There should be net benefit for members or advantages in terms of internal management for superannuation funds considering taking investment inhouse, according to Sunsuper chief investment officer David Hartley. He said funds should be prepared for the impacts internalisation could have on culture and processes. In an exclusive interview with State Street, published in its recently released report Evolving Superannuation Funds for the Future, he said there’s a “logical disconnect” in super funds internalising their investment management functions purely to save cost.
Is less more?
“You are effectively hiring a group of people and paying less than it would cost to get those same people externally,” he told Lochiel Crafter, Asia Pacific head of State Street Global Advisors.
“One of two things is going to happen. They are either going to be unsuccessful, in which case you’ve got all the problems of rectifying that. Or, if they’re successful, you’re paying them less than what they can get in the open market. So you have to expect to lose those people.”
Hartley said some funds internalise because the asset-owning model is “better suited to internal management”, such as some large defined-benefit funds in North America that insource their investments in infrastructure.
“One reason for this was the belief that the North American model for owning infrastructure assets was wrong. It had grown out of a private equity model.”
Hartley said Sunsuper is paying approximately $100 million in fees a year to external managers, a figure that would double if the fund was to grow to twice its size.
“$200 million dollars can buy you a fair bit of internal expertise, and that’s when people start saying, ‘Can I save on these other aspects? Can I beef up another part of the portfolio so I can get a better value out of the money I’m spending?’”
Managers, he said, don’t appreciate super funds’ capacity to manage money in house as they get larger.
“It doesn’t cost a manager twice as much to manage twice as much money, so why should the fee be close to double?”
In relation to when there would be value in bringing investment in house, Hartley said it depends on the asset class and investment style.
“For example, for Australian shares it would actually be more expensive for us to insource at the moment. We’d have to pay the costs of the staff and the systems, and the governance structure. Plus, with Australian shares we’ve got pretty low marginal fees.”
For Sunsuper, it would have to double in size before “it starts to become a meaningful cost benefit, just in terms of the fees”, he said.
“Then there’s the question as to whether we’re giving up return as well, because it’s not just about fees.”
Hartley said funds go through stages of growth called “punctuated evolution”. It begins with a governance board, a hired consultant, then an investment expert to work with the consultant.
“That internal person soon says, ‘I can do more if I can get some more people,’ so you start to build up an internal manager-of-managers team. I’ve seen these all around the world in different areas, companies and funds,” Hartley said.
“Next, they start to say, ‘We can manage some of this money ourselves internally.’ And then, ‘Maybe we should manage money for other people as well.’”
Hartley identified the next phase as the internal investment team being on a par with “just another manager”, with people hired into the trustee office to oversee them.
“When you think about it, you’re just going back to a manager-of-managers structure.”
Hartley said the manager-of-managers model offers a long-term stable structure.
“It’s just a matter of making sure you don’t get ripped off in the economics as you get bigger and bigger. Since the pricing models of a lot of investment management companies are not really designed around growing clients, super funds are being forced to at least consider insourcing.”
Read the full interview with David Hartley here.