pension funds, size really does matter. While the need to match assets and liabilities concerns all funds, big or small, the largest face unique advantages and challenges.
And the number of large funds is growing. Last week, the IPE Global Top 1,000 survey of institutional investors highlighted the rise of the mega-fund, showing that the number of European pension funds with assets under management (AUM) of €10bn or more has risen by 24 per cent between 2006 and 2009 to 75.
Research conducted jointly by Towers Watson and Pensions & Investments yesterday showed that the top 20 funds globally saw their assets rise by 6.2 per cent to $4.4 trillion in 2009. This is their highest AUM ever and accounts for more than 16 per cent of global pension assets.
These larger funds usually have greater internal resources. This gives them much more ability to diversify not only among investment managers but also across asset classes, says Tom Geraghty, European head of Mercer Investment Consulting.
In contrast, smaller institutional investors, which are less likely to have the internal resources to do the due diligence on alternatives such as private equity and property, find themselves hamstrung.
Bigger funds also tend to be in a better negotiating position: “Size affords you the ability to negotiate harder with suppliers of products and services to reduce running costs in a serious and significant way,” says John Belgrove, principal in Hewitt’s investment division.
But while bigger can be better, more assets under management can pose challenges for pension funds’ governance structures and allocation decisions. When you have a significant amount of assets it can be difficult to be dynamic whereas small and mid-sized funds can move assets around without market impact. “The challenge to make timely decisions applies to both larger and smaller funds. But for larger funds there could be more operational headaches associated with moving large sums of money,” says Mercer’s Geraghty.
Larger funds can also be slower to alter their investment decisions and to change managers, he adds. The largest funds may also come under more scrutiny when it comes to shareholder engagement and stewardship.
To meet all of these issues, the governance models of the large pension funds are starting to change, says Hewitt’s John Belgrove. He says that the traditional model of governance resulted in pension funds that had a fairly significant equity weighting but with little exposure to alternatives. They also took a very long-term investment approach and consequently were prepared to take on more risk.
However, funds such as USS and Railpen are moving towards a more active approach, which involves much more use of alternatives. They have also hired internal resources to facilitate a broader range of investment options and provide more real-time stewardship of assets. Consequently, the mega pension funds are now calling on consultants more for projects and specific tasks.
Ever-larger funds will be forced to follow the lead of the likes of USS and RailPen. They will have to diversify more broadly and bolster their internal resources to cope with coordination and more thorough due diligence on such epic scales.