Is bigger really better?

As the debate about the consolidation of local government pension schemes (LGPS) rumbles on, AXA Investment Managers has produced, “Is Big Better?”, a paper looking at whether larger pension funds enjoy advantages over smaller funds.

Pension fund consolidation is being debated globally, with debates similar to the one in the UK going on in Denmark, the Netherlands, Sweden, Canada and other countries. In the report, AXA concludes that bigger is not always better. “While it may appear that large pension funds have the size advantage because they can negotiate lower asset management fees and are more likely to access alternative investment opportunities, there are some challenges that come with size, such as manager and market capacity, efficient trade execution and additional risk considerations.” Consequently, AXA states that the solution is to increase collaboration and to share resources: “There is no reason why smaller pension funds should not be working with other funds in their industry (or even across industries with common interests) to leverage their size and clout as key players in investment markets to negotiate better fees and access alternative investment opportunities.”

In its analysis of the relationship between size and performance, the report looks at how the size of a pension fund affects returns, expenses and risk management. On whether larger funds can earn higher returns, the report says while larger funds may have better access to alternative assets, through greater resources and higher allocations, funds can become too big to fulfil target allocations in high conviction opportunities. According to the report, there are also diseconomies of scale for large investors in illiquid markets.

On fees, AXA said its experience in managing fund of funds products shows that managers do not always give discounts to larger investors, particularly if a strategy is successful or close to capacity. It commented: “Some consultants have released studies that demonstrate the economies of scale that can be achieved with size. Interestingly these studies show a trend of diminishing marginal savings. This leads us to a conclusion that two small funds may be able to capture asset management fee reductions through consolidation or collaboration but large funds may not realise a noticeable difference.”