It is “completely mad” that there are 34 public sector pension funds in London alone and 100 local ones across England, Scotland and Wales says Mike Taylor the Chief Executive of the London Pension Fund Authority. The debate about the future of the Local Government Pension Scheme has an elephant in the room - fund mergers!
There is enough evidence in the UK and globally that fund mergers are a key issue for the survival of defined benefit schemes, and defined contribution schemes come to that to fill that room! Another academic report is now been published called Is Bigger Better? Size and Performance in Pension Plan Management http://www.rotman.utoronto.ca/pomorski/Is_Bigger_Better.pdf
And was recently reviewed in the Financial Times. http://www.ft.com/cms/s/0/ef034e0a-dee4-11e0-9130-00144feabdc0.html#axzz1Yrm5rO00
A new study conducted by two professors at the University of Toronto’s Rotman School of Management adds to a mountain of evidence supporting the argument that scale pays off for large pension plans. The review’s thesis – derived from an analysis of the performance of 842 global pension plans between 1990 and 2008 – is that bigger DB schemes outperform smaller ones by as much as 0.43 to 0.50 per cent per year if measured in terms of returns above the benchmark after costs.
These estimates suggest the savings of workers in a plan with assets of $33bn would be 13 per cent larger at retirement than savings in a plan with $1bn in assets. This disparity is less than egalitarian, but workers who sign up for smaller DB schemes can do little to correct it as most cannot move their retirement money elsewhere unless they switch jobs.
“Bigger is better when it comes to pension plans,” write Profs Alexander Dyck and Lukasz Pomorski of the University of Toronto.
A chunk of the gains arise from the cost savings that come when pension funds oversee their own investments and do not delegate the task to outside managers, which costs three to five times as much depending on the sorts of assets in question.
Higher allocations to alternative investments also improve larger pension plans’ performance as do sounder corporate governance practices. And Profs Dyck and Pomorski say that the cheaper costs bigger plans achieve through economies of scale greatly improve their returns from private equity and real estate investments as well.
“Larger plans have access to and can take advantage of co-investment opportunities (ie the ability to buy a share of portfolio companies without fees) and are better placed to identify the better performing private equity funds,” note the academics.
Other studies draw similar conclusions. An analysis of English DB schemes, presented last spring at the UK’s National Association of Pension Funds conference by Mark Packham, a director with PwC’s pensions practice, for example, also supports the theory that bigger is usually better when it comes to pension funds.
Larger funds with more than £2bn in assets threw up net annual returns of 3 per cent on average in the eight years through the end of March 2009; mid-sized ones with less than £2bn in assets saw returns of 2.9 per cent, meanwhile; while smaller funds with less than £1bn to hand returned 2.2 per cent. Mr Packham also discovered scant evidence to suggest that the performance of larger pension funds tails off after collecting a certain amount of assets.
Anecdotal evidence offered up by pension funds supports the University of Toronto professors’ thesis as well.
David Denison, chief executive of CPP Investment Board, which invests the C$153bn ($155bn) held by the Canada Pension Plan – one of the country’s largest public pension schemes – boasts that by managing its own investments, the fund’s board pays just a tenth of the costs they would be forced to dish out to an outside investment manager.
The plan’s size also permits it to reach into asset classes such as toll roads and other public works projects, private equity, private debt and real estate. “We can achieve far more diversification in asset classes and geographies,” Mr Denison says. “We have people on the ground in Hong Kong and London scouting out opportunities. The reach of our investments is more global. We invest in real estate across China, Japan, Australia and Singapore, for example.”
The appeal of taking direct stakes in property or infrastructure is that it permits the CPP Investment Board to gain steady income streams that last as long as 10-20 years. They also face fewer competitors when making bids on multi-billion dollar investments. “They give us better risk-adjusted returns than we would get by investing solely in the public markets over say 10, 15 or 20 years,” says Mr Denison. But the fund’s board of directors plays a critical role as sophisticated guidance is needed on the complexities of taking direct stakes in infrastructure, real estate or private debt. “If governance is weak in my view it’s impossible to get the advantages of scale that I’ve talked about,” he concludes. “We’re blessed by having a strong board.”
The benefits of scale suggest small funds are failing their beneficiaries by struggling on alone. The idea of consolidation is gaining growing support among overseers of smaller, weaker plans, but appears hard to put into practice.
