European pension funds should manage the core of their business internally, and outsource only the specialist areas of asset management to external managers. This is because pension funds understand their liabilities better than anyone else.
Broadly, this was the conclusion of six managers in the pension industry when they debated the proposition that “pension funds are better investors than asset managers” at the annual IPE 2003 Awards in Amsterdam.
Silvio Vecchi, administrator of the reserve funds for pensions and social security at the European Patent Office in Munich, said that the objectives of internal and external management often differed significantly: “External managers have to cope with inflows and outflows of money which are independent of the inflows and outflows of your fund. This can force an external manager to take decisions which are not always in the same direction as the intent of the fund.”
Inigo Colomo, manager at the Grupo Telefonica pension funds in Madrid, pointed out that asset mangers also tend to have a much higher turnover in their investment portfolios than pension funds. Internal management was preferable “because pension funds operate on a long-term basis”. Internal management also enables pension funds to control their costs more effectively “and all the pension fund managers I know are obsessed with costs”.
The long-term approach perspective of pension funds also means that pension funds should have complete control over asset allocation, said Paolo Tosi, manager of the Inarcassa pension fund in Italy: “The internal management of long term investments is concerned with strategic and tactical asset allocation. We are supposed to be the only ones that know personally our liabilities, that look into our actual balance to see what will be our future liabilities. We are the only ones who know the needs of our associates, so we can balance and re-balance the asset allocation totally internally.”
Tosi said that full control over asset allocation was crucial if a pension fund was to achieve its target returns. Delegation of asset allocation could prevent this. “We strongly believe that that a higher percentage of the return can be provided from a good asset allocation related to our target returns and to our risk tolerance.”
Internal managers were best suited to manage core investments such as domestic equities and bonds, he said. The business of external managers was to manage asset classes that were beyond the expertise of the internal managers.
“Portfolio management has become too complex to be handled entirely in-house,” said Nigel O’Sullivan, managing director at Goldman Sachs International’s pension and insurance strategy group. He said portfolio management was simpler in the past with only domestic equities and bonds and real estate portfolios to worry about. “In previous years, life was a little bit easier and definitely in-house managers were able to do fairly well. However, as we got more complex in terms of the opportunities that were available to us I think there are areas there that really do have to be outsourced.”
Aiming for beta is now no longer enough, he said. Pension funds are now looking for specialist investment manager to try to generate some alpha . “There’s room for both sides, but in the alpha-generating areas, specialist managers are the way forward.”
Carsten Eckert, of Chemie Pensionfonds and HVB, said that the key question was what is necessary to drive performance. “We have to ask what does someone who generates top performance every day need to have. We all know the answer to that – continuous luck. But in the real world we have to tackle it in a different way. We have to create a large infrastructure to cope with today’s highly integrated, highly volatile global markets. Putting that infrastructure in place can only be done by someone who has economies of scale. Of course there are pension funds out there that have the size to manage this.
Christian Cuenod, fund administrator of the CERN pension fund in Geneva, said: “There is no definitive answer of which is best. It is just a question of whether you feel comfortable with an internal manager and whether you feel comfortable with an outside manager. One important aspect is a close understanding of a trustee’s intentions.”
Carter Harrison, chief investment consultant at Invesco, who chaired the debate, said there was something to be said for both internal and external management of pension fund portfolios. “It’s an open issue and maybe there is no right or a wrong – it depends on your perspective. There are certain functions that should be done internally and there are certain funds that should be done externally. Intuitively I would think that internal managers would have an advantage when it came to making strategic asset allocation and determine their risk budget simply because they have a much greater grasp of the situation within their plans.”

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