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Earlier in the day, the Canadian Club hosted a webinar in Toronto featuring Ontario Investment Management Corporation (IMCO) CEO Bert Clark and CEM Benchmarking CEO Rasha Jetalal to discuss the scale of the case.The discussion was sponsored by Stikeman Elliott and moderated by Jim Leach, Chairman of the Advisory Board of the Institute for Sustainable Finance and former Executive Director of the Ontario Teacher Retirement Plan.

You can watch the discussion here (repeat, go to 56 minutes to watch it) or watch it on YouTube below and here.

Before giving my opinion on the discussion, I am sending you the latest CEM Benchmarking research paper, Case for Scale: How the World’s Largest Institutional Investors Use Scale to Achieve Real EfficiencyWhich you can download here.

The co-authors of the paper were Alexander D. Beath, Rashay Jethalal and Michael Reid.

You can read the executive summary below:

Many large institutional investors believe that they have an advantage over small investors because of their scale. How does this scale equate to an advantage and does the scale really provide a better return? An analysis of the cost and performance data of large asset owners in the CEM Benchmarking Database shows that the largest institutional investors add value to small funds. In particular:

  • Institutional investors, on average, were able to offer income that exceeded the total costs of the fund. Out of the expenses, the funds, which have more than USD 10 billion (USD) assets under management, consistently generated excess income, which significantly exceeds the small funds with assets of less than USD 1 billion..
  • These large funds have been able to achieve these positive results Less active risk-taking than small funds.
  • The advantages of scale are most clearly revealed Ability to internally implement private assetsWhich will lead to much lower costs of managing private assets.
  • Expenses net, largest institutional investors Supplying more value-added than small funds in both the public and private markets is an advantage caused by almost entirely less dollars invested in staff and lower fees paid to external managers.

I recommend you read the whole paper, but let me draw your attention to the beginning where they check how much institutional investors really value:

To assess the fund’s success, we will focus on the value added, the difference between the fund’s policy benchmark and the fund’s actual income. Value added is both the sum of the manager’s value added in asset classes and the tactical portfolio decisions between asset classes. Value added has the advantage of being relatively agnostic towards the asset mix, making it possible to compare funds.

Analyzing almost 9,000 observations from 1992-2020, we find that the average fund in the CEM database exceeded their benchmark by 67 basis points (bps) with total costs and 15 bps without costs. [exhibit 1]. It is reassuring to note that Evidence shows that large institutional investors can add value over a long period of time, even if more than 75% of the total value added generated falls apart.

The breakdown of these results by Assets under Management (AUM) begins to reveal the effectiveness provided by larger funds. Small funds with an AUM of less than $ 1B were able to perform more than 47bps before cost, 36bps lower than the 83bps provided by funds with an AUM of more than $ 10B. In fact, after value accounting, amounts less than $ 1 billion could not deliver any value on average, while larger funds averaged 29 bps of annual excess revenue..

One possible explanation is that larger foundations simply take more active risks than smaller foundations. Looking at the observed value-added range, we can say with certainty that this is not the case.; The standard deviation of value added for the largest funds (190bps) is 33% lower than for the smallest funds (291bps). Larger funds not only generate more value, but also seem to do so while taking a lower level of active risk (or, more likely, diversifying their active risk).

1644464047 668 The IMCO CEO is reviewing the case on a case by case The IMCO CEO is reviewing the case on a case-by-case basis

This observation is especially important when considering the almost complete lack of sustainability observed at value added. In other words, much of the value-added variability can be attributed to randomness rather than ability.

As already mentioned, we observed that the average fund (regardless of size) generated an average annual net value of 15 bps. The standard deviation from this net value added is 242 bps. This means that in any given year, the observed net value added will be approximately 2/3 of -227 bps to 257bps. This is a fairly wide range and raises the question: Is it possible to achieve a realistic goal at the top of this range each year?

We can estimate how much difference there is in the net value-added skills difference compared to the 1-year value-added range over the multi-year value-added range. If success and failure in generating above-average value-added are random, then the distribution of value-added should be reduced over time as the “lucky” years disrupt the “unlucky” years.

