“If you’re a larger scale fund you’re better able to get costs down but you don’t have to be big to get good returns,” Dwyer says. “For niche players who have strong support, provided they manage their costs, there is no imperative to merge.” Greg Nolan, general manager of investments at the $4.6 billion Care Super, says that as large funds get even bigger, they eventually outgrow the benefits of scale. The fund, which is in formal discussions with the $1.6 billion Asset Super about a potential merger, recently commissioned asset consultant JANA Investment Advisers to assess whether super funds with $10 billion or more under management were more successful investors than smaller funds. JANA concluded that there is little or no correlation between fund size and returns. Bigger funds did not perform badly but their smaller peers were not disadvantaged by their size. It finds that once funds reach a “critical mass” they can exploit benefits through economies of scale.

These include: tiered fee structures within collective investment pools; greater control over investment strategy through discrete, cost-efficient mandates; the ability to provide a broader range of investment products at lower costs per member; and the use of larger mandates to negotiate greater alignment with service providers. However, Nolan says that some benefits of being small can be compromised when a portfolio grows into the tens of billions. “Getting beyond a $10 billion fund, it becomes harder and harder to get efficiencies,” Nolan says. He says larger funds find it more difficult to change asset allocations and to invest with managers who limit how much they are willing to invest in particular strategies. “We manage $1 billion in Australian equities with six managers, and to change one manager is a significant process,” he says. The JANA research shows that very large funds find it challenging to secure enough capacity with active managers of Australian equities and bonds. It says funds between $5 billion and $10 billion are probably best able to achieve an optimal balance between maximising investment performance and minimising costs. This balance is close to what some fund executives, such as Sicilia, call the “sweet spot” of fund scale. It is different for each fund, he says, and is reached when a fund is not forced to reject an investment idea because it is too small. Sicilia knows the feeling of hitting the sweet spot.

“There is nothing I’m aware of in which the Hostplus board would say, ‘It’s a great idea but we don’t have the money or resources to do it’,” he says. But this sensation can sour as, inevitably, funds grow bigger – and bigger – in a market where contributions are mandated. “No fund can stay in the sweet spot,” Sicilia says. What is worse, however, is that “size brings headaches”. An initial problem is the difficulty of investing with funds managers who have capacity constraints. By accepting a large mandate from a big fund, a manager takes on the business risk of one day losing its big client and seeing revenues drop sharply overnight. Some managers prefer to have a more diverse clientele of smaller funds, Sicilia says. Moreover, these funds have less ability to use the size of their mandates as a bargaining tool to negotiate lower fees. He asks: What incentive does a manager have to accept a large mandate, which can incur considerable business risk, for a lower fee when they can take on a number of smaller mandates from smaller funds that pay higher fees? He also says that big funds with investment teams must be wary that their sector specialists do not fall prey to “asset-class capture” and champion their area of expertise irrespective of market conditions.

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