Reducing the Number of External Asset Managers Could Cut Costs for Public Pensions

An Issue Brief from the Center for Retirement Research (CRR) at Boston College, “Internal vs. External Management for State and Local Pension Plans,” reveals results of an analysis that shows the number of external managers used by state and local pension plans is directly related to investment fees.

Researchers Jean-Pierre Aubry, associate director of state and local research at the CRR, and Kevin Wandrei, assistant director of state and local research at the CRR, note, “As the types of assets in which state and local pension plans invest have expanded, so have the number of external asset managers that plans use. The increase in the number of external managers used has coincided with steady growth in plan allocation to alternative investments, such as private equity and hedge funds.”

Concerns about fees and questions about the value of active management have led some large public plans to re-evaluate the size of their external management teams. The researchers cite the California Public Employees’ Retirement System (CalPERS), Wisconsin Retirement System (WRS) and Nevada Public Employees Retirement System (PERS) as examples of large plans that have recently consolidated their external management teams as part of an overall commitment to reduce investment fees, which cut into after-fee returns. In 2016, CalPERS reported that it achieved $325 million in savings in its investment office by reducing reliance on external consultants, internalizing functions previously outsourced at a higher cost and re-negotiating existing investment contracts with external managers for more favorable cost terms and improved economics.

The researchers’ initial analysis shows that the relationship between the number of external managers and the fee rate for public pensions is positive and statistically significant. Specifically, a one-standard deviation difference in the number of external asset managers (roughly 65 managers) relates to a 7-basis-point (bp) difference in the fee rate. The researchers conclude that the number of external asset managers explains roughly one-fourth of the variation in fees.

According to the report, fees could be related to the number of asset managers for two reasons. “First, using fewer asset managers translates to more assets under management [AUM] for each manager, which may give managers an incentive to negotiate reduced fee rates. Second, using fewer asset managers may increase competition between them for the reduced asset management opportunities, which could also lower fee rates offered by managers,” the report says.

Further analysis shows, however, that the relationship between the number of external managers and after-fee returns is not statistically significant. “A possible reason for this result is that plans with fewer external managers miss out on some out-performing managers,” the report says.

The researchers conclude that their findings suggest that public plans could reduce their fees by consolidating external asset managers, but, “in terms of after-fee returns, it matters which managers get cut.”