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The writer is a former global head of asset allocation at a fund manager
The reforms outlined by UK chancellor Jeremy Hunt in July to revitalise the British economy by channelling savings in a better way hung on the premise that larger pools of capital will deliver better pensioner outcomes. Labour’s Rachel Reeves — increasingly seen as chancellor-in-waiting — has also championed the idea. The data doesn’t support this consensus, but I’m nonetheless inclined to agree.
The reasons to consolidate are plain to see. With thousands of private defined benefit schemes and tens of thousands of defined contribution ones, the market is highly fragmented. Greater economies of scale would allow them to reduce average costs while also being able to afford to attract top talent, run state of the art risk systems and build in-house private market teams.
With much larger individual mandates to delegate, fee rates paid to external managers could perhaps be halved. Research from New Financial — a London-based capital markets think-tank — suggests that average annual costs for UK pension schemes come in at 0.65 per cent of assets. I estimate moving costs in line with the Canadian Pension Plan, Sweden’s AP4 Fund, or even the Universities Superannuation Scheme, the biggest private sector UK pension fund, would cut industry costs by between £11bn to £17bn a year. With more than £400bn of public sector pension assets controlled by 86 different English and Welsh local government administering authorities, the chancellor has the opportunity to lead by example.
The case against consolidation is thinner. True, some fund strategies have capacity constraints. As Warren Buffett argued, there might be more opportunities for smaller, more nimble funds. “It’s a huge structural advantage not to have a lot of money.”
This though tends to become only a serious problem where managers are engaged in concentrated stockpicking. Beyond this, arguments against amalgamation can sound like special pleading from fund managers keen not to see their revenues shrink. And the prospective hit to their revenues is not trivial.
But try as I might, I’ve been unable to match data to the arguments for consolidation. Looking to US public pension plans, the economies of scale have not translated into better investment returns. There is almost no correlation between investment performance over the past 10 years and the size of their asset pool. Nor is there much of a correlation with their allocation to private assets. Given that the last decade of ultra-cheap leverage has been ideal for private assets, this is surprising.
The OECD’s Annual Survey of Public Pension Reserve Funds finds a similar lack of correlation between size and investment returns, although this is complicated by multicurrency reporting. And the wild differences between the investment performance of defined contribution default funds of UK master trusts — a type of pension scheme where multiple employers in different areas pool their staff pensions — also appear entirely unrelated to pool size.
If evidence that larger pools deliver better member outcomes is scarce, why make the move? A recent report from the Resolution Foundation takes a somewhat Marxist approach to argue that concentration of company ownership matters to the economy for structural reasons.
Almost everyone agrees that Britain needs more investment, but — the authors argue — diffuse ownership has impeded this by weakening UK business owners’ engagement over the past two decades. Activist equity managers have seen their powers ebb with successive waves of clients allocating away from them towards liability-matching bonds or passive exposures. Hence, UK firms possess the OECD’s lowest share of “blockholder” shareholders capable of wielding substantial decision-making influence, according to Resolution. Consolidation could boost fund managers’ voices and ability to push for investment.
The proposition would probably require management of equity positions to move in-house in these new larger pools of capital to overcome well-documented incentives for external fund managers to underinvest in stewardship. Any benefits would, furthermore, be shared across the whole economy. As such, this seems a reasonable aim for the government.
Policymakers have hitherto sought to increase value for pension scheme members by reducing costs. Given that only the latter can be controlled, this approach is understandable. Implemented correctly, the move to create larger pools of pension capital could, however, be the catalyst to unlock value for all.
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