORTFOLIO BENCHMARKS ......................................................................... 24

APPENDIX 2 INFORMATION ABOUT AKG ........................................................................ 25



1. INTRODUCTION

1.1. BACKGROUND

In January 2009, Scottish Life, the “Client”, launched its Governed Range, incorporating Governed Portfolios and Governed Lifestyle Strategies, as a replacement for Managed Strategies.

As with Managed Strategies, the Governed Portfolios comprise nine risk-rated and term-dependent portfolios. They are subject to a rigorous on-going governance process. This involves a quarterly review by the Investment Advisory Committee (IAC), a body made up of 6 pension and investment experts, four from Royal London (the Group CEO, the CEO of Royal London Intermediary, the Royal London Intermediary Proposition and Strategy Director and the CEO of Royal London Asset Management) together with two independent experts. The IAC is supported through the governance process by experts including Barrie & Hibbert and Morningstar OBSR. The second layer of the governance process is in the form of a tactical overlay which takes overweight and underweight positions against the long term benchmarks according to the Royal London Asset Management Chief Investment Officer’s view of short term market conditions.

The governance theme runs throughout Scottish Life’s investment proposition. Combined with re-balancing and lifestyling functionality, it is designed to help advisers ensure that their advice is suitable at outset and remains suitable for the lifetime of the contract

1.2. ABOUT AKG AND THE REVIEW’S LEAD AUTHOR

AKG Actuaries & Consultants Ltd (AKG) is an actuarially based organisation specialising in the provision of information and consultancy to the financial services industry and a well known and respected provider of evaluated information within the UK financial services sector.

An independent company, AKG has provided expert detailed assessments of life company financial strength, propositions and services for over 20 years.

Within AKG's specialist focus on the financial services industry, there is a broad complementary range of clients, including life and pension companies, intermediary software and services providers, financial press and publishers, fund management companies and banks. However, AKG has a particular focus on the needs of intermediaries. As a result, AKG has developed an enviable reputation for providing information and support, specifically designed to meet their needs through the focused application of an actuarial and technical skill set blended with market knowledge.

AKG has a particular focus on the assessment and rating of financial services product providers. Within this, AKG’s ratings and associated assessments are widely used by both providers themselves and across all forms of intermediary distribution.

Used to working in conjunction with third parties, and to distributing its independent information through third party mechanisms, AKG brings an essential dimension to the assessment of providers, their propositions and support services, in a form that incorporates its specialist actuarial expertise, together with its reputation and wide market footprint.

Lead author – Assessment and compilation of this review was led by Gary Bown. Gary is an actuary with 30 years of experience in UK financial services and has been with AKG for over 15 years, following spells working in UK life offices and consultancies.



1.3. AKG’S ASSIGNMENT

In October 2013, Scottish Life commissioned AKG to review Scottish Life’s Investment Governance process for its retail pension investment proposition, with particular reference to the following changes:

• Pension & Cash Lifestyles • Rathbone Global Alpha fund • Updates to the individual risk profiler

The regulatory context should also be updated to consider:

• FSA Finalised Guidance “Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection” issued in March 2011

• FSA Finalised Guidance “Assessing suitability: Replacement business and centralised investment propositions” issued in July 2012.

The review of Scottish Life’s governance and performance track record should also be updated. This report focuses on Individual business. There is a separate report, which considers group business.

AKG has performed previous reviews on Scottish Life’s Investment Governance process in March 2009 and November 2010. In September 2012, AKG issued an Independent Review of Scottish Life’s Governed Retirement Income Portfolios (GRIPs) and Income Planning Tool.

1.4. INFORMATION SOURCES

The main documents used in producing this review were as follows:

• Scottish Life – Investment Advisory Committee (5L22302 January 2013)

• Risk Attitude Profiling Questionnaire Factsheet 511RF/13 July 2013

• Governed Portfolio 1-9 Annual Review 520259/13 - 520262/13 & 520266/13 - 520270/13 November 2013

• Governed Range Fixed Lifestyle Strategies 511B/8 August 2013

• Governed Range Flexible Lifestyle Strategy 511C/12 October 2012

• Rathbone Global Alpha Fund The right qualities for global equity 5L22332 August 2013

• Scottish Life Governed Portfolios - due diligence report August 2013

• Pension investment options - a clear and simple guide 5G15/20

• Scottish Life Acting on our governance promise 5L22304

• FSA Finalised Guidance – Assessing suitability: Replacement business and centralised investment propositions (July 2012)

• FSA Guidance consultation – Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection (January 2011).

Information has also been obtained from the Scottish Life Website.



1.5. RELIANCES AND LIMITATIONS

The information upon which AKG’s comments are based has been supplied by the Client. AKG has relied upon the accuracy and completeness of such information, and will not accept any responsibility or liability for any inaccuracies or omissions or for any consequences arising. Under no circumstances will AKG accept any liability in respect of the investment decisions of investors or for any loss arising there from. It should be assumed that AKG has not conducted any due diligence investigations to confirm the accuracy of any of the information supplied, unless it is explicitly stated to the contrary herein.