Indeed, while the 1-year standard value deviation is about 240 bps, the 4-year standard value deviation is half that, about 120 bps, and the 20-year value is lower than 54 bps. Not only does the standard deviation decrease, but it does almost exactly the pattern that would be expected if the value added from one year to the next were random. In other words, most of the variability in 1 year value added is not the difference in skills but the difference in luck.

This suggests that it is not advisable to expect that recent successes (or insufficient) will continue compared to similar peers. It also points to the fact that the low level of active risk taken by larger funds is likely to be reflected in the overall payoff in the long run. The largest funds performed better over a longer period of time, both before and after spending – and they did so at less active risk. Are there any additional empirical views we can make to enhance the scale?

Here is the critical part: “It also points to the fact that the low level of active risk taken by larger funds is likely to be accrual to total revenue in the long run. And they did it at a less active risk. ”

Now, none of this surprises me, larger foundations have comparative advantages, smaller foundations simply do not:

  • Better compensation for attracting the best talent and more internal management of assets in public and private markets.
  • More assets under management, allowing them to collaborate with top partners around the world and negotiate lower commissions and larger co-investment transactions, which reduces commissions.
  • The greater the balance that allows them to use that balance wisely Increase diversification and reduce risk (See my recent comment where CPP Investments CIO Ed Ed Cass discusses the levers of CalPERS’s Board of Directors).
  • Ability to make highly sophisticated credit transactions that small funds simply can not afford (see my recent discussion with Andrew Egel, CEO and Global Credit Investments, CPP Investments).
  • A total fund management approach that manages liquidity and risk very closely and focuses on where the best opportunities are in assets.
  • Finally, but no less important, better governance that will enable them to operate like big business, independent of governments.

I’m not going to lie, there are many good and even big small foundations, but if it were up to me, I would definitely combine many small pensions into bigger ones.

For me it is all about achieving better results and scales are needed to achieve the best results.

Again, scale is not the only thing you need, but without scale, you are limited in what you can achieve.

In the long run, the results speak for themselves, with larger funds adding significant added value to the low level of active risk.

Anyway, the discussion between Bert Clark, Rashay Jetalal and Jim Leach was excellent.

Bert put it well in the report, saying, “The manager is obsessed with value-added.” The truth is, what really matters is “combining your assets properly, making sure you manage your commitments, making sure you” manage your liquidity well. ”

He talked about “diversification free lunch” and reducing your costs to “improve net performance without risking more”.

He said, “Many risk-free return strategies are only available to large investors, so unfortunately small investors need to increase the risk to get the same return.”

Again, think about what a balance sheet management expert recently told me: “You can easily add 50 basis points of added value without risking more, just by optimizing your balance sheet management.”

Small foundations simply cannot do this for many reasons.

Bert said there are 80 small foundations in Ontario that are run on a “small scale” and here he was not targeting them, simply by the fact that many of these foundations were not set up properly from the beginning and the IMCO was set up. Properly and has the necessary scale / management to easily grow its assets under management.

He said IMCO was set up in 2016 and although public sector organizations are not moving fast, IMCO is starting to get more assets from new clients (Ottawa Retirement City, Ontario Judges, etc.).

It is important to note that unlike its peers, IMCO does not have “captive clients”, they are voluntary clients who can leave if they are not satisfied with the management of their retirement assets.

Bert also pointed out that it is not easy to reach the top private investors in the market and the fees you pay may eat away at all the profits over time.

So the IMCO identifies the best investors in each class of assets and selectively invests with them and co-invests with them to reduce commission shifts.

This, in short, explains the many successes of the Canadian model.

And Jim Lech made a good point, you still need a good internal team to co-invest in larger transactions to avoid negative consequences.

Rashay Jetalal has confirmed that many small funds are providing private market remuneration in commissions. He offers many great sins in this discussion.

Importantly, he states: “The data does not support a reduction in revenue as funds increase.”

Jim Leach noted that Americans have a lot of big funds, but they have never appeared among the best performers in the world. The main reason why they lack the management of Canadian funds.

Finally, Bert Clark noted that larger funds can capitalize on the largest and best opportunities in the energy transition market that have resulted from their investment in Green Frog Power.

Rashay has proven ESG through large-scale issues and produces significant added value.

Anyway, take your time and listen to this discussion below, it is wonderful and involves a lot.


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