Luring talent to manage pension assets in-house when you don’t have much to offer

If you want something done right, do it yourself.

This cliché rings true for more and more pension funds worldwide. Looking to save on investment fees, they’re managing ever-larger chunks of their assets in-house.

Last year, 81% of pension funds around the world said they plan to increase the portion of assets they run internally over the next three years in order to save money and increase asset oversight. Those were the findings of Pension Funds DIY: A Hands-on Future for Asset Owners, a State Street survey of 130 pension executives.

The do-it-yourself method comes with obstacles, though. Luring investment professionals is difficult, particularly for public DB funds based away from global financial capitals. They have less cash to spend than asset management firms, and the governments they’re tied to usually oppose paying top dollar for talent. But funds are finding ways to circumvent these roadblocks.

“It’s incredibly difficult for a lot of the smaller pension funds to attract and retain strong investment talent because, oftentimes, [the analysts at] external money management companies are making more than the head of the pension fund,” explains Brad Kelly, a partner at Toronto-based Global Governance Advisors.

No Money

Matching asset management firm salaries is an issue even if you’re not a small pension fund. Take the US$36-billion Fourth Swedish National Pension Fund, which goes by the moniker AP4 and manages about 75% of its assets in-house. It outsources certain alternatives.

“We would never, ever consider doing private equity in-house because we would never be able to compete in terms of remuneration to get the best people inside,” says CEO Mats Andersson, who adds AP4’s location doesn’t help either. “Even though Stockholm is a beautiful spot in the summer, many non-Swedes would say that living here in November, December and January might not be what they want.”

Salaries for full-time investment staff at pension funds managing assets internally vary worldwide. In 2011, Canada had the highest average compensation—US$536,000 a year. British funds offered the second highest salaries, at US$246,000, followed by American funds at US$148,000. Australian and New Zealand funds came last, at an average of US$139,000.

These are the findings of How Large Pension Funds Organize Themselves, a global survey of 19 pension funds managing, on average, 49% of their assets internally and ranging in size from US$12 billion to US$341 billion. The survey was conducted by CEM Benchmarking, a Toronto-based provider of benchmarking data for institutional investors.

How many people should you hire?

A pension fund needs six full-time investment professionals, on average, for every US$10 billion of internal assets under management.

Source: 2011 international survey of 19 major pension funds by CEM Benchmarking

When pension funds can’t pay big bucks and they’re away from prime locations, their pool of eligible candidates shrinks. Bob Jacksha, chief investment officer at the New Mexico Educational Retirement Board, with offices in Santa Fe and Albuquerque, discovered this a few months ago. He was working on internalizing his investment-grade fixed income mandate, made up primarily of domestic bonds, after years of running U.S. large cap active mandates in-house.

“There wasn’t a large number of qualified people to select from,” Jacksha says. “Our salaries don’t stand up very well compared to private industry.” And, he adds, the New Mexico state compensation system prevents him from offering bonuses and pay raises, making it impossible to lure Wall Street high flyers.

Penny Wise, Pound Foolish

So, Jacksha had to jump through hoops to hire fixed income professionals. Like other public pension fund managers, he needs government approval for many operation issues. Problem is, he says, New Mexico state officials tend to have a “penny wise and pound foolish” attitude when it comes to pension investments.

“If I want to hire a new person and I want to pay them $75,000 a year, that does require a legislative approval in the annual budget process. And it’s very hard to get new people approved,” he explains. This often forces him to use external asset managers. “You can hire [an outside] manager for a million dollars a year and nobody blinks an eye, but to hire [an internal] person at $75,000, or even less, often gets turned down,” he notes.

The same attitude prevails on pension boards— usually made up of plan members who lack investment knowledge—although many studies have shown internal asset management leads to lower investment fees and higher net returns. For example, the How Large Pension Funds Organize Themselves survey found external manager fees accounted for an average 85% of a fund’s total costs. But, managing assets internally made up only 15% of the total costs.

The survey also showed that “for every 10% increase in internal management, there was an increase of 3.6 basis points in net value added; this increase was driven largely by the lower costs attributed to internal management.”

