What are the implications of pension funds assuming third party investment management responsibilities for other funds? The current premise is that pooling of assets will allow for economies of scale, thus enabling “large” pension funds to compete more effectively on a global scale with “mega” sovereign wealth funds, particularly when it comes to alternative assets.
However one can’t help but wonder whether the ultimate result will be top and bottom line revenue for the fund providing the asset management service—in other words, pension funds becoming “for profit” institutions. And why stop there? An infusion of capital from the capital markets for such an institution would allow for an even larger balance sheet to achieve even greater economies of scale.
Hang on a minute, pension funds have already been using both financial (special purpose debt) and non-financial (long/short strategies) leverage for some time now, expanding the scope of their balance sheets significantly. The financial turmoil of 2008 highlighted the potential dangers of leverage and the importance of management maintaining an eagle eye on the state of their balance sheets. As with financial institutions, some pension funds have passed the test more readily than others. (Any manager of a financial institution is well-advised to ensure that they never relinquish control of their balance sheet to a third party—to quote the firefighters’ code, “never surrender your axe.”)
When the Canadian insurance industry demutualized in the 90s, some of the outcomes were a shorter time horizon for decision-making and changes to compensation structures for executives. Will pension funds end up even more vulnerable to short-term decision making to satisfy external stakeholders? Will pension fund executives soon be needing to disclose their option grants and level of resulting share dilution? Will we soon be voting on “say on pay” for pension funds as well?
Actually the deferred compensation programs popular with major pension funds are already tantamount to option grants, the difference being that payouts typically depend on relative fund performance (relative to markets or competitors) rather than absolute performance (share prices for listed companies). Each approach has its advantages. Absolute returns align managers’ interests with the owners, where the performance objective is an absolute level of return on capital. However relative performance measures reward managers for adding value relative to the “passive” market which the owner could have secured on a more cost-effective basis.
So what about listing pension funds on the TSX? Is it a ludicrous premise? Their market cap would put them in the big leagues, their management talents will soon be accessible to others as “investments” and we’ll all be curious to see which funds attract the most attention from those who wish to invest versus those who wish to sell short.
Will the hedge funds be able to get their revenge on those funds that weren’t open to their marketing charms? Whose balance sheet will assume the most risk and who will deliver the best returns to their members over the long term? Stay tuned!