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Difference can amount to a 13 percent bigger pension at retirement.
Toronto (16 September 2011) – When it comes to pension funds, bigger is better according to a recent paper written by two professors at the University of Toronto's Rotman School of Management.
The research study points to economies of scale in pension funds as a powerful tool to increase the wealth accumulated for retirement. The study found that the largest pension funds – those that average $37 billion in assets – outperformed smaller plans – an average of $1 billion in assets – by 45 to 50 basis points, or 0.4 percent each year.
The annual difference "sounds small, but it is huge economically," points out Lukasz Pomorski, an assistant professor of finance at the Rotman School. Pomorski co-authored the paper with colleague Alexander Dyck, a professor in pension management. The difference can amount to a 13 percent bigger pension at retirement for employees invested in the plan for their full working lives.
One thing that makes larger funds advantageous is their increased use of in-house management, where costs are at least three times lower than under external management. The related costs savings account for up to half of the improved performance, the study found. The other half comes from larger pension funds’ flexibility to invest more in alternatives such as private equity and real estate, both of which afford large plans lower costs and higher gross returns. The ability to take advantage of scale depends on plan governance with better governed plans having higher scale economies.
The study suggests an opposite effect for RRSPs held in large mutual funds. Large mutual funds typically underperform their smaller equivalents, according to Pomorski, pointing out that mutual funds do not have the same incentive to cut costs as they grow.
“I would be much happier to be able to invest in a portfolio similar to the Canada Pension Plan Investment Board than in a mutual fund, if only because of the substantially lower costs,” said Pomorski.
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