Premier Trend Among Superannuations: Insourcing, Paper Concludes

One of the more prevalent trends in institutional investing within the superannuation industry has been a movement toward in-house investment management.

(February 3, 2012) — Insourcing — the act of taking internal control of any investment management activity previously handled by a service provider — has emerged as a growing trend within Australia’s superannuation world within the past couple of years, a recent paper by Round Tower Solutions concludes.

In order for the investment management industry to be successful at taking more activities in-house, organizations must weigh risks, reward, and cost, according to Aongus O’Gorman, the paper’s author — previously at QIC – Round Tower Solutions’ Managing Director, told aiCIO.

He said: “If you’re going to start from scratch, get the governance structure right — that will be fundamental to everything.”

According to O’Gorman, organizations most likely to be successful at in-sourcing are generally larger funds — or those with greater resources and more advanced governance structures. “A big organization can screw things up as much as small a small organization, so it’s a question of how you deploy the resources you have.”

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The paper asserts that a number of factors have driven this trend toward insourcing.

1) Funds have grown in scale and thus have the resources to undertake more detailed investment activities;

2) Increased competition has led to a focus on costs, with larger funds realizing that internalizing investment management may be more efficient than hiring external managers;

3) The success of a number of endowments in the US and some local success has led funds to believe this success can be replicated;

4) Disenchantment with the cost and use of external management.

This growing sense of disenchantment with the cost and use of external help is not unique to Australia’s investment management industry. In March of last year, Scott Sleyster, chief investment officer for Prudential’s American operations, told aiCIO:

“We actually like to run most strategies in-house. There has been a move to outsource investment management at a number of insurance companies, even with fixed-income investments, which really should be an insurance company core competency. At Prudential, if we see an asset class and we like what we see, we usually want to build that capability internally.”

Meanwhile, Leo de Bever the CEO of Alberta Investment Management Corporation (AIMCo) — the corporation created to manage the province’s pension and sovereign wealth fund — spoke positively of internal private equity teams to aiCIO. “I paid [US $160 million] in external fees last year,” he said in a December 2010 interview. “I think we can cut that down by four times if we move some of it internally.” His outlook reflects other large Canadian institutions, which have created internal private equity team to pursue direct investments and avoid external fees.

(February 3, 2012) — Large companies in the United States are facing a ‘challenging’ year despite seeing a reduction in their aggregate pension deficit in January, according to investment consulting firm Mercer.

The aggregate deficit in pension plans sponsored by S&P1500 companies fell by almost 11% from $484 billion to $431 billion in January, Mercer said today.

This represents an improvement in the funding ratio from 75% to 78%, however Mercer foresees obstacles ahead.

Kevin Armant, principal with Mercer’s Financial Strategy Group, said: “The coming year is shaping up to be a challenging one for pension plan sponsors. Over the past few weeks, we have seen many companies announce significant increases in planned contributions to pension plans, as they need to begin dealing with these deficits.

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He added that Mercer expected to see additional announcements of large cash contributions to plans as companies file their I0Ks over the next few weeks. Armant said the company expected this to carry into 2013.

The improvement in funding ratio was due to positive equity performance in January, Mercer said. US markets, to which domestic plans have the largest equity exposure, were up 4.5% over the month while US fixed-income markets were up 1.5%.

However, interest rates on high quality corporate bonds, against which much of these companies’ pension liabilities are measured, also fell over the month as the market grew more confident of their relative quality. This meant that liabilities on some corporate schemes could have seen their discount rates fall by up to 20 basis points, according to Mercer.

Armant said: “It really highlights the level of interest rate risk that most US pension plans are exposed to. It appears that many plans are, in effect, making an implicit bet on interest rates rising, but with the recent announcements by the Fed, it is likely that we are looking at a low rate environment for the next few years.”

Last month the Pension Protection Fund, a lifeboat for bankrupt company schemes in the United Kingdom, announced the aggregate deficit on these funds had hit record highs at the end of December due to similar reasons US companies have faced.