The Globe and Mail, Report on Business
Published May 2, 2009

Last week I was at the Richard Ivey School of Business speaking to an investing class. It is part of the Benjamin Graham Centre for Value