Whilst it is not the purpose of this report to analyse or otherwise comment on the past or future absolute performance of one or more of the various funds or portfolios of funds which together comprise Scottish Life’s pension proposition, some reference has been included regarding the relative performance of the portfolios.

Whilst many aspects underlying AKG’s recommendations are likely to change only slowly, the financial services industry is a competitive, dynamic marketplace, with new products and developments being announced regularly. As a result, AKG cannot guarantee that any particular comment will remain appropriate at any future date.

AKG personnel are available to expand upon the comments in this report, if required.

1.6. CONFIDENTIALITY

This report has been produced for the Client’s consideration.

AKG is happy for the Client to reproduce all or part of this report in any internal or external published material, subject to prior written agreement of the content, context, duration and volume of such reproduction and of any reference, explicit or implicit, to AKG’s involvement in producing this report.



2. WHAT IS GOVERNANCE?

There appears to be no ‘one size fits all’ definition of what constitutes good governance. AKG has therefore drafted the following paragraph, having reviewed various sources from a number of different spheres of business and governmental activity.

In general terms, governance can be regarded as the combination of competent processes and structures within an organisation that ensures its meets its objectives in a legal, ethical and honest way. Most importantly, governance, which put another way is a framework of control and competence, must be transparent. An organisation is accountable for its governance and must be able to demonstrate the same.

This overarching definition then needs to be interpreted in the context of financial services in general and the role of intermediary-led advice in particular. Good governance resonated very strongly alongside the Financial Services Authority’s (FSA’s) theme of Treating Customers Fairly (TCF), which continues under the stewardship of the Financial Conduct Authority (FCA). It also resonates strongly with The Pensions Regulator.

Intermediaries provide investment advice to their clients, a process which implicitly brings with it a duty of care. Advice provided to its clients by an intermediary should be relevant and appropriate at the time it is given and based on a sound, transparent and robust process. Where necessary, the process should also encompass ongoing reviews to ensure the advice remains appropriate.

Good governance encapsulates the duty of care an intermediary has for their client and ultimately it is the responsibility of the intermediary.



3. THE INTERMEDIARY MARKET

The intermediary market has changed in recent years and continues to do so, with:

• Increased focus on value of clients

• More segmentation of client base

• Delivering a range of solutions in line with the value of clients as well as their different needs

1. At higher value (HNW etc) an expectation of having to deliver on more sophisticated needs and, crucially, demonstrating this

2. At lower value clients (mass affluent etc) a need to contain the cost of service provision via use of outsourced solutions, whilst still delivering consideration of risk (demonstrable governance)

• Greater acceptance of outsourced solutions

• Greater need for demonstrable process and governance in general

The intermediary market increasingly looks to deliver a more sophisticated offering, particularly to a client segment considered as high net worth or similar and particularly since a shift in the regulatory landscape under the Retail Distribution Review (RDR).

It does so in the context of a ‘new world reality’ of fee charging. Although it should be noted some intermediary firms had made this transition some time ago, it was previously only a fraction of the market. A fact which, together with other aspects, has placed an increasingly significant accent on cost.

Indeed the more explicit nature of cost and revenue apportionment along the value chain has put real pressure on competitiveness for each entity in the relationship, as well as giving the intermediary a growing focus on his/her own cost base and each client’s ‘value’.

Cost pressure has contributed, along with a desire to enhance propositions (inclusive of governance and improved client outcomes), to the greater use of technology and tools. This includes the increased adoption of platform (wrap) technology and the use of tools/techniques in areas such as risk assessment, performance comparison and model portfolios. Investment components that are available via outsourced arrangements need to fit with these other components.

Further, and outwith the RDR, other regulatory change and ongoing pressure has meant that intermediaries’ own thirst for robust process, clear competencies and clarity of governance has increased. Indeed delivering such a ‘defined investment process’ has become something of a hygiene factor for intermediary investment operations. Scottish Life’s Governed Range is well placed to meet these requirements.



4. THE ADVICE PROCESS

Before considering the governance process per se it is necessary to understand the underlying process, or processes, that the governance is in respect of.

In this report AKG considers the provision of investment advice in the context of pensions business, although similar considerations apply to other types of investment products.

There are essentially four stages, or building blocks, to the advice process, namely:

• Determining a client’s attitude to risk (also referred to as risk profile or risk appetite)

• Recommending an asset allocation strategy consistent with the risk profile

• Constructing a portfolio by selecting appropriate funds within the required asset classes

• Reviewing the appropriateness of the portfolio at regular intervals.

Each of these four stages is a process in its own right and needs to be carried out consistently, with appropriate skill and competence.

Whilst governance may be viewed as a “ring of confidence” surrounding the whole advice process, in reality each separate process should also be subject to its own specific governance.

Thus, whilst an intermediary is ultimately responsible for demonstrating the outer ring of confidence, it would be possible to “contract-out” one or more elements (or inner rings) of the governance process relating to the four stages outlined above. The reasons that an intermediary might contract-out parts of the process could be on grounds of cost, resource availability, competence, consistency or simply convenience.

The importance of governance, and the FCA’s continued interest in all things TCF, means that intermediaries who contract-out parts of their governance process must have full confidence in those they choose to delegate to. Equally importantly, not contracting-out elements of governance will still require an intermediary to demonstrate good governance with the appropriate skills and resources this requires.

