Pension Funds Plan to Bring More Asset Management In-House, Finds State Street

Due to challenges such as risk and cost, 81% of pension funds will explore bringing more asset management responsibilities in-house over the next three years, according to a new report from State Street.

The study, conducted on behalf of State Street this summer by the Economist Intelligence Unit (EIU), obtained responses from 134 pension fund executives around the world, including a mix of defined contribution and defined benefit plans, across the public sector, private sector and superannuation funds.

A large reason for bringing asset management in-house involves the challenge of gaining a complete view of risk-adjusted performance, especially across multiple managers, according to 58% of respondents.

Fifty-two percent also think it’s difficult to ensure that asset managers’ interests are aligned with their own, and 29% find it hard to justify the fees, though only 6% say this is a major challenge. Still, the trend toward insourcing is apparent.

“Can we insource some components of the process and outsource other components? Traditionally we’ve bought the whole car. Maybe we need to buy the engine or buy the brakes or buy the engineering capability and just build the car ourselves,” Richard Brandweiner, chief investment officer, First State Super, said in the report.

In addition to insourcing, several pension funds said that they would like to de-risk their portfolios, but the current investment environment has been difficult with interest rates remaining historically low. As a result, 77% expect their institutions will take on an increased risk appetite over the next three years.

As these pension funds look for better returns, many expect to increase their allocation to alternatives, particularly private equity (60% expect an increase), direct loans (54%), real estate (46%) and infrastructure (39%). Hedge fund allocation should also go up, as 29% who already do invest in hedge funds plan to allocate more, while 25% will invest in hedge funds for the first time.

At the same time, though, 53% plan to make greater use of low-cost investment strategies, with many using a barbell strategy to blend the cost of passive strategies and the higher costs of investing in alternatives.

“Pension funds’ desire to deliver strong investment returns to their participants coupled with improved oversight and governance and is leading to a need for more in-house accountability for asset and risk management,” says Marty Sullivan, head of Asset Owner sector solutions for North America at State Street. “However, this undertaking requires pension funds to carefully evaluate how to achieve a balance of in-house and external talent, tools and technologies.”

Going forward, 43% of pension funds plan to expand the number of technology platforms and software solutions they employ, which could be critical for managing more complex portfolios. Also, 51% said they will place a high priority on strengthening their governance over the next three years. Yet just under a quarter of respondents think their increasing portfolio sophistication requires a change in the composition of their trustees, and only 10% think contingency planning is a high priority (46% think it’s a medium one).

“While the largest and most sophisticated funds can handle most aspects of multi-asset class portfolios in-house, the majority of pension funds will need to make a choice about where to be a specialist and when a sub-contractor is needed,” adds Sullivan. “This shift underscores pension funds’ need for new, more collaborative partnerships with asset managers who can offer them transparency and effectively tailor investment ideas and solutions to their unique needs.”