Study: “Bigger Is Better When It Comes to Pension Plans”

(September 9, 2011) – Larger pension plans such as Ontario Teachers’ and the New York State Common Retirement Fund are more likely than their smaller peers to provide better investment returns, recent academic work from University of Toronto researchers Alexander Dyck and Lukasz Pomorski shows. 

Unlike mutual funds, the authors argue in the paper, pension funds increase in performance as their size grows. “First and most strikingly, we find increasing returns to scale for pension plans,” the authors conclude. “Bigger is better when it comes to pension plans. Larger plans outperform smaller plans by 43-50 basis points per year in terms of their net abnormal returns.” 

This is partially the result of a greater preference for internal management of assets at larger plans, the authors conclude. “While delivering similar gross returns, external active management is at least [three] times more expensive than internal active management, and in alternatives it is [five] times more expensive,” they write. 

Large plans also outperform because of asset allocation decisions unique to them, the authors write. “We find that larger plans shift towards asset classes where scale and negotiating power matter most and obtain superior performance in these asset classes,” they assert. “Larger plans devote significantly more assets to alternatives, where costs are high and where there is substantial variation in costs across plans.” Real estate and private equity add the most value, they insist. 

Governance issues also influence returns, the study shows. “Finally, we present suggestive evidence that plan governance affects performance and the ability to fight scale diseconomies,” the authors write. “Long standing concerns about plan governance…are likely greater in the public than in the private sector, particularly where public plans have severe limits on pay for internal managers …We find that stronger governance provides higher returns and a greater ability to take advantage of scale economies.” 

The data on which the study is based comes from CEM Benchmarking, the well-known Canadian pension benchmarking company. 

For a look at the world’s largest asset owners – including the world’s largest defined benefit pension plans – go to aiCIO’s recently launched interactive database, the aiGlobal 500, here.