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Australia's A$2.1t pension funds work to cut out middleman

[SYDNEY] Australian pension funds are luring dozens of portfolio managers to work in-house to boost returns in a cut-throat investment environment, a move that could see external fund managers lose A$230 million (S$246 million) in annual fees.

Two of Australia's largest pension funds, AustralianSuper and Cbus, intend to manage in-house at least 20 percent of their combined A$140 billion in assets within the next decade.

Both plan to hire in-house investment managers to run their equities, fixed income, infrastructure and property portfolios, rather than relying entirely on external experts. "I wouldn't be surprised if we had (a team of) 60 over the next few years," said Kristian Fok, CBus's executive manager in investment strategy, which has already doubled the membership of its in-house funds management team to 29.

Around a third of the workforce of AustralianSuper, the nation's largest pension fund with A$105 billion of assets, are in-house investment managers.

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Veteran professionals from banks, asset consulting companies and fund managers, have already taken the big leap. George Batsakis, formerly of Goldman Sachs, joined AustralianSuper, while debt portfolio manager Linda Cunningham started with Cbus earlier this year from external asset manager IFM Investors.

Though fund management fees are low by international standards at around 0.78 per cent, Australian pension funds are keen to reduce them even further. To do that they are wagering on their market power as Australia's current A$2.1 trillion pool of retirement savings is set to reach an astronomical A$10 trillion by 2035, according to Deloitte.

Australia's tax-advantaged retirement savings are larger than the country's economy and are the fifth largest such pool after those of the US, UK, Japan and Canada.

AustralianSuper estimates that the internalisation model will bring a cost reduction of A$150 million by 2018, a saving it said will be passed to members.

But critics say the amount is vastly exaggerated. "We are talking about a handful of basis points in savings across a fund, it's not huge," said Geoff Warren, research director at industry body Centre for International Regulation (CIR).

Skeptics also cited onerous risk and compliance systems which, combined with staff retention incentives, will dent the expected net returns.

A rush for high profile hires in Canada, one of the early adopters of internalisation, led to vastly inflated salaries and made its funds the world's most generous in terms of compensation.

It outraged members who saw their earnings eroded, and undermined pension funds' credibility when fighting excessive pay at the companies in which they invested.

Australian in-house adopters, though, say they've learned lessons from the fallout in Canada and won't be matching for-profit sector salaries and bonuses.

But critics argue that they won't be able to attract the top talent needed to make the switch a success without paying the market price.

That's one reason pension fund Hostplus, which manages A$22 billion of assets, is not convinced of the benefit of in-house management on a net return basis. "(External) star investment managers have been able to outperform their peer groups over a sustained long period of time," said Hostplus Chief Executive David Elia. "It's incredibly difficult to in-source this type of talent because we simply don't have the capacity to pay." It is too early to tell whether in-house management can deliver higher net returns to members said George Boubouras, chief investment officer at Contango Asset Management.

That verdict would be known in three to four years, he said.