The advice process, and the governance provided by Scottish Life, are considered further in this report.



5. THE REGULATORY/COMPLIANCE CONTEXT

For this review, the following are of greatest relevance:

• FSA Finalised Guidance – Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection (March 2011)

• FSA Finalised Guidance – Assessing suitability: Replacement business and centralised investment propositions (July 2012)

FSA Finalised Guidance – Assessing suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection (March 2011)

This considers:

‘• how firms establish and check the level of investment risk that retail customers are willing and able to take (in the wider context of the overall suitability assessment);

• the potential causes of failures to provide investment selections that meet the risk a customer is willing and able to take; and

• the role played by risk-profiling and asset-allocation tools, as well as the providers of these tools.’

Looking at more detail at the use of tools, the guidance goes on to state:

‘If a firm uses a third-party tool to help make suitability assessments for their customers, we expect that firm to:

• ensure that the tool is suitable for use with its customer base;

• understand how the tool works, so it can interpret and evaluate the results when it is applied to individual customers;

• understand to what extent the tool will help meet its regulatory requirements;

• have a robust process to mitigate shortcomings or limitations of the tool; and

• where a tool (such as an asset-allocation or fund-selection tool) suggests investment selections, to understand the product, market and asset risks for these investments.’

and that:

‘Providers of tools can assist the firms who use their tools by:

• ensuring the tools perform as intended and as described to the firms that use them.

• providing supporting information to firms that will use the tools, so that they can understand:

the extent to which the tool will help the firm meet their regulatory requirements;

the scope of the tool including situations for which it has, or has not, been designed to work;

any limitations of the tool, including any circumstances for which the tool should not be used;

any assumptions relevant to the use of the tool, for example, about the advice or discretionary management process or target market; and

• ensuring that supporting information is clear and easily accessible.’



The Scottish Life Risk Attitude Profiling Questionnaire, which is covered in more detail later in this report, provides a clear and robust method of establishing risk appetite. It also has the ongoing support of Scottish Life, who also supply a considerable amount of relevant supporting and explanatory material.

FSA Finalised Guidance – Assessing suitability: Replacement business and centralised investment propositions (July 2012)

In this report the FSA raised concerns that, in certain circumstances, a centralised investment proposition (CIP) may be unsuitable for a retail investor. For example:

• ‘Shoe-horning’ – firms might recommend a ‘one size fits all’ solution which is not suitable for the individual needs and objectives of a client;

• Churning – firms might advise clients to switch their existing investments into a CIP without adequate consideration of whether the switch is both suitable and in the client’s best interest; and

• Additional costs – the use of a CIP might result in higher (and potentially less transparent) charges than the client’s existing investments and with few additional, actual benefits.

Of most relevance in the context of this report is ‘Shoe-horning’. Scottish Life’s Governed Range clearly offers a solution that guards against this, it is not a ‘one size fits all’ proposition.

Amongst other considerations, the paper sets out the following:

• CIP provider’s reputation and financial standing – Scottish Life has a good reputation as a pension provider with good financial strength (rated B+ by AKG).

• CIP’s flexibility and whether it can be adapted to meet individual clients’ needs and objectives – the availability of five risk rated strategies together with a choice of three equity funds provides a good range of flexibility.

• CIP provider’s approach to undertaking due diligence on the underlying investments – the role of the IAC is now well established, credible and has a proven track record.

In its guidance the regulator has recognised that there can be benefits to offering a CIP for both clients and firms. Clients can benefit from more structured and better researched investments and firms can benefit from efficiencies in the management of risks associated with investment selection. The Scottish Life Governed Range clearly offers these benefits, particularly given the presence of the IAC.

The robustness checks mentioned elsewhere in this report are clear examples of Scottish Life reacting positively to regulatory concerns, aiming to identify contradictory or inconsistent answers. Scottish Life has also revised its explanatory materials to reflect regulatory guidance. Throughout these changes, Scottish Life has maintained the basic structure of the questionnaire. The questionnaire was also tested on 2000 people chosen to be representative of the British adult population.



6. ATTITUDE TO RISK

In providing a client with investment advice, intermediaries, as part of “know your client”, will need a process whereby they can gauge that client’s risk profile or attitude to risk.

The approach adopted by intermediaries needs to be consistent, both between clients and, equally importantly, for an individual client over successive reviews. Whilst some intermediaries have developed their own approach, there is a plethora of different risk profiling questionnaires available to choose from. These vary in complexity but essentially achieve broadly the same outcome, namely, based on the answers to a range of questions, the client is placed in one of a range of risk rated categories. This risk category, plus any other information the intermediary has in relation to that client, is then used to determine an appropriate portfolio asset allocation.

The Scottish Life Risk Attitude Profiling Questionnaire (the profiler) is relatively simple and straightforward to use through a dedicated web page. A full printout facility is available for audit and compliance purposes.

The profiler has been produced, independently of Scottish Life, by Alistair Byrne CFA (Fellow of the Pensions Institute at Cass Business School and Senior Lecturer in Finance at Edinburgh University) and Dr David Blake (Director of the Pensions Institute and Professor of Pensions Economics at Cass Business School). The questions have been tested and a norm group created using YouGov, a market research company.

