There is no clear evidence of there being an “optimal scale” for an efficient and effective superannuation fund. Smaller super funds can equal the net return performance of large funds, provided they execute administrative and investment strategies properly. But larger funds do have competitive advantages, which can help boost returns as capacity increases.
Those are some of the conclusions reached by Dr Geoff Warren, a finance researcher and academic at the Australian National University who has looked at strategies for asset managers to exploit scale and manage capacity.
He argues that industry speculation about potential “diseconomies of scale” for larger super and pension funds focuses on the disadvantages of scale when investing in public markets such as equities, particularly small-cap equities. But there are advantages for larger funds investing in private markets such as direct property and infrastructure, “despite current crowding”.
Warren outlined these findings in a presentation to the Investment Magazine Fiduciary Investors Symposium, held in the Blue Mountains, NSW, May 15-17, 2017.
While Warren agreed that there may be a minimum efficient size for an asset owner, beyond that he dismissed the idea of an optimal scale or the assumption that investment capabilities necessarily improve as funds under management grow. He said the real question for success was whether funds were exploiting their different competitive advantages, which may vary according to fund size.
“Once you account for that, small funds might do as well as large funds, if they [approach] it differently,” he said.
Funds in the $1 billion to $2 billion range can benefit from being nimble and capture economies of scale by outsourcing otherwise costly administrative processes. But they are disadvantaged by not having the same number of people or the governance budgets that are available to $5 billion-plus funds, Warren said.
Cbus mindful of capacity constraints
The question of how best to exploit relative economies of scale is something that has been given much thought in recent years at Cbus Super, as the fund has overhauled its investment model to insource more asset allocation and management decisions.
Cbus chief investment officer Kristian Fok, said the $40 billion construction industry fund ran an exercise around capacity changes in Australian equities in 2015, when it had less than $30 billion in funds under management.
“We ranked current fund managers and the next on the list based on a level of alpha we thought we could achieve…We found confidence in continue delivering deliver strong alpha was vulnerable to what would be quite small changes in circumstances.”
Cbus found a 5 per cent allocation shift into Australian equities would have created capacity problems, as would making changes to fund manager mandates of reasonable size.
“Looking forward, the capacity issue was real,” Fok said. “Our 1.5 per cent alpha conviction for the sector would have dropped by about 15 basis points, from 1.5 per cent, by about another 15 basis points, and by adding new managers would have increased our fees by two basis points.”
“Our strategy is about focusing on our long term investment horizon, investing from a total portfolio perspective and targeting investments the generate real economic benefits (particularly focused on the built environment) ,” he said.
Our strategy takes advantage of our strong net cash flows and helps avoid potential diseconomies of scale, as does managing assets on a whole portfolio basis across asset classes such as property and infrastructure.
Cbus is looking at launching its first internal international equity strategy, which would be cost neutral at $400 million, equivalent to 1 per cent of the portfolio.
“Funds could internalise at a smaller size than we are,” Fok explained. “But there are other factors that need to be in place such as strong delegations and culture and portfolio information systems and reporting. For us, our strategy relies on building a broad set of capabilities. We’ve also built out a partnership approach to selectively outsource particular components of our internalisation strategy such is the stock trading function.”
Five tips for optimising scale
Warren’s research has concluded there are five attributes of investment strategies that are more scalable:
- Able to be successfully applied in any large liquid market.
- Has limited reliance on large volumes and can be spread across opportunities with long investment horizons.
- Liquidity supplying rather than demanding, so trading against consensus.
- Focused on asset classes with low competition from other investors.
- Can leverage benefits of a resource pool such as large staff, systems and networks, and an ability to wield influence through offering long-term capital to the market.