Being tied to the government can also make it more difficult to reverse underperformance. “When you have an outside manager and they don’t perform, you can just fire them and hire another one,” says Jacksha. If internal managers underperform, firing them is practically impossible because they’re civil servants—unless their underperformance is severe and protracted. “Now you have to own that, and you have to deal with headlines,” Jacksha notes.

Local Heroes

Still, pension funds are finding ways around these recruitment challenges.

Take the New Brunswick Investment Management Corp. (NBIMC), which manages more than 80% of its total portfolio internally, including all public securities and 20% of private assets.

Tasked with investing the assets of public pension plans in New Brunswick, the Fredericton-based corporation doesn’t pay Bay Street salaries. It offers the median of what similar-sized Canadian pension plans with in-house management pay, says CEO John Sinclair.

So while someone from Bay Street may scoff at the idea of working there, youngsters fresh out of the local universities can be interested, and the corporation has found a way to lure them.

What to insource first?

Regardless of how big they are, pension funds are most likely to manage fixed income assets internally, followed by stocks and real assets (such as real estate and infrastructure).

Source: 2011 international survey of 19 major pension funds by CEM Benchmarking

In the late 1990s, NBIMC set up an investment program at the University of New Brunswick, which lets business administration students invest real money (originally provided by NBIMC and later by the university) using NBIMC’s trading platform and custodial arrangements.

Once the students graduate, NBIMC hires three or four of them as analysts for renewable one-year periods, Sinclair says. The corporation then pays for these analysts to get CFA Level 1 certifications. And, Sinclair adds, when these analysts move on to other jobs, the corporation stays in touch with them so it can potentially rehire them once they gain more experience.

NBIMC also courts investment professionals working outside Fredericton who may be interested in returning to the area because they have local ties. “People do have to see value in that from a lifestyle perspective,” says Sinclair, referring to the outdoor activities Atlantic Canada is famous for, such as canoeing, skiing and hiking.

“I’m an example of that [hiring strategy],” Sinclair explains. “I went to university in New Brunswick and spent about 15 years in various capacities in different parts of North America. Then I was approached to see if there was an interest in coming back here.”

Jacksha’s New Mexico pension fund also looks for people already living in Santa Fe, or who are interested in moving there either because they have connections to the city or because they want to enjoy warm winters, mountains, pristine forests and clean air.

For his newly internalized bonds mandate, Jacksha found a local fixed income professional who was working at another government agency. “And we found somebody from a neighbouring state who had worked for a pension fund and was looking to make a move and had fixed income experience.”

Another strategy, Jacksha says, is to seek seniors who have already established their careers and made their money. Those candidates often aren’t as motivated by astronomical salaries.

Superior Workplaces

Yet another recruitment strategy is emphasizing to candidates that, in some ways, pension funds are better workplaces than asset management firms.

Working at a pension fund means you don’t have to look for clients. “You have a constant stream of money coming in for you to invest, and you’re not out there searching for the dollars. It takes a huge chunk of the stress out,” says Kelly.

How big should you be?

Pension funds with a size of less than US$10 billion manage, on average, 8% of total assets internally. Funds with a size of more than US$50 billion manage, on average, 51% of their assets internally.

Source: 2011 international survey of 19 major pension funds by CEM Benchmarking

And, you typically aren’t evaluated quarterly or annually because pension funds’ investment horizons span decades.

For example, even though compensation is based on performance at AP4, its shortest evaluation period for a mandate is three years, says Andersson. “I’m not interested in what you achieve in the coming three months. I want you to be good in the coming five years.”

But, he cautions, “don’t think it’s less competitive; don’t think there’s less pressure to deliver [on] the targets.”

Also, working at funds with in-house asset management is far from boring. “You’re able to go out there and find the deals; that’s what really energizes a lot of people in this industry,” Kelly explains.

So, he says, working for a pension fund—even one that’s away from a global financial centre and off the list of glamorous mega institutions—isn’t unappealing in the least when compared to working at a money management company. In fact, he notes, “it’s a far superior place to work.”

Yaldaz Sadakova is associate editor of Benefits Canada.

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