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Board Conflicts of Interest Pose Threat to Pension Fund Returns

Pension returns suffer when fund operations are outsourced to firms that board members have ties to, according to a new study.

  • By Alicia McElhaney

When a pension fund's board has close ties to the service providers it outsources to, the fund tends to underperform its peers, a new study shows. 

According to the research, published by the University of New South Wales, pensions that outsourced fund operations to firms their board members had previous ties with — a practice most commonly seen in Australia's retail superannuation funds — underperformed peers by roughly 0.77 percent per year between 2004 and 2016.

"Both the use of related-party outsourcing arrangements and trustee director affiliation in retail funds is detrimental to fund member's investment performance," the research paper stated. 

This research comes at an important time, as more funds consider outsourcing their chief investment officer operations. But the market is growing crowded, and with more options for outsourcing, pension funds have to be discerning in selecting their money managers, experts say. 

[II Deep Dive: Fear and Loathing in the Outsourced CIO Market]

The research, compiled in a study called "The Impact of Related-Party Outsourcing and Trustee Director Affiliation on Investment Performance of Superannuation Funds" and written by Kevin Liu of the UNSW Business School and Elizabeth Ooi of the University of Western AustraliaBusiness School, was published on February 14. It studied a sample of 101 Australian superannuation funds between 2015 to 2016. 

The research found that the more members of a pension's board that are affiliated with a third-party service provider — including fund administrators, investment consultants, insurers, custodians and asset managers — the more likely they are to hire that firm. According to the study, affiliations could include a director hiring a fund manager they already know, or directors appointing fund managers in exchange for board seats at other organizations. "Where related-party service providers control the fund board through affiliated directors, the board becomes 'captive,' and the outsourcing arrangements cannot be expected to be truly at arm's length," the authors wrote. 

Those "captive boards" then focus on engaging potential outsourcing candidates from a commercial lens. That is, they focus more on using the relationship to make a profit for themselves, sometimes at the expense of fund members' interests, the study found.  

The issue of director affiliation affects a number of pension funds surveyed; over 94 percent of the retail superannuation funds were managed by boards on which at least 50 percent of members were considered affiliated with a service provider. 

Though the practice is almost standard in Australia's pension fund industry, at least, the study concluded that it should change. 

"As this business model is significantly detrimental to fund members' interest, it represents a major source of inefficiency in the superannuation system and hence should be the focus of current and future governance reforms in the superannuation industry," it said.

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