Wednesday, March 28, 2012

Pension Reform: Is Bigger Really Better?

Alyshah Hasham of the Toronto Star reports, Pension reform: Is bigger really better?:

Ontario's big three in the public-sector pension fund world have combined assets of more than $200 billion. The new budget means a fourth could be joining the list.

The province plans to introduce a framework this fall to pool the investment management functions of smaller public-sector pension plans.

The management of assets could be run by an existing large public-sector fund — like the Ontario Teachers' Pension Plan, the Ontario Municipal Employees Retirement System (OMERS) or the Healthcare of Ontario Pension Plan (HOOPP). Or they could be run by a new entity altogether.

It's about time, says Keith Ambachtsheer, the director of the Rotman International Centre for Pension Management at U of T. The idea has been popping up since it was raised in a 1980's pension reform report that led to the creation of the Teachers' pension fund, he said. It even appeared in last year's provincial budget.

The reason it is taking wing now is perhaps because “it fits into the government theme of doing more with less,” Ambachtsheer said.

But is a bigger pension fund really better?

They're certainly more cost-effective to manage. Individual university plans, even big ones like the University of Ottawa, the biggest they'll get to is about $1 billion, says Tyler Meredith, research director at the Institute for Research on Public Policy and co-author of a recent study on pension reform.

That restricts the ability to reduce the size of management expenses. A decrease of 0.02 percentage points can have huge impact on the pension payments received, Meredith said. Large funds allow the hiring of in-house investment professionals, and can attract top talent.

“You can get the same job done internally at 10 per cent of the cost, so why wouldn't you do it?” Meredith said.

The other benefits lie in access opportunity and diversification, says pension and benefits lawyer Mitch Frazer.

“If you look at what some of our larger public-sector plans are doing, like the CPPIB (Canadian Pension Plan Investment Board) or Teachers' or OMERS, they're investing in infrastructure ... Teachers' owned the Leafs and associated enterprises,” he said.

Those aren't investments you can make with a $1 billion or smaller pension fund. They can also partner with other pension funds or financial institutions because they are recognized players, he says.

And a recent Economist article points out, politicians find Canadian pension funds, with their long-term horizons, to be “cuddlier partners.”

While larger firms may be slower to react in the short term, they can also be safer in the long term, says Frazer. The economic downturn in 2008 hit the Quebec Deposit and Investment Fund hard, but the fund has mostly recovered in less than four years, he said.

The nature of this proposed pension reform entity is still unclear, but it could be something like the BC Pension Corp. that quietly handles the municipal, college and public-service pensions, or the recently created Alberta Investment Management Corporation (AIMCo).

If so, the fund “could position Ontario to become a significant economic player,” said Meredith.

“It could provide access to capital markets, benefit the Ontario economy, and, if structured properly, be significant sources of capital for other kinds of public development such as infrastructure,” Meredith added.

Let me be clear on something, when it comes to pension reform, bigger is definitely better, but you still got to get the governance right or else bigger will turn out to be a bigger mess when the next financial crisis hits you.

Kudos to the Ontario government for introducing this new framework to pool functions of smaller public sector pension plans. Every single province in Canada, including Quebec, should follow Ontario (and BC's lead). Instead the Quebec government is touting VRSPs to self-employed and companies with more than five employees, a measure that is completely and utterly sub-optimal.

No DC plan, PRPP or VRSP can compete with a large, well governed DB plan. None. They are more expensive and cannot invest in the best managers across public and private markets, including top hedge funds. Let's stop pretending otherwise and get public policy on pensions back on track for the common good of all Canadians, not just those working in the public sector.

Below, Global News reports on tomorrow's budget. Finance Minister Jim Flaherty is trying to calm nerves before the federal budget is announced but the winds of austerity will be blowing our way too, and it could impact growth at the worst possible time.

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