The profiler consists of 12 questions and the result is that an investor is allocated to one of 7 risk categories based on the score achieved. The category titles are typical for a tool of this type and are as follows:

Very Cautious / Cautious / Moderately Cautious / Balanced / Moderately Adventurous / Adventurous / Very Adventurous.

Each category has a written definition. With the exception of investors classified as either Very Cautious or Very Adventurous (which fall outwith the scope of the Governed Range) each risk category is directly aligned to one or more of the defined Governed Portfolios.

Intermediaries may wish to carry out a number of test runs using the questionnaire. Given their own knowledge of their client they will need to feel comfortable with the results, including the risk category descriptive words, before adopting it more widely.

Having used the Scottish Life Risk Attitude Profiling Questionnaire to assess the client’s risk appetite, the intermediary can then move on to determine an appropriate asset allocation.

The Scottish Life Risk Attitude Profiling Questionnaire was updated on 12 July 2012 and more recently on 3 April 2013 following regulatory guidance. The questionnaire now has robustness checks built in to it to guard against the client not understanding questions and also to avoid being allocated to an inappropriate risk category. It also includes some guidelines on assessing capacity for loss. This is also accompanied by revised explanatory materials, also taking regulatory guidance into consideration.

In addition to catering for regulatory change, the tool now includes the new Lifestyle Strategies launched at the end of June 2012 and referred to elsewhere in this report.



AKG View

There are a number of risk profiling tools available to intermediaries and the decision as to which one to use will often be one of personal taste and usability. The Scottish Life tool is easy to use and not too long. Its prime advantage is that it also takes account of an investor’s term to retirement and directly relates to the underlying Scottish Life investment proposition and its governance framework.

An intermediary is able to demonstrate good governance by the use of a third party risk profiler developed by individuals or organisations expert in the field of risk profiling. Governance may be further enhanced in the event there is a clear link between the risk categories and the asset allocation matrix (see next section).

The use of a risk profiling tool to make an initial assessment of a client’s attitude to risk was seen as “good practice” by the FSA in its report on the “Quality of advice on pension switching” published in December 2008.

The robustness checks are a welcome inclusion and aim to address some of the issues raised by the regulator in recent times. Scottish Life has demonstrated a clear commitment to update the risk profiler to take account of regulatory developments and concerns.



7. THE GOVERNED RANGE

There is general consensus that, when constructing an investor’s portfolio, investment returns are determined more by appropriate asset allocation than by stock/fund selection. Asset allocation should therefore be an integral part of the advice process and the intermediary requires a robust and credible approach to asset allocation, based on the client’s risk appetite. A robust asset allocation approach results in appropriate diversification whilst allowing for risk and reward allied to the specific risk profile.

Depending on an intermediary’s preferred approach, resources and competence, this can range between adopting a pre-populated asset allocation through to determining their own asset allocation tailored for a particular client or group of clients.

At the pre-populated end of the spectrum Scottish Life provide a range of nine Governed Portfolios, the asset allocations for which are determined by the IAC based on information provided by Barrie & Hibbert.

Barrie & Hibbert is well known and respected for providing stochastic modelling solutions to clients around the world, helping them to improve their understanding of financial market risk in what are complex and often volatile world markets. Central to this is their Economic Scenario Generator (ESG) - the engine that powers their range of products and services.

Using output from the Barrie & Hibbert ESG, Scottish Life has derived a set of investment strategies which depend both on the investor’s outstanding term to vesting/retirement and their attitude to risk. These strategies are referred to as the Governed Portfolios and are set out in the table below.

At 15 years At 10 years At 5 years

Governed Portfolio 1 (target volatility 10.5)









The table also shows the target volatility for each portfolio. Volatility is a high level proxy for risk i.e. the higher the volatility the higher the risk but equally the higher the potential return.

Each Governed Portfolio has its own benchmarks for asset allocation purposes, although at any one time the actual allocation will reflect tactical positions taken by RLAM Chief Investment Officer Robert Talbut. Details of the current benchmarks are shown in Appendix 1 and reflect the generally accepted pattern, that is an increased exposure to “riskier” assets (e.g. equities) as the risk appetite increases.

As an alternative to adopting the standard asset allocations, intermediaries have the flexibility to determine their own asset allocations, developing customised portfolios with the added option of branding the portfolio.

Market movements will mean that unless action is taken regularly, a portfolio will “drift” from its benchmarks, thereby potentially changing its risk profile. All Governed Portfolios are automatically rebalanced monthly. Customised portfolios can select the frequency for re-balancing.



An investor’s appetite for risk is likely to reduce as retirement approaches and to reflect this it is accepted practice to move from riskier to less risky assets, a process generally referred to as lifestyle profiling. This is potentially a very onerous and costly task for intermediaries should they undertake this task themselves

As part of its Governed Range, Scottish Life offers the option of Governed Lifestyle Strategies.

The table below sets out how, under a Fixed Lifestyle Strategy, an investor will see their investment move successively from one Governed Portfolio to another as they approach retirement. Switches occur gradually each month.

