The Ontario government’s decision to allow two of the country’s largest pension funds to act as third-party investment managers has spawned a debate within the retirement industry. At first glance, the unrivalled scale that superfunds Ontario Teachers’ Pension Plan (Teachers’) and OMERS can provide for prospective clients is awfully enticing. The track record and breadth of investment options that both funds bring to the table—previously objects of envy—are now available to small funds, likely for a reasonable fee.
But a closer look raises some tough questions. Will superfunds be able to deliver appropriate investment portfolios for each client? Is it possible to avoid conflicts of interest? And should a publicly funded organization be competing with private industry?
A powerful proposition
Few would deny that smaller funds would enjoy significant benefits as clients of superfunds. Indeed, Harry Arthurs’ report from the Ontario Expert Commission on Pensions— which was instrumental in OMERS’ decision to pursue the idea—concluded that acting as a money manager for other plans will allow for economies of scale and provide access to larger capital pools. Infrastructure, private equity, real estate and certain hedge funds— prohibitively expensive asset classes for most plans—would all be on a superfund’s menu. Plus, smaller funds would be relieved of the need for in-house investment management staff and would gain instant access to top-notch talent—a formula that gets the attention of Glenn Zederayko, head of schools with Toronto Montessori Schools.
“It seems to me that being able to leverage the power of such a large fund as Teachers’ for our employees would be attractive, depending on the fees,” he says. “We would want the salesperson to clearly explain how these stack up versus other plans and versus the internal plan for members.”
Hugh O’Reilly, a partner with Cavalluzzo Hayes Shilton McIntyre & Cornish LLP in Toronto, agrees that it makes sense for smaller plans to look at leveraging investment expertise from larger funds. “You can see the attraction from a theoretical point of view,” he says. “People can run their money more cheaply, they gain access to expertise and they have the economies of scale.”
However, observers point out that bigger is not necessarily better. What if your plan’s situation requires an investment strategy that does not fit with OMERS’ existing framework? For a plan seeking to match its assets with its liabilities, a one-size-fits-all approach suddenly looks less appealing.
“I would have to think that liability driven investing (LDI), being a holistic approach, has to be done with the interests of the unique plan in mind,” says Peter Arnold, leader of Buck Consultants’ Canadian investment consulting practice in Toronto. “On that basis, I would find it hard to bundle a solution for one plan and have other people invest in it. If you’re really trying to do it on a customized basis, it may not work.”
But does the presence of an LDI mandate necessarily shut the door on superfund management? Couldn’t OMERS set up a swap arrangement for clients looking for specific asset/liability matching? The answer is no, and yes, respectively, according to Zainul Ali, a consultant in the Towers Watson investment practice. “Plan sponsors can set their own unique asset mix, and most plans will,” he says. “They can just buy pieces of the OMERS fund. It’s no different than a pooled fund, and I don’t see why their ability to execute an LDI strategy would be impaired. OMERS has the internal derivative and actuarial expertise to implement LDI strategies, if necessary.”
Arnold concedes this point but says it ultimately comes down to a compromise in some form on the part of the smaller plan. “In order for LDI to be most effective, it has to be done on a unique plan basis and holistically,” he adds. “If the big fund unitizes all of its asset classes (or the ones it wants to ‘sell’) and permits smaller plans to buy units of an asset class fund in accordance with the smaller plan’s unique asset allocation, then yes, it is just like buying units of a pooled fund.” But pooled investing and segregated investing are not the same, he explains, and when pursuing LDI, “customization is usually required to do it right. Customization and pooled funds rarely jive.”
Is it safe?
Tactical considerations aside, a larger debate swirls around the propriety of the idea. If a pension fund handles third-party money, is it still a pension fund? How does it balance the best interests of its members—its core mandate—with those of its new clients? And what of the risks involved in launching a new business? Are plan members on the hook in the event of a loss?