Cost savings are just one reason, among a strikingly diverse range, driving super funds to bring their asset management activities in-house, according to new research.
The Centre for International Finance and Regulation (CIFR) study, presented at the annual Frontier Advisors conference, found that between 5-20% of funds were now practicing in-house management across many major asset classes.
“It was like we were seeing a portrait of the industry that was feeling its way,” CIFR research Director Geoff Warren said.
“We thought on the surface there was a fair amount of agreement about the sort of areas you should be thinking about. Beneath the surface though, there was striking diversity about the ways they talked about those areas and what aspects they thought to consider and were most important.”
At least three-quarters of funds placed some importance on the investment return impact, alignment, governance, staff, culture, systems and processes. Key drivers behind the in-sourcing trend included an increase in net returns; scale (the benefit of fixed internal costs versus variable external manager fees as well as capacity constraints cited by external managers); competitive advantages such as greater access and control; and better alignment with the fund’s objectives.
“I think it starts off with people wanting to save money but then people become conscious that it’s not that easy,” Frontier Advisors Director of Consulting, Fiona Trafford-Walker, said. “You might save money but it might also cost returns so that focus of thinking on net return dimensions is really important.”
Funds need to attract the right people if the strategy is to succeed. The difference between the best and worst performing Australian equity manager over the last year was about 40%, she said – a major difference for any fund.
Warren said the ability to attract staff with appropriate remuneration was a big issue among the 13 industry funds they interviewed. Are there suitable employees who will work for less because they value the culture a super fund can offer?
“I’d suggest yes, probably,” Warren said “but whether it bears up under scaling the industry up remains to be seen.”
Trafford-Walker said the industry was recalibrating what was an appropriate level of fund manager remuneration thanks to super fund pressure, a low-return environment, and greater regulatory focus on fees.
Executives at two super funds quoted in the CIFR study said that managers were offering unsolicited fee discounts, partially due to the threat of in-sourcing.
“Every manager we’re talking to at the moment is offering cost reductions,” one executive quoted in the report said. “Virtually, they’re asking for them. They all know it’s sort of out there.”
The CIFR study found super funds in-sourcing management followed one of four different models:
- Dedicated: assets are managed 100% in-house (a relatively rare approach).
- Hybrid: a mix of internal and external (the most popular approach, common in core assets such as equities).
- Co-investment: super funds piggy-back on the fund manager, taking an extra investment slice, boosting access for modest resources but with limited control.
- Partnership: either between funds or with an external manager where the fund provides capital, while some management functions are performed externally.
Warren said the study, which also included interviews with executives at seven advisory firms, largely convinced him of the strategy’s merits.
“I was a sceptic before I did the interviews – I became less sceptical. The benefits became more apparent after doing the interviews, the key risks seemed more manageable, I heard good strategies for managing them and the key one – I realised that in-house management was limited in scope. Not everyone was outsourcing the whole fund – it’s occurring in little pockets across the fund.”
Trafford-Walker cited the Canadian market, where the hybrid model is prevalent, as being particularly advanced.
“Even they still use some external management for some strategies so it’s not as if you have to be one or the other – you can run a hybrid model and capture the best of both worlds.”
Read the full CIFR paper, In-House Investment Management: Making and Implementing the Decision, here.