Risk Category At 15 years At 10 years At 5 years

Cautious Governed Portfolio 1 Governed Portfolio 2 Governed Portfolio 3

Moderately Cautious Governed Portfolio 4 Governed Portfolio 5 Governed Portfolio 3

Balanced Governed Portfolio 4 Governed Portfolio 5 Governed Portfolio 6

Moderately Adventurous

Governed Portfolio 7 Governed Portfolio 5 Governed Portfolio 6

Adventurous Governed Portfolio 7 Governed Portfolio 8 Governed Portfolio 9

There are now three Lifestyle Strategies to choose from depending on the preferred equity fund:

• The Fixed Lifestyle Strategy invests the equity holding in the SL Global Managed Fund. • The Fixed Lifestyle Strategy – Tracker option invests the equity holding in the SL/BlackRock Aquila

Global Blend Fund. • The Fixed Lifestyle Strategy – Active option invests the equity holding in the SL Global Blend Core

Plus (Rathbone Global Alpha) Fund. This fund is considered further later in this report.

Scottish Life offers additional flexibility through its Flexible Lifestyle Strategy. Here the intermediary is free to choose any three Governed Portfolios to match their client’s attitude to risk as they approach retirement, rather than be constrained by the Fixed approach.

Relative Performance

AKG has been provided with information on the performance of each of the 9 Governed Portfolios for 1, 3 and 5 year periods up until 12 January 2014, the date at which the Governed Portfolios reached their fifth anniversary. This revealed that all the portfolios had outperformed their strategic benchmarks over 1 and 3 years. The performance of GP1, GP4 and GP7 is slightly below benchmark over the 5 year period.

These strategic benchmarks are set not by using sector averages, where, within any sector there may reside funds of different risk profiles, but by using a weighted set of market indices. In this way each benchmark more accurately reflects the risk profile of each of the funds within the Governed Range



It is interesting to note the relative performance of the nine portfolios.

• Performance relative to Risk :

The expectation would be that the greater the risk taken by the portfolio, as measured by the volatility, the greater the expected return. The actual results were as follows:

• GP7>GP4>GP1; GP8>GP5>GP2; GP9>GP6>GP3 over 1 year and 5 years to 12 January 2014 • GP7<GP4<GP1; GP8<GP5>GP2; GP9>GP6>GP3 over 3 years to 12 January 2014

• Performance relative to Duration:

The expectation would be that the longer the duration, with inherently a heavier weighting towards riskier assets, the greater the expected return. The actual results were as follows:

• GP1>GP2>GP3; GP4>GP5>GP6; GP7>GP8>GP9 over 1 year and 5 years to 12 January 2014 • GP1>GP2>GP3; GP4<GP5>GP6; GP7<GP8>GP9 over 3 years to 12 January 2014

From the above it can be seen that over 1 year and 5 years the portfolios have each performed relative to each other exactly as would be expected within the risk matrix over the time periods considered. The position over 3 years is not as consistent, for example GP5 has outperformed GP4.

Whilst there are inevitably time periods over which performance is behind benchmark, generally performance is good when compared with benchmarks.

Lifestyle Strategies (Pension & Cash)

In June 2012, Scottish Life introduced Pension & Cash Lifestyle Strategies, designed to deliver above inflation growth in the value of the fund and income at retirement, assuming 25% is taken in cash and 75% is used to purchase an annuity. There are 15 such strategies available, depending upon the investor’s attitude to risk and choice of equity fund. The strategy uses three of the Governed Portfolios. A gradual switching process is employed between portfolios so that the holding is 25% cash and 75% index linked at retirement.

If this strategy is chosen, the investor is automatically invested into it at the point that matches their term to retirement.

Rathbone Global Alpha Fund

On 19 August 2013 Scottish Life added the Rathbone Global Alpha Fund, a new global fund of funds. This fund is core to the proposition and can be used within the Governed Portfolios as the equity component in an Active Lifestyle Strategy, sitting alongside the in-house SL Global Managed Fund and the passive SL/BlackRock Aquila Global Blend Fund. It replaces the Close TEAMS Global Alpha Fund.

Rathbone Brothers plc has a history dating back to 1742 and is a leading provider of investment management services. Rathbones had funds under management of £20.8bn as at 30 September 2013.

AKG View

The Governed Range represents a coherent and sensible range of risk rated portfolios and lifestyle strategies which also take into account the outstanding term of the investment.

The asset allocation process combines seamlessly with the profiler and forms the core of the governed offering, leaving intermediaries with the option of customising it as best suits their needs. The Governed Range, with its various options, provides intermediaries with a range of possible support facilities.



The need to manage risk as retirement approaches is very important. Whilst it is inherently a very straightforward process with the right systems, it can be very time consuming, and hence costly, if intermediaries carry it out themselves.

The approach to setting benchmarks relative to the risk profile of the funds, rather than a more simplistic overall sector average approach, is both logical and appropriate.

Intermediaries can either opt for the Fixed Lifestyle Strategy approach or alternatively, if preferred, mix and match funds and portfolios to suit their business model and/or their clients’ requirements. There is now also the option of three different equity funds with differing investment styles, providing more choice to meet the client’s needs. The Lifestyle Strategies (Pension and Cash) are a useful option to have available as part of the retirement planning process.

