NETHERLANDS - It is generally accepted that small pension funds perform less well than their bigger brothers, but economies of scale can also work the other way around, suggests a new study conducted in the Netherlands.

Smaller pension funds may have the advantage over their larger peers in terms of coverage ratio and performance, according to Lodewijk van Pol, head of the fiduciary management bureau of Lombard Odier Darrier Hentsch in Amsterdam, which conducted the analysis.

“We carried out a study based on Bureau Bosch data to determine the behaviour of coverage ratios in relation to the level of assets,” said Van Pol. “The correlation appears to be negative.”

The study covered the ten-largest Dutch pension funds with a diverse group of very small, small and mid-sized funds. “The top 10 account for 55% of pension assets in the Netherlands, but that group lost 60 percentage points from coverage ratios. In the case of the smaller group, the average loss was 42 percentage points,” commented Van Pol.

This divergence can partly be accounted for by the fact that large funds invest in more complex asset categories and often have somewhat more in equity - precisely the assets that have suffered the greatest losses.

“Another cause may be the fact that large funds often do not have interest rate hedging completely in place,” said Van Pol. “Not that they do not see the utility, but rather they are not able to hedge. That is a serious concern,” he continued.

Although the swap market is liquid, it is much harder for a fund with a high level of assets to build a hedge which gives protection against interest rate risk than it is for a smaller counterpart.

Van Pol said: “Under pressure from the credit crisis, counterparties such as investment banks have barely been willing to enter into contracts. It might have been possible for a fund with tens of millions in assets to find a solution, but a fund of a few billion would not have been able to do the business.”

In terms of execution costs, size does deliver advantages of scale but there is a downside, he also argued.

“In terms of investment funds, it is commonly accepted that there is such a thing as an optimal size. When that is reached, managers close the fund to ensure it does not grow too large to protect flexibility and performance, and to ensure that it can still operate in the market,” added Van Pol.

“You can also regard a pension fund as an investment fund. A size of between €2-10m is ideal. Above that, it becomes more difficult. Since pension funds must also operate flexibly and perform optimally, there are limits when it comes to size.”

Such limits are not imposed at present. On the contrary, the DNB, the regulator of Dutch pension funds, has repeatedly called for an increase in the scale of Dutch pension funds. But this might have to change.

“There is always a one-sided emphasis on the cost benefits of greater scale,” said Van Pol. “The crisis is showing us that greater scale also brings with it considerable disadvantages. More attention should be given to those.”

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