In-House Management: Lower Cost, Same Returns

A growing number of institutional investors are moving assets in house. And, according to some new research, they’ve got some very good reasons to do so.


After a decade of paying high fees to external managers for low returns, a growing number of institutional investors (like these guys) are moving assets in house. And, according to some new research, they are right to do so. A (non-public) study by CEM Benchmarking (reviewed here) has some pretty remarkable findings:

“‘leading’ funds have an average of 49 per cent of assets managed in-house, and yet the internal staff and non-manager third-party costs make up only 15 per cent of total investment costs.”

“...these funds spend an average of 46.2 basis points on external management, compared to 8.1 basis points on internal investment capabilities.”

And are you ready for the big kicker? Check this out:

“...the funds with internal management platforms are better performers after cost, and this is largely driven by lower costs of internal management.”

In general, the argument against internal asset management is one based on net returns; that pension funds and sovereign funds shouldn’t mind paying high fees to private managers if, in fact, those private managers deliver a value-add beyond that which the internal teams could provide. This research shows that’s not the case. Here’s CEM Benchmarking’s Terrie Miller:

“We haven’t found any real difference in returns between internal and external managers, of course there are always individual managers here and there who are kind of singular in their ability to beat the markets but on average, between the two groups there is no real difference,” she says.

So there you have it. In-sourcing does not, in fact, result in lower overall returns. And this is remarkable given its low cost:

“The biggest cost savings were from internal private equity, with the median cost of internal management for private equity 25 basis points, while for external private-equity management the median cost was 165 basis points.”

“For fixed income the difference was 3 versus 18 basis points, for equities 10 versus 40 and for real estate 21 versus 75 basis points.”

So if you can build a good internal team, you can get the same returns for a fraction of the cost. But this raises some important questions: How does a direct investor attract and retain the required human capital to implement internal investment programs? How does a direct investor obtain local knowledge of foreign markets? How does a direct investor access quality deal flow on a global basis? How does a direct investor access large deals, while still maintaining diversification?

In my view, answering these questions in a way that’s credible requires good governance. For example, you need a savvy board that’s willing: 1) to think creatively; 2) to pay internal teams; and 3) to resource the investment functions in a manner that sets them up for success. Consider this:

“The average salary of the top five investment staff in Canada was $1.5 million, in Europe $720,000, in the US it was $372,000 and in Australia $297,000.”

Which country do you think is known for its internal asset management skill? Exactly. But it’s not just about paying top level folks. According to CEM, a successful internally managed pension fund requires nearly 2 people in the back office for every one person in the front office. The Board has to understand this to be successful.

And one more thing: the Board and the management team have to be willing to take some personal career risk in this process. Remember that asset managers offer pension and sovereign fund staff a sort of political and career risk insurance policy. When things go bad, they can point fingers at (and even fire) managers, insulating themselves from the actual bad investments through an intermediary. So setting up an in-house team will mean giving up this comfort level and getting involved in the challenging and sometimes painful business of investing.

Given the remarkable cost savings – for the same performance – I think it may be a fiduciary obligation to do so.