The inclusion of Discretionary Fund Managers is a logical and welcome move and sees the proposition evolve in line with the requirements of advisers and their clients. Offering such a fund as a core part of the proposition is also seen to be positive and is a demonstration of Scottish Life’s commitment to the Governed Range.

Note: Investors and intermediaries should be aware that past performance is not necessarily a guide to future performance.



8. REGULAR REVIEWS

Having established a client’s portfolio, the key to continued good governance is to ensure that all aspects of the portfolio remain relevant and appropriate i.e. the intermediary fulfils their ongoing duty of care to the client.

Indeed, the need for ongoing review was a key issue highlighted in the FSA’s report on the findings of its thematic review into the “Quality of advice on pension switching” published in December 2008. In paragraph 3.6 the report states that “where an ‘asset allocation’ approach has been recommended, the scheme needs to be reviewed periodically and rebalanced where necessary, to ensure it continues to be suitable.”

Reviews, which should happen regularly at reasonable intervals, will need to address the following questions:

1. Has the client’s risk appetite changed?

2. Is the asset allocation still appropriate for the risk category and term to retirement?

3. Is it necessary to rebalance the portfolio?

4. What tactical opportunities are there?

5. Should the allocation be changed to reflect lifestyling requirements?

6. How are the selected funds performing?

7. How does the intermediary administer change and seek necessary permissions from all clients and employees?

It is important to emphasise that the totality of these questions, when replicated over an intermediary’s entire client base at regular intervals, represents a significant undertaking and one which detracts from the business of attracting new clients.

With the exception of the first question, the remainder are very much key of the intermediary managing their client’s investment expectations and being seen to do so.

Intermediaries have a range of options as to how to address these questions. These might involve carrying out all the functions themselves or alternatively buying-in or contracting-out specific functions.

Through its Governed Portfolios and Governed Lifestyle range Scottish Life provides options specifically designed to assist intermediaries in carrying out client reviews.



In the context of the Scottish Life proposition the position is:

Question Solution

Has the client’s risk appetite changed? Reapply the Scottish Life Risk Attitude Profiler.

Is the asset allocation still appropriate for the risk category and term to retirement?

Benchmark asset allocations for risk categories are reviewed quarterly by the IAC. Any changes to asset allocations are carried out automatically.

Is it necessary to rebalance the portfolio? Rebalancing is automatic within each Governed Portfolio.

What tactical opportunities are there? Funds managers take tactical positions within a risk budget set by the IAC.

Should the asset allocation be changed to reflect lifestyling requirements?

Monthly lifestyling is automatic provided the intermediary selects it.

How are the selected funds performing? The IAC monitors all funds quarterly.

How does the intermediary administer change and seek necessary permissions from all clients and employees?

At no extra cost, policyholders are automatically updated if there are any changes to asset allocation or a fund is replaced.

AKG View

The need to review a client’s portfolio represents a significant overhead for intermediaries. It is also an area of compliance that the FCA is paying increased attention to and as such represents a regulatory risk for intermediaries who fail to pay sufficient attention to this aspect of their business. It is therefore not a question of “if a review is done”, rather “how is it done?”

The Scottish Life proposition, through its governance approach, provides the intermediary with tangible benefits through its comprehensive approach to monitoring appropriate asset allocation and implementing any change that may be required.



9. INVESTMENT ADVISORY COMMITTEE

The Investment Advisory Committee is central to the Scottish Life governance proposition, as well as being an integral part of investment management and operations.

The IAC meets quarterly and is comprised of six members, and as from November 2011, at least two of whom will not be a director or employee of Royal London. The current membership is:

Julius Pursaill Independent Chairman

Phil Loney Royal London Group CEO

Hugh McKee CEO Royal London Intermediary

Andy Carter CEO Royal London Asset Management

Ewan Smith Royal London Intermediary Proposition and Strategy Director

Colin Taylor Independent Representative

It is readily apparent from this list that the IAC occupies a very important part in the Scottish Life governance proposition. It represents an array of experience and expertise that an intermediary is very unlikely to be able to replicate, or indeed afford.

In addition to the above, various other experienced investment personnel will be in attendance.

The role of the IAC as set out within its Terms of Reference is as follows:

• To appoint and terminate the appointment of investment managers

• To approve the agreements between asset managers and Scottish Life

• To determine asset allocation benchmarks, performance objectives and performance benchmarks

• To monitor investment performance

It is the latter two which have most bearing on the operation and governance of the Governed Portfolios. During the course of the meeting the IAC will consider detailed reports from Barrie & Hibbert (for investment outlook and asset allocation), Morningstar OBSR (for fund analysis and considerations of selection/de-selection) and RLAM (for economic outlook and short term tactical positioning – tactical investment decisions being delegated to RLAM’s Chief Investment Officer, Robert Talbut).

Each Governed Portfolio has its own predetermined “risk budget” which enables tactical positions to be taken. Risk budgets are defined in terms of maximum tracking error. The risk budget for each portfolio controls the extent to which Robert Talbut can take tactical positions away from the long-term benchmark asset allocations. Higher risk portfolios can benefit from larger tactical positions than lower risk portfolios.

