Pension Funds Are Desperate to Cut Costs, but Consolidation Isn’t the Answer

Larger funds, in particular, aren’t racking up big savings when they merge, according to a new study.

Troy Harvey/Bloomberg

Troy Harvey/Bloomberg

Public pension funds that merge with their peers have historically hailed it as a smart way to cut costs and achieve economies of scale.

But the strategy of consolidating funds, particularly for large ones, is not yielding the benefits it once once did, new research shows.

In fact, for some funds, the economies of scale they are achieving is “rather mediocre,” according to a paper published this month by researchers Jacob Antoon Bikker and Jeroen Meringa from De Nederlandsche Bank, the Netherlands’ central bank.

“The argument for consolidation still exists, but is limited,” according to the paper. The research comes as pension funds continue to form tie-ups and as many smaller pensions do pension risk transfer deals with large insurance companies. The argument for either type of transaction is to lower costs for each invested dollar or euro. One recent example in the U.S. of consolidation is the state of Illinois’s push to combine more than 640 local police and fire pension funds after Governor J.B. Pritzker signed a law requiring it in December 2019.

The researchers analyzed reports on 280 Dutch pension funds’ investment costs from 2012 through 2019, which had previously been sent to the country’s central bank. At the end of 2019, the total value of pension fund assets in the country amounted to €1.47 trillion (USD $1.78 trillion), the paper said.

The researchers defined investment costs as the sum of management and performance fees, transaction costs, market analysis research expenses, risk management charges, and consulting fees. They noted that these costs aren’t always clearly reflected in pension reporting, particularly when investments are outsourced, as the fund may not even be aware of certain hidden costs.


The majority of the benefit that pensions can get from achieving economies of scale has been squeezed out, except for the smallest pension funds, according to the paper.

The paper showed that for the funds they analyzed, the total costs per invested euro have been decreasing: They fell from 0.54 percent in 2012 to 0.49 percent in 2019.

Management Fees Fall the Most

From this data, the researchers found that on average, pension funds saved 6 percent of total costs, or roughly €751 million. Between 2012 and 2019, economies of scale for small pension funds were around 10 percent, while for larger ones, it was closer to 5 percent, the paper said.

“Economies of scale in total investment costs of pension funds are nowadays smaller than in the past, but [have] not yet disappeared completely,” according to the research.

These savings are particularly applicable for management fees — the researchers found economies of scale for this category to be 9 percent.

Meanwhile, for small pension funds, performance fees have “huge” economies of scale, up to 47 percent. The larger the funds got, though, the closer the cost savings got to zero. At consolidated funds, transaction costs actually grew in comparison to those that stayed small. The larger funds actually throw away their scale advantages by plowing more into high-cost alternatives.

Certain asset classes benefit more than others from consolidation. For fixed-income and stocks, cost savings hover around 5 percent on average. For private equity and real estate investments, costs increase as pension funds grow or consolidate.

“This unexpected result for real estate may be explained by the fact that larger pension funds have more complex real estate categories, such as shopping centers and office buildings, to which higher management and analyses costs are attached, but where expected returns may also be higher,” the paper said.

A similar argument, the researchers added, may be true for private equity as well.