There might be a way for the largest public pension fund in the United States to improve returns and reduce costs. But it's going to have to start acting like a Canadian pension fund.
A consultant advised California Public Employees' Retirement System to consider replacing some external active management services with in-house passive indexing portfolios, according to U.S. trade paper Pension & Investments.
By doing so, Calpers could reduce its investing and staffing costs. It would also align its investment strategy even closer to the pension plans that pioneered the internal management, such as the Ontario Teachers' Pension Plan.
"If you want exposure to the equity markets in the world, the best way to get that exposure is very cheaply," said Keith Ambachtsheer, director of the Rotman International Centre for Pension Management at the University of Toronto, of which Calpers is a member. "Traditional active management – why would you do that? It can't possibly add value," he said, noting that internal management can cost up to 90 per cent less.
Calpers matched the S&P 500's gain of 13 per cent in 2013 – its best performance since before the recession. Allan Emkin, a consultant with Pension Consulting Alliance, found in his review that only 25 per cent of external mangers are beating their benchmark indexes.
Trading costs eat into profits. Index investing requires fewer resources and provides less-costly exposure to equity markets, where Calpers has about half of its investments. It is an important decision for a pension fund that manages more than $256-billion (U.S.) for 1.6 million public employees and retirees.
Teachers' was the first pension fund in Canada to turn to in-house management in the 1990s, introducing performance-based incentives to managers. Teachers', which has $117.1-billion in net assets, prides itself on promoting internal talent, and it uses external management only "to target investments that require local or specialized expertise that we have strategically decided not to develop in-house."
It is a model many others have emulated. The Ontario Municipal Employees Retirement System managed about 88 per cent of its fund assets internally in 2012, and hopes to reach 95 per cent. It has also been pushing more of its $60.8-billion in net assets away from the public markets toward private investment over the past few years.
Alberta Investment Management Corp. chief executive Leo de Bever has whittled external management fees from $175-million in 2008 to $109.7-million, according to its most recent annual report. AIMCo's clients include 26 pension, endowment and government funds in Alberta.
Already, less than half of Calpers' public equity investments are controlled by external firms and managers. And Mr. Ambachtsheer believes the pension fund will continue to internalize through index-tracking products, real estate and infrastructure.
But moving away from external asset management can be a lengthy process and have costs of its own; You need good people, and you have to pay them competitive salaries. Pay has increased at pension funds, but it's hard for them to compete with the salaries and bonuses at banks and other fund companies.
That's one reason Mr. Ambachtsheer says it will take some time for U.S. pension funds to fully adopt the Canadian style of pension fund management.