Pensions World

Keeping investment management in house seems to have contributed to the success of the best performing large funds explains Anthony Hilton, Evening Standard

It is well understood that several of the most challenged pension schemes are those of what we used to call the nationalised industries – the giant utilities privatised in the 1980s by the then prime minister Margaret Thatcher – and some like the Post Office scheme which never quite got there.

They have more than their share of troubles, partly because they promised relatively generous benefits as a result of the nature of the industry they were in – the very early retirement for pilots in the British Airways scheme being an example – because of their sheer size and because of the structural change in their industries. They have all massively slimmed down their payrolls and often closed to new members so today they have to live with the cash flow implications of schemes where the number of active members is small relative to the deferred members and those in retirement.

Better performance

But with the right management approach the situation is by no means hopeless in spite of what the doomsayers might have us believe. Step forward, for example, the British Steel pension scheme which is one of the best performing schemes in the country over the last ten years, according to recent State Street analysis. Nor is this simply an issue of investment performance. It is one of that increasingly rare breed in the private sector – a defined benefit (DB) fund still open to new members.

The interesting thing, though, is what lies behind the success and the challenge it poses to conventional wisdom. It is surely highly significant that it has kept its fund management in house – something which was the norm 30 years ago but which is relatively unusual today where instead the running of the money is outsourced to professional fund managers.

Arguably this trend – pushed by pension consultants, of course – has been the biggest single mistake made by the industry. That analysis just referred to shows that the best performing large funds in its universe are all those which have retained in house management. In performance before fees, in house teams have comfortably beaten their benchmarks in ways which the “professionals” can only dream about. And because in house management is usually cheaper, the same pattern emerges net of fees, albeit with some variations of position.

Diversification

Business risk is part of the explanation. Outside fund management groups are focused on their own profits first and the clients’ profits second. People get upset when it is put this bluntly, but it is true. Independent fund managers have as a priority the minimising of business risk which means that they are for the most part closet index trackers concerned that they do not stray too far from what everyone else is doing.

The other side of this coin is that in house management finds it easier to take long term bets and capture the illiquidity premium because it is less exposed to quarterly performance measurement. It may still report the numbers, but it does not have consultants whispering in the trustees’ ear that they should consider a switch.

Against this, people would argue that outside managers bring the benefit of diversification. But there are two things here. Diversification applies to markets and asset classes, not to the agents who provide the access. A sole in house manager can diversify if that is required. Second, markets seem so correlated in this globalised age that one is beginning to wonder if diversification is still the free lunch it used to be.

That is a debate for another day. For today it is enough to digest the lesson of British Steel – that sensibly paid in house management does a better job, generally speaking, than expensively paid outside talent.