The clearest benefit of scale for pension funds lies in the ability to provide excess returns after cost in private assets, according to a new report from CEM Benchmarking, the Toronto-based provider of cost and performance benchmarking information.

Drawing from CEM’s database of more than 1,100 funds representing over $11trn (€9.7trn) in assets under management, the company said that small funds with less than $1bn in assets historically failed to achieve positive net value add (NVA).

The largest funds, those managing $10bn in assets or more, averaged 29bps in annual excess returns over the same period (1992-2020).

In terms of the sources of the benefits of the scale, CEM said that gross of costs, being more actively invested was the largest driver of value added.

Once costs were considered, however, the advantages of scale and the related ability to implement internal management programmes, particularly in private assets, were revealed, it said.

According to its research, internally managed portfolios of private equity and unlisted real estate perform marginally worse than external investments gross of costs, but “the cost savings, measuring in the hundreds of basis points, far outweigh any difference in top line return”.

A second advantage that could be gained by internalising private equity and unlisted real estate, according to CEM, was the ability to exert control over the use of leverage.

Several large Canadian pension funds issue debt and participate in repo markets, but doing so requires scale, said CEM.

It said small investors had some internally managed real estate, but the asset base was usually low and the performance tended to trail those of larger funds. Bringing private equity assets in house, meanwhile, was an activity limited to the largest funds.

According to CEM, the smallest investor in the CEM database that reported having substantial internal private equity investments in 2020 had $18bn in total assets, while the average investor with private equity investments in 2020 had total fund AUM of $152bn.

“This is the real win for scale, the ability to deliver cost-effective and diversified private asset management by leveraging scale to implement these assets internally,” said CEM.

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