Two professors at The Rotman International Centre for Pension Management have been awarded the Canadian Investment Research Award from the Toronto CFA Society and Hillsdale Investment Management for research showing that larger pension plans outperform their smaller counterparts.
Alexander Dyck and Lukasz Pomorski received the $10,000 award at a ceremony downtown Toronto on Thursday, for their research paper entitled: Is Bigger Better? Size and Performance in Pension Plan Management.
The research showed that larger defined benefit pension plans benefit from economies of scale, which results in higher investment returns.
“[Pensions] differ tremendously in size,” said Pomorski, who accepted the award on Thursday. “There is tremendous scope for potential disadvantages, or maybe advantages in size.”
The paper shows that large plans, on average, outperform smaller ones by about 50 basis points. That half percentage point could amount to substantially higher savings for retirees who are accumulating assets over many years. According to the research, a participant’s retirement savings in a larger DB plan (the top 20% by size) could be 13% greater at retirement than savings in a smaller plan (the bottom 20% by size).
Pomorski said he was surprised by the extent of the difference in performance.
Up to half of the performance gains arise from lower investment costs due to internal management, which costs at least three times less than external management fees, according to the research.
This presents an important lesson for all investors – including individual retail investors – about the impact that fees can have on their investments over time. “Fees matter tremendously,” Pomorski said.
Also contributing substantially to the superior returns of larger pensions is their ability to invest more assets in alternative asset classes, such as private equity, real estate and infrastructure. Since size and direct investment capabilities are an advantage in these asset classes, large plans have both lower costs and higher gross returns for alternative investments, yielding up to a 6% improvement in returns per year.
“This was the second big surprise for us,” Pomorski said. “Large plans disproportionately more invest in alternatives, and within alternatives, primarily in private equity and real estate, and we found huge economies of scale in both of those classes.”
The research showed that governance practices factor into pension performance as well. Certain large U.S. public pension plans that were studied did not outperform their smaller counterparts the same way as large private sector plans, and Pomorski suggested that this is likely due to governance practices.
“We both strongly believe that good governance pays in terms of how much value you create,” he said. For example, he said compensation policies approved by the board to attract and retain talent and align compensation to performance could impact the ability of plans to take advantage of economies of scale.
University of Waterloo students win research challenge
Also at the award ceremony on Thursday, the winning team of the annual CFA Institute Research Challenge for Ontario was announced. The challenge is an equity research competition among student teams from university business and finance programs around the world, which aims to promote best practices in equity research among the next generation of analysts.
Finalists in the Ontario competition included student teams from Schulich School of Business, York University, University of Toronto, Scarborough, University of Waterloo and Wilfrid Laurier University. The teams presented their research and analysis of a company to a panel of judges earlier on Thursday, who judged the teams based on the quality of their written analysis and presentation.
The University of Waterloo’s team of five students won the Ontario challenge, and Wilfrid Laurier University’s team was the runner-up.
The University of Waterloo team will compete at the regional North American competition to be held in New York City on April 10, and the regional winner will advance to the global final in New York City on April 11.