Economies of scale are powerful for driving down costs, through greater bargaining power with third parties and moving management in-house where this would be more efficient. But scale can also raise costs: market liquidity makes trading large portfolios expensive, and finding sufficient return opportunities for a large asset pool can be much more challenging than for a smaller one.  To help overcome these “diseconomies of scale” larger plans allocate more into more complex asset classes such as private equity and infrastructure. Here return is often generated less by active trading, but management costs are often inherently higher.

Responsibility for owning and driving the investment policy gravitates from the Board to the CIO as fund scale increases.  Greater resources allow division of responsibilities that bring efficiency gains but can easily lead to silo behaviour and create co-ordination problems for a CIO.  Governance structures therefore play a critical role.

Policymakers and regulators often drive consolidation, keen to boost policyholder outcomes but also to create local mega-funds capable of helping to fund the domestic economy.  The drive to pool resources needs to be framed in terms of better outcomes – a narrow focus on costs would prevent plans in their pursuit of returns as they grasp new opportunities.  Larger plans have delivered greater returns both before and after costs, but not by keeping their allocations fixed.

Australia’s superannuation funds perhaps show a path. The regulator APRA publishes a net-of-fee active return metric that has helped to drive consolidation within the industry, creating a small number of large players.

The funds that have closed or merged did not allocate as much to infrastructure or private equity as their peers.  The larger Supers generally allocate more here than smaller funds and produce higher returns.