The researchers draw on databases, including that maintained by pension fund researcher CEM Benchmarking, which cover about 40 per cent of assets managed in the US pensions industry. This includes the returns of 463 defined benefit funds from 1990-2006 and those of 248 defined contribution funds from 1997-2006. They find that greater size results in pension funds incurring lower costs than mutual funds; but the performance of pension funds, after expenses and trading costs, was positive but “relatively small” compared to the benchmark. “While larger scale brings cost advantages, these are apparently overshadowed by size disadvantages in equity performance,” the paper states. It also finds that small mandates, particularly those focused on smallcap equities, beat benchmarks by about 3 percentage points each year while similar strategies run by mutual funds did not perform as well. “Liquidity limitations seem to allow only smaller funds, and especially small-cap mandates, to outperform their benchmarks,” the researchers write. Bigger funds are not able to exploit the illiquidity premium in some small-cap equities because they are unable to invest a meaningful amount of capital in these stocks.

DIY funds management Some large funds with investment staff take a big next step: run money themselves. The common motive for this is to reduce the amount of fees paid to external fund managers. Even though many senior portfolio managers at AustralianSuper are former investment managers, the fund has not decided to insource this operation. It will begin managing money if it becomes clear that “we think we can do it cheaper and better” than external managers, Delaney says. Some funds have made the move. UniSuper, for instance, manages a portfolio of core Australian equities and some fixed income, while Telstra Super manages 30 per cent of its domestic equities allocation plus some cash. About 30 per cent of Equipsuper’s $4.4 billion in assets – a mix of Australian equities, fixed income and direct infrastructure – is managed by an internal team of five. Danielle Press, CEO of Equipsuper, says funds that manage their own money internalise the risk of a funds management operation. This includes finding skilled investment professionals and then retaining them, because most of the value in an investment strategy is inside the brains of the people developing and executing it.

“The people risk is huge,” Press says, and these people must often be paid similar amounts to what they could earn in a funds management business. But this risk does not only materialise in cases of staff turnover: “You’re dealing with egos,” Press warns. “That is a very different management game.” The team runs at a “fully loaded” cost of 14 basis points – including systems, rent and accounting – which is far cheaper than the percentage-point fees charged by external active managers. But funds running money internally should not focus only on saving money. “You have to make sure you’re not giving up returns by doing this,” Press says. The risk of costly operational errors, stemming from compliance breaches or breakdowns in counterparty relationships, must also be managed.

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