Under my roof
If you manage money in-house you must ask yourself whether your aim is to add value or to save on fees. Now is also a good time to find talented staff, finds Gail Moss
Pension funds choose to run their investments in-house not only to avoid management fees but, more importantly, to add value to their portfolios. But it is not a decision to be taken lightly.
And although it is probably not feasible for portfolios under €1bn, according to Jeroen Molenaar, head of implementation, continental Europe, at Watson Wyatt, size is not as important as the fund’s management capability.
“What we’d like to see as a starting point is strong governance, the right amount of people, and the right quality of people,” he says. “Clients also need to be very clear as to whether they are going in-house to save costs or to add value, because they are achieved by different routes. If the consideration is cost, they should go for passive management and low cost overlays. If it is adding value, they should be looking to manage actively, as long as they have the knowledge base.”
One way to build up knowledge capacity is by using a piecemeal approach. In Germany, for instance, few pension funds manage their entire portfolio in-house. Instead, they may outsource the management of most of their portfolios but retain, say, the low-risk portion of their bond portfolio, plus some equity holdings, to run themselves.
This can be done for fairly small amounts of money, says Herwig Kinzler, head of Mercer Investment Consulting in Germany. “With total assets worth at least €200-300m, they could run between 30% and 70% of that in-house, depending on the number and skill levels of staff,” he says.
However, index fund fees have been cut substantially over the past two years and for the big pension funds can be as low as 2bps for larger portfolios.
“Typically, if you run bonds or equities in-house versus an index on a buy-and-hold strategy, you will need one or two individual managers,” says Kinzler. “So for a very small investment, say below €200m, this will be more expensive than going for an external passive index fund. But for portfolios of €500m or more, it could be cheaper to stay in-house, as fixed costs like salaries remain the same however much money is managed.”
BVK, the Canton of Zurich Pension Fund, invests part of its CHF20bn (€13bn) portfolio in common trust funds from State Street and BGI to get its global equity exposure, but runs large-cap Swiss equities and all its bond funds in-house. “Standard ETFs are normally quite expensive - for example, 45 basis points for small and mid-cap - but we can bargain down to a few basis points because of our size,” says Thomas Liebi, head of investment research at BVK.
Swiss equities are run in-house against the Swiss Market index (SMI), although small and mid-cap exposure is acquired using an SMI Mid portfolio; the 30 largest stocks in Switzerland are not in the main SMI index.
“In-house management works for us because we have a very passive approach towards equities and bonds,” says Liebi. “If we were more active, we would have to do more fundamental research, which could be expensive in terms of salaries.”
But lower cost is not the only reason why BVK runs some portfolios itself. “Because we are a large public pension fund, it is politically desirable for us to use our voting rights at shareholders’ meetings, and this is not possible with ETFs or index products,” says Liebi.
Meanwhile, the Danish fund PKA runs its DKR50bn (€7bn) investment grade bond portfolio - just over 40% of its DKR115bn total assets - with five investment professionals.
“The information you need to run investment grade bond portfolios is perhaps easier to access than for, say, European equities,” says Claus Joergensen, head of equities, PKA. “It doesn’t take a difference of many basis points in fees to an external manager to cover the costs of in-house management. And we believe we can create the same or better performance.”
However, PKA has always outsourced its international listed equities and last year Danish listed equity holdings were also outsourced.
“It is difficult to keep a stable equity team internally,” says Joergensen. “For most asset classes it is not possible for PKA to build up teams that can compete with external managers and funds. Furthermore, while there are a lot of good bond people in Denmark, for some asset classes, there is no way we can hire people because asset managers are just as good.”
All these issues underline just how crucial it is for pension funds considering in-house management to recruit the right staff. But it is not just a case of getting the right people - it is about avoiding the wrong ones, even where they can boast a track record in fund management or private banking.
“In this environment, pension funds are in a buyers’ market, but that is partly because they are a safe haven, offering security and longevity of employment,” says Sarah Dudney, partner with headhunter Lockwood Gibb. “So pension funds have to make sure that candidates are applying for the job for the right reasons. Do they intend to stay, or will they be there for 18 months, then out again once the situation improves?”
For some pension funds, the creation of an in-house hedge fund selection team can also help to motivate staff. “Constructing an in-house hedge fund portfolio structure is more fascinating and challenging than just investing in hedge funds, where it is the manager, not the investor, who runs the solution,” says Kinzler
Several years ago, Ilmarinen Mutual Pension Insurance Company of Finland started increasing the size of its hedge fund portfolio, the new money being managed in-house.
“Our view was that hedge fund risk in general is desirable, but the problems in using external managers were cost, lack of transparency and a total lack of liquidity in the investments,” says Ville Helske, head of allocation and alternative investments, Ilmarinen. “Our investment performance is now significantly better than when we had external managers,”
The allocation to the internal hedge fund is about 6% of all Ilmarinen’s total assets of €25bn, whereas the allocation to external managers is about 3%.
The hedge fund team has come from a variety of employers - hedge funds, banks and even academia - and a spin-off has been the creation of extra skills and knowledge in-house.
“Outside the pension fund, we are seen as a very good place to work,” says Helske. “No-one else in Europe is doing this, so it is easy to attract very good people, even though we can’t match the salary of a hedge fund prop desk.”