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Impact Investing

IPE special report May 2018

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Benefits of economies of scale vary by asset class, DNB study shows

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Research by the Dutch pensions regulator (DNB) has found that a tenfold increase in assets under management (AUM) equates with a 7.7-basis-point reduction in investment management costs on average, irrespective of a pension fund’s scale. 

The DNB’s Dirk Broeders, Arco van Oord and David Rijsbergen, the authors of the study, also found that the relative benefits of economies of scale often varied according to asset class.

Over the course of 2013, they examined 225 Dutch pensions funds with nearly €930bn in combined AUM, analysing the link between investment costs and a pension fund’s scale and calculating investment expenses for six asset classes.

The researchers said they found “significant” economies of scale in fixed income, equities and commodities but not in real estate, private equity or hedge funds.

A tenfold increase of the fixed income and equity allocation lowered annual investment costs by 4.8bps and 7.8bps, respectively, with an even stronger effect for equity mandates of less than €20m.

However, the study indicated that, for commodities, the initial benefits of scale largely disappeared for investments of more than €300m.

In contrast, property investments were subject to diseconomies of scale, which the researchers attributed to small mandates.

Broeders, Van Oord and Rijsbergen also found that performance fees largely dictated investment costs for equity, private equity and hedge funds, with a tenfold allocation increase increasing fees by 0.7bps, 41.5bps and 33.4bps, respectively.

They said they found that larger pension funds paid significantly higher performance fees for the latter three asset classes and suggested these schemes invested relatively more in asset classes with higher investment costs.

The researchers said company pension funds on average paid 7.3bps more in investment costs than industry-wide schemes, citing a “misalignment” of interests, “as they usually rely on commercial asset managers”.

They added that they did not see significant differences in investment costs between defined contribution and defined benefit plans.

They also concluded that increasing the interest hedge on liabilities had cost advantages, as a duration increase of a pension fund’s government bond portfolio reduced investment costs by almost 3bps for every year that was added.

“Therefore,” they said, “it is more attractive to hedge through bonds than through derivatives.”

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