Actions Taken

In addition to the normal quarterly meetings, the IAC also held two additional special (interim) meetings in 2009, against the background of the unprecedented market volatility.

Not only must governance be done it must be seen to be done. Detailed minutes of the IAC meetings are published on the Scottish Life website, thereby ensuring the process is very transparent.

Since August 2009, Scottish Life also produces a summary of the meeting of the IAC and the decisions that have taken place with regards the Scottish Life Governed and fund ranges. This highlights the fact that there was a strategic benchmark change to some of the portfolios on 12 January 2010 to reduce the risk within the benchmarks, which had resulted from increased equity volatility. To date, there have been 17 tactical portfolio changes and 10 fund changes.



In November 2012 Julius Pursaill was appointed as Independent Chairman of the IAC.

AKG View

Specialist input is a key part of the overall governance process. The IAC is supported through the governance process by a number of internal and external areas and has access to a significant amount of detail (including sophisticated stochastic model outputs) and access to a wide range of knowledge and experience. This enables it to provide a robust challenge and make consistent recommendations.

The use of tactical positions is a tangible improvement to the overall proposition, although this is an area where intermediaries may need more insight and understanding into the extent of likely movement outwith the agreed benchmarks.

Rather than sticking rigidly to a quarterly pattern of meetings, the IAC has consistently demonstrated that it is able and willing to convene as and when conditions require it, as evidenced by two special meetings in 2009, one of which took place to consider the changes to the benchmarks referred to above. This is a clear demonstration of governance in action. As for regular meetings, full details of special meetings are published on the Scottish Life website.

Any model is just a tool and there are no right answers. Stochastic models are complex and the Barrie & Hibbert ESG is no exception to this. However, it does provide meaningful input into the IAC discussions. The result is a blend of Barrie & Hibbert quantitative expertise and the IAC’s qualitative experience-based input.

The IAC is a key element of the Scottish Life governance proposition and provides serious grown up transparent governance – a combination of high level experienced internal input and extensive third party input. Whilst the members of the IAC have changed quite a lot recently, this is more about the evolution of the Royal London Group as a whole, internal representation is still of a high and relevant calibre. An Independent Chairman and additional independent representation are also seen as positive to the overall process.



10. OVERARCHING QUESTIONS

Underpinning AKG’s review of the process were a number of overarching questions. These are set out below, together with suitable comments and observations.

Why should an intermediary use the Scottish Life approach?

Subject to normal due diligence in selecting a product provider the governance process, as offered by Scottish Life, clearly supports an intermediary in their day to day client management, review processes and governance requirements. It provides disciplined asset allocation allied to rigorous fund selection and monitoring.

The requirements of TCF and the demands of the RDR have seen advisers place more focus on segmented solutions that are designed to help them meet client objectives profitably.

Are there any shortcomings in the process?

Whilst the process is subject to continual refinement, AKG was not able to identify any shortcomings within the governance process.

Is the process transparent?

Overall the process is transparent, as evidenced by the IAC minutes being available online.

Does good governance produce good performance?

In substantiating good performance or defending bad performance, the underpin of a sound and justifiable process is paramount and that is what this is. However, whilst absolute performance per se is outwith the remit of this report, the relative performance exhibited by the Governed Portfolios is generally consistent with expectations.

Will the proposition take account of regulatory requirements?

Scottish Life has shown a commitment to update the Governed Range and its supporting documentation to keep abreast of regulatory guidance.

In addition to AKG’s questions there are a number of questions an intermediary might ask. These include:

What is the “governance process”?

The “governance process” is a combination of tools and routines designed to manage a client’s portfolio in a way consistent with their attitude to risk and term to retirement.

What are the safeguards?

The Scottish Life IAC is committed to providing regular and comprehensive oversight of the investment proposition, including asset allocation and suitable investment funds. All changes are carried out automatically.

What does it cost?

There are no explicit costs to the intermediary in opting into the governance process (and hence no savings if they opt out). However nothing is completely free; for example the costs of the IAC remain a corporate overhead and would be met out of overall charges and margins.



How does it compare with other companies?

A direct comparison of the Scottish Life Governed Portfolios with other similar offerings from other providers is outside the scope of this report. However AKG believe it compares very well with other offerings.

What do I need to do?

Intermediaries need to understand precisely what is expected of them, both by clients and the regulator, and, based on that, determine how much of this they wish to carry out for themselves and how much needs to be contracted-out.

What is in it for me?

A menu of product options and governance processes that provides a clearly auditable governance process.

How does this benefit my clients?

Clients benefit from a robust ongoing review process and the knowledge that their portfolio remains appropriate for their risk appetite and term to retirement.

How does it help my business?

Depending on the level of governance contracted-out it should free up time for developing and expanding the business. More specifically, the cost of carrying out regular reviews for individual clients and employees, a potentially expensive process, is borne by the Governed Range process. Adviser charging means that fees are much more explicit so the value of any service must also be apparent to customers. For advisers wishing to build an ongoing revenue stream the Governed Range delivers an on-going review service at an appropriate cost for the client and in a way that is profitable for their business.



11. CONCLUSION

Governance, in the context of an intermediary’s advice process, is the responsibility of the intermediary. However, it is possible for intermediaries to get third party involvement in what, whilst it is an essential part of the service, can also be an onerous, time consuming and expensive undertaking.

Having established a client’s investment strategy there is a clear need to keep it on track. Ongoing review is an essential aspect of the role of an intermediary. Intermediaries may not have either the time or the resources to undertake this function themselves.

The overriding themes underpinning the process are the need for consistency and the need for documentation and record keeping.

The Scottish Life approach is not the only facility of its type available to intermediaries and more will follow. Indeed, third party solutions may not be necessary at all if the intermediary is confident as to their ability, systems, process, knowledge and experience - and can prove it.

However, in this increasingly compliance-driven world, it is probably fair to say that many intermediaries would welcome assistance and support in meeting their obligations, particularly if it doesn’t explicitly incur additional costs.

Governance provided by Scottish Life involves very senior buy-in to the review process, something that clearly demonstrates a commitment to supporting intermediaries.

The Governed Range provides the adviser with a streamlined end to end investment process that includes ongoing reviews. At the same time it provides extensive support modules designed to help intermediaries meet their TCF obligations.

There is continuing and increasing regulatory interest in issues relating to a client’s attitude to risk, appropriate asset allocation and completion of regular reviews (portfolio advice services), as is apparent in the regulator’s ongoing scrutiny. Scottish Life has shown a commitment to adapt its governance in line with this.

Notwithstanding the clear compliance and regulatory framework provided by the Governed Range, it is also apparent that relative returns produced by the Governed Portfolios in the 1, 3 and 5 year periods to 12 January 2014 are generally consistent with expectations. Furthermore the funds have mostly outperformed their benchmarks, which are set to reflect the underlying risk profile of each fund.

The Scottish Life Governed Range has been in existence for five years. During this time, Scottish Life has shown a clear commitment to it. It has been well maintained as evidenced by regular IAC meetings and its evolution and development to meet the requirements of the regulator, advisers and investors.

The Scottish Life Governed Range proposition has performed to expectations during the period and continues to tick all the boxes. It is up to the intermediary which boxes he/she chooses to open, but it clearly it has the potential to add value to an intermediary’s business.

The inclusion of an Independent Chairman to the IAC is a welcome addition and a clear strengthening of Scottish Life’s proposition and its overall governance.

AKG Actuaries & Consultants Ltd January 2014



APPENDIX 1 PORTFOLIO BENCHMARKS

Portfolio asset allocation benchmarks are reviewed at all IAC meetings.

Governed Portfolio Equities

%

Corporate Bonds

%

Index linked Bonds

%

Property

%

1 55 15 12.5 17.5

2 42.5 22.5 20 15

3 15 45 30 10

4 67.5 7.5 7.5 17.5

5 55 17.5 12.5 15

6 30 40 20 10

7 82.5 0 0 17.5

8 70 7.5 7.5 15

9 45 25 20 10

NB. Benchmarks are as at November 2013.

The performance of each Governed Portfolio is measured against a basket of suitable market indices aggregated in the same proportions as the asset allocation benchmarks shown above.



APPENDIX 2 INFORMATION ABOUT AKG

AKG is an actuarially based consultancy specialising in the provision of ratings, information and market assistance to the financial services industry.

A wide range of Clients

Within a specialist focus on the financial services industry, AKG has developed a broad, complementary range of clients including: Intermediaries (IFAs), Life Companies, Friendly Societies, IFA Networks, Regulators, Fund Managers, Trade Bodies, Service Providers, Banks, and Building Societies.

Support for Product Providers

AKG assists Providers in:

• Financial Strength Analysis and Presentation

• Data and Information Provision

• Actuarial Consultancy

• Distribution Consultancy

Assistance to Financial Intermediaries

AKG assists Intermediaries in:

• Financial Strength Analysis and Ratings of Product Providers

• Best Advice Panel Services

• Data and Information Provision

• Actuarial and Technical Support

Regular Reports

AKG publishes the following reports to assist providers and intermediaries:

• AKG Company Profile & Financial Strength Reports

(Covering UK life assurance companies)

• AKG Offshore Profile & Financial Strength Reports

(Covering Offshore life assurance companies)

• AKG Platform Profile & Financial Strength Reports

(Covering platform operations)

• AKG UK Life Office With Profits Report

(Providing further depth in the assessment of with profits funds)

For further details on any of the above please contact AKG:

Tel: +44 (0) 1306 876439, email: [email protected]

Or online at www.akg.co.uk

mailto:[email protected]

http://www.akg.co.uk/


Produced by:

AKG Actuaries & Consultants Limited

Anderton House, 92 South Street, Dorking, Surrey, RH4 2EW

Tel No: 01306 876439 | Fax No: 01306 885325 | E-mail: [email protected]

www.akg.co.uk

Documents

AN INDEPENDENT REVIEW OF SCOTTISH LIFE’S … · AKG has performed previous reviews on Scottish Life’s Investment Governance process in March 2009 and November 2010. In September