Does Ontario really need five Pension Plans? part 2

It seemed such a simple topic: does Ontario really need five different management teams running its large public pension funds (see prior post “Does Ontario really need five Pension Plans?” Nov 24-11)? Unexpectedly, it set off some very interesting discussion in several quarters, including the Globe & Mail’s comment section (88 in total), Oxford University, and the Healthcare of Ontario Pension Plan CEO himself.

Readers (here and over at the Globe) opined on the varying Management Expense Ratios at OTPPB, OMERS, HOOPP, OPB and OPTrust; the merits and drawbacks of “bigger is better”; solvency and overall pension affordability; would consolidation breed a “Too Big To Fail” scenario?; relative performance differences between the funds….

I could have been more clear about the point, as folks seemed to think a single Ontario mega fund was my ultimate goal. That wasn’t really the upshot; but the idea that the Ontario taxpayer is paying to replicate five similar functions can’t possibly be the most effective use of our tax dollars; these aren’t hospitals serving different cities.

Having relatively smaller pension plans recreate the Infrastructure, Private Equity or Real Estate principal investing teams of their bigger sisters is counterintuitive, particularly when they might end up competing to acquire the same assets. OTPPB and OMERS have established places in the Alternatives marketplace, and HOOPP pursues its own thoughtful investment path, but should every single taxpayer-backed fund (not to mention the many Ontario-based University pension plans) get into the game of private deals as they chase Alpha in a tough investing climate?

The Canadian banks, for example, share many back office services, such as cheque clearing and Interac. Ontario’s state-funded plans appear to individually manage their own pensioner web access interface, as well as telephone call centres and real estate overhead, to name but three simple functions. If you’re a teacher, someone will take your call until 5:30pm, but not if you work (or worked) for a City or Township; that phone isn’t picked up past 5pm — but your service is advertised as being available in both official languages. There must be a way to combine these efforts, share the bilingual call centre resources, computer systems, perhaps even extend service, while saving millions over time.

And that’s before looking at the replicated backoffice, actuary and audit costs.

The earlier discussion has been healthy, I think, and perhaps we’ve all learned a few things along the way. The concept isn’t meant to gore anyone’s ox, nor to suggest that one investment strategy is clearly preferred over another. Some funds are doing better than their peers, but does that give them a free pass on efficiency opportunities?

It is notable that each of these five government plans use different amounts of leverage, and are serving different population types. And that itself causes reflection, since the investment styles of a “younger” plan are going to be different than one with a “worse ratio” of active-to-retired members. And yet, it’s the same taxpayer funding these two very same plans with potentially stark equity/fixed income investment mixes — mixes that are understandably geared towards to different populations, but may be poorly timed given the state of the overall investment climate.

If the age and stage of your particular pension population pushes you toward a higher weighting of fixed income investments, what do you do if there’s no way to earn your necessary 6.7% per annum? You miss your “bogey” for a few years, which increases your liability deficit (so long as the risk free stays low and actuarial voodoo doesn’t skate you onside). That’s when the regulators kick in and demand lump sum cash “solvency payments”; funded 100% by, guess who? The employer cum taxpayer.

The folks at The Oxford University Soverign Wealth Project picked up the discussion thread, with a on-the-one-hand and on-the-other approach. They focused on the relative “cheap” cost of the aggregate management fees versus the gross assets being managed in Ontario. I looked at the pension plan’s gross asset figures, rather than the net, as is the traditional approach to calculating expenses. Had I looked at net assets under management, the overall cost might have increased from 30 bps to perhaps 41 bps; but some plans have an MER in excess of 100 bps. Does the Oxford team think 40 bps is still cheap? Perhaps. Hopefully they’ll let us know in their next instalment.

One of the most newsworthy element of the dialogue was the intervention from the HOOPP CEO, John Crocker. According to a letter he wrote to to the Globe’s Boyd Erman: “our CIO Jim Keohane notes that once a fund grows beyond $75 billion in assets the real risk is diseconomies of scale – costs can actually start to go up.”

Two things that come to mind there: First, hats off to him for stepping up to the plate and engaging with the public on a tricky topic. Many a investment steward hides behind the monolithic veil, but not these folks; and for that the HOOPP team deserves our utmost respect. The other, and equally interesting, point is that some senior pension fund managers are prepared to go on the record and say that after a firm gets beyond $75 billion under management, there are “diseconomies of scale” that arise.

What does that say about the CPP Investment Board, for example, which is projected to be managing more than $300 billion before too long?

MRM