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  2. DEFINED BENEFIT
June 29, 2015 01:00 AM

More pension funds ponder going in-house

Execs seeking more return with lower investment cost

Christine Williamson
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    Brad Kelly said staff investment discretion is key to the Canadian model.

    The need for higher net-of-fee investment returns is driving more asset owners to consider internal management for the first time or for a greater portion of their portfolios.

    Just doing the math, comparing the cost of external management vs. internal management is enough to persuade many pension plans to review operations to gauge their ability to manage some portion of their portfolios internally.

    Calculated on the basis of investment cost, a CEM Benchmarking Inc. survey of 19 large pension funds showed an average expense of 46 basis points for external money management vs. eight basis points for internal management.

    Calculated in terms of investment returns, 3.6 basis points of additional performance resulted from every 10% increase in assets under internal management, according to CEM research that benchmarked the pension funds from North America, Europe, Australia and New Zealand, which ranged in size from $12 billion to $314 billion.

    “Interest is definitely picking up within our global client base. A lot of other funds are looking at what they call the Canadian model,” which features a high percentage of internal management, said Jody MacIntosh, a CEM vice president based in the firm's Toronto headquarters.

    Recent convert

    Pension Protection Fund, London, is a very recent convert to in-house investment management, starting with its liability-driven investment portfolio. The move to internal management is the first for the £20 billion ($31.1 billion) fund, which handles payments of defined benefit funds for insolvent U.K. companies, said Leonie Furman, a PPF spokeswoman, in an e-mail.

    The fund plans to begin moving about 25% of the LDI program in-house immediately. The fund's LDI managers are BlackRock Inc., Insight Investment Management (Global) Ltd., F&C Asset Management PLC and Legal & General Investment Management (Holdings) Ltd.

    The fund began with its LDI program because “we have experience in this area across the team, and having control of this element we believe gives us the biggest bang for our buck,” said a statement e-mailed by Ms. Furman.

    “We will only insource the management of assets where we genuinely believe that this is to the benefit of levy payers and members. This is not the case for certain asset classes. For example, the management of our small emerging markets allocation is best served by a specialist fund manager,” said the statement.

    Ms. Furman did not provide further information on the size of LDI assets, internal staffing or reductions of external managers' portfolios.

    A number of the world's largest pension funds already manage significant portions of their portfolios in-house, led by some of the largest Canadian pension funds, including the C$154.4 billion ($125.2 billion) Ontario Teachers' Pension Plan and the C$72 billion Ontario Municipal Employees' Retirement System with about 80% and 88%, respectively, of internally managed assets. Both pension funds are based in Toronto.

    The Canadian pension funds are widely recognized as the earliest adopters of an internal management model that provides investment staff with sufficient discretion to invest plan assets without the cumbersome requirement of approval from the board of trustees, said Brad Kelly, a partner at governance consulting firm Global Governance Advisors Inc., Toronto.

    Another driver toward internal management is the trend toward “professionalizing the management of pension funds,” said Carole Judd, director of investment organizational change, Towers Watson Investment Services, Reigate, England.

    Pension fund board members have realized they “need investment-led people, which means they need a bigger budget to be competitive regarding salaries. The increase in the building of internal investment teams means that would-be employers are competing with many others to attract the best talent from a relatively small pool. Not everyone can do this job,” Ms. Judd said.

    Among newer, non-Canadian pension converts to internal management is RPMI Railpen. The in-house manager of the £21 billion ($32.7 billion) Railways Pension Scheme, London, is 18 months into restructuring its portfolio to include a significant portion of in-house management to reduce investment costs. Railpen hasn't shed external managers yet, but is a step closer with a recent decision to outsource its investment administration to Northern Trust Corp.

    Further along in the internal conversion is the $11.5 billion New Mexico Educational Retirement Board, which finished converting its $1.1 billion active core fixed-income portfolio to internal management in March.

    Investment staffers at the Santa Fe-based pension fund gained some confidence in their management abilities after converting the pension fund's passive $2 billion domestic equity and $132 million real estate investment trust portfolios to internal management a couple of years before, bringing the investment cost down to less than one basis point, said Bob Jacksha, chief investment officer.

    But managing an active portfolio required that “we ask whether we have the resources or can get them,” Mr. Jacksha said, noting he and another investment officer already had experience managing active fixed-income portfolios.

    Source of concern

    Recruitment was a source of concern, Mr. Jacksha said: “The main problem is our salary structure. We thought it could be difficult to find the talented people we needed to run the fixed-income portfolio internally because our salaries are low, even compared to other public pension funds.”

    Location won out: “Santa Fe is a pretty nice place to live, and one of the people we hired actually worked just five blocks away from our office.”

    Although internal management of the fixed-income portfolio is new, Mr. Jacksha said the program is on track to save about $500,000 annually in investment costs, a figure he described as “conservative.”

    Like the New Mexico fund, most pension funds choose passive and fixed-income portfolios in the early stages of internal management. But with experience, they tackle more complicated investment strategies.

    The $90 billion North Carolina Retirement Systems, Raleigh, for example, is advancing its internal investment management capabilities to global equity, private equity, opportunistic financing, real estate and inflation-sensitive strategies, with five portfolio managers and five investment analysts to replace external managers, said Kevin SigRist, chief investment officer.

    Reporters Sophie Baker, Hazel Bradford and Rob Kozlowski contributed to this story.

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