Pension fund consolidation is generally welcomed in the belief that big equals beautiful. Our sister publication, IPNederland conducted an in-depth analysis based on comprehensive data on Dutch pension funds

Our sister title IPNederland has analysed data from nearly 200 Dutch pension funds covering well over 90% of total second pillar pension assets in The Netherlands, over a period of three years. Pension funds of different sizes were compared based on funding ratio, investment returns and cost. Our analysis shows that pension funds with assets of €1bn in terms of average funding ratio or three-year average returns. In addition, our results show that the largest pension funds - with AUM of >€20bn - underperform smaller peers both in terms of average coverage ratio and average return.

Funding ratio
A first look at pension funds in four size categories (€1bn) shows that there is little difference between the funding ratios of the largest and the smallest pension funds, with funds of €1bn in two of the three years examined. Under closer examination, the funding ratios diverge quite a bit between size intervals, particularly when sub-categories in the >€20bn interval are taken into account. Pension funds in the size categories of €5bn-€10bn and €10bn-€20bn report the highest funding ratios. However, the data does not mean bigger is better. The smallest pension funds (€20bn).

In a ranking based on average funding ratio, pension funds €20bn get the roughest deal as these giants net the lowest score. A ranking based on annual averages with regard to percentage of funds with funding ratio /=105% shows that pension funds >€1bn on balance net the lowest score.

Comparing the returns of small and larger pension funds, two things jump out: smaller schemes tend to lose a lot less money during bad times, while positive returns during good times are pretty much the same regardless of size. The 50 pension funds in the interval >€1bn booked an average negative return in 2008 of -14.29% while the small funds of €1bn interval did achieve higher returns than the smallest pension funds, but the difference was at most just 1.7%.

According to DNB, Dutch pension funds returned on average 4.8% in the period 2000-10.
A few years of above-average returns can be easily wiped out in one bad year. Looking at three-year average returns for the period we examined - including the crisis year 2008 and the bounce-back years following - the smaller pension funds net the highest scores in terms of investment returns.

In the years we examined, asset management fees were often not itemised, as returns were reported net of fees. With that caveat, asset management fees are similar for the various size intervals - for the year 2010, for instance, fees vary between 18 and 21 basis points. In contrast to pension administration costs, asset management costs are trending downwards.

Pension administration costs, which include benefit administration, advisory, control and related costs, are trending upwards. Here, larger funds are clearly at an advantage. Small schemes, by and large, face the same mounting bureaucratic and regulatory burden that their larger peers do, but have fewer participants to spread the pain and so pay a higher price per participant. The smallest funds of €1bn peers.

The tally: bigger isn't better
The largest pension funds can save their participants and pensioners several hundred euros annually in pension administration costs. But these savings are offset by a significantly lower performance in terms of coverage ratio, steeper investment losses during ‘bad times' and lower multiple-year average returns. By contrast, small pension schemes, on average, deliver fair to good funding ratios. They manage to avoid steep losses in times of crisis, and deliver returns ‘for better or worse' that generally top the industry benchmark of 4.8%. In terms of asset management fees, they are but a hair more expensive than their larger counterparts. Smaller funds are, however, disproportionately burdened by the mounting costs of pension rules and regulations.

In the final analysis, bigger is not better. If one were to look at cost only, the larger funds would win hands down. But according to the rankings based on funding ratio and returns, pension funds with assets under management of >€20bn achieve the lowest score. In our analysis, the sub-category of funds between €5bn-€10bn is shown to be the optimal size category. Pension funds