Across the global pension industry we are seeing a significant shift towards consolidation driven by regulatory change and pressure from sponsors to reduce costs. However, is big better? In order to help answer this question, AXA Investment Managers (AXA IM) has produced a paper outlining the potential for gain or increased burden that can be realised by merging pension funds.
If we translate ‘Is big better?’ into a measurable investment outcome then we are asking whether increasing the size of a pension fund will improve the risk-adjusted return, net of fees. We therefore considered whether bigger funds earn higher returns, if they pay lower fees and the impact of size on risk management and risk tolerance.
Our key findings include:
• The return benefit for larger pension funds comes from their ability to get direct access to asset classes and investment opportunities that are not available to smaller funds; however large pension funds can experience a performance drag from investing in traditional asset classes, when the size of their trades gets too large to allow for efficient execution.
• The capacity for banks to transact large derivative trades has declined, suggesting that there is a point when pension funds become ‘too big’ to implement interest rate and inflation hedging at the times and pace they may wish.
• A culture of consensus ‘group think’ can emerge if pension fund consolidation leaves a country or industry with a small number of large funds.
• A collaborative approach might allow small funds to capture some of the benefits of being bigger without giving up their flexibility or agility.
Madeline Forrester, Head of UK Institutional at AXA IM, comments: “The current call for evidence on fund merger in the LGPS closes shortly, and we would encourage all those with a view on this topic to respond to the call for evidence. In our opinion this is not just an LGPS issue but a wider challenge affecting different funds in all markets.”
“Our short answer to the question, is big better, would be not always. While size can bring advantages, such as the ability to negotiate lower asset management fees or more ready access to alternative investment opportunities, it also brings challenges. Examples include manager and market capacity, efficient trade execution and additional risk considerations. We believe that collaboration may allow small pension funds to capture some of the benefits of size without having to surrender their flexibility or agility.
“A collaborative approach will only be successful if it is led by the decision makers, but we believe that once a clear message of intent has been given asset managers and other industry participants will evolve their solutions to meet the new demands of investors.“
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