Have scale, will bedazzle … but beware

Keith AmbachtsheerKeith Ambachtsheer, director of the Rotman International Centre for Pension Management (Rotman ICPM), believes increased scale expands the capabilities of pension funds, while also enhancing their operations and lowering costs. But their financial strength should not be allowed to compromise their core purpose. He shares his thoughts with Simon Mumme.

In 1992, Keith Ambachtsheer was a co-founder of Toronto-based CEM Benchmarking, a business which has grown to provide investment and administration benchmarking services for more than 500 pension funds – both defined benefit and accumulation plans – around the globe.

The CEM database reaches back to 1982. Over the years, the information compiled has conclusively shown that larger scale brings an array of benefits to pension funds. At the forefront of this list are the cost efficiencies that big funds can generate.

“But larger funds outperform small funds by more than just the cost differential. Scale shows up everywhere,” Ambachtsheer says.

By committing more resources and capital to alternative and emerging investment strategies, such as co-investments and allocations to private markets, bigger scale enables funds to better diversify their portfolios and potentially enhance returns.

“Over that time period, large funds have generally done quite well with real estate, infrastructure and private equity, and small funds haven’t been in those asset classes.”

Another scale kick is what Ambachtsheer calls “indirect scale effects”, such as the internal management and administration of assets.

“Right across the spectrum, it’s cheaper to do things inside than outsource,” he says.

Such insourcing of skill is feasible only to big funds, which can afford to pluck talented investment staff from the market.

So, what size does a fund need to achieve before it enjoys these benefits? “It keeps rising over time as I look at the numbers. In 1997 I thought the number was $5 billion. Now it’s more like $25 billion,” Ambachtsheer says.

“The reason for this is that I see a potentially exciting future for funds management to get involved in the economy. Infrastructure is a classic example. There is a huge infrastructure shortage across the world. Pension funds are a natural source of funding for these projects, but to it they need to be large, and have enough experts on the board to assess if infrastructure project A or B makes sense economically. Small funds don’t have this capability.”

Big funds can enter co-investment deals, and those with specialised private markets teams are more likely to be capable of originating deals. But as big funds absorb the skills usually found in funds management businesses, they should remember their core purpose.

Ambachtsheer is wary of pension funds that own asset management businesses. While incubating emerging managers enables pension funds to tap into their strong early returns, owning a mature asset management business brought on the risks of running the operation, diverting resources from the core investment and product delivery purposes of pension funds.

“Those models tend to self-destruct. The strategy works with a few hundred million under management, but when it gets to the billions, the alpha goes away.

“It’s thin ice, slippery slope. You get into incentive issues. And is it really in the interest of [pension fund] beneficiaries? A lot of time and energy is required to go out and market to get other business.”

Ambachtsheer was speaking ahead of the Rotman ICPM forum in Melbourne. The organisation, headquartered in Toronto, aims to bridge academic researchers into management with practitioners, and enables the member pension funds, called ‘research partners’, to share ideas about investment strategy and benefit design.

While the member funds, which include many big plans such as the Ontario Teachers’ Pension Plan and PGGM, can find themselves competing to secure deals and recruit key staff, they share the common fiduciary goal of running investment vehicles to help members live with dignity in their retirement.

“In this country, as we speak, research partners are meeting and comparing notes,” Ambachtsheer says.