Large institutional investors are being driven to outsource investment management, but is this a welcome trend?
- There has been a surge in investment outsourcing by pension investors, endowments and foundations
- The trend concentrates assets in ever-larger pools, which comes with economies of scale, but also some notable disadvantages
- Managing money in very large pools has seldom proved to be a great way to run capital
As ‘treacherous’ markets wrong-foot investment teams, The Financial Times reports a surge in outsourcing as pension investors, endowments and foundations hand over their cash to the industry’s biggest players. The reason? A lack of resources and better risk management, according to chief investment officers, but is it a problem for financial markets?
The trend concentrates assets in ever-larger pools. There are elements of this that may be good for investors: they may achieve economies of scale in terms of trading costs, for example. This should push overall costs lower for investors. Those that believe costs are the most important consideration will welcome this development.
Equally, it hands capital to those with the greatest resources. The largest money managers tend to have the largest risk teams, the largest banks of analysts and, often, the strongest sustainability teams. Investors are, perhaps, ‘safer’ with these commoditised solutions.
However, there are some uncomfortable trends associated with greater outsourcing. It concentrates power into the hands of a very few, extremely large global investment managers. This limits diversity of decision-making and, potentially, price discovery. It may accelerate the race to the bottom on costs, which doesn’t necessarily bring a better outcome for investors.
Managing money in very large pools has seldom proved to be a great way to run capital. It tends to limit investment flexibility, leading to an index-plus approach. It may see capital concentrated in larger stocks. There is an argument that this is bad for capitalism: capital goes to larger, less dynamic companies that don’t need it, while starving smaller, faster-growing and more productive companies. A type of reverse-Darwinism ensues.
It is easy to see why it is happening. The running of pension funds in particular has become more complex as the fixed income market has become skewed. Investment management can become a troublesome distraction from the business of, say, running an airline (British Airways recently outsourced its $30bn pension plan). Fiduciary rules and other regulations have become more complicated, and companies don’t necessarily want the responsibility.
However, something is lost in the increasing commoditisation of investment management. It may misdirect capital and it may not ultimately, be very good for investors. It is difficult to resist a trend with such momentum, but it may put too much power in the hands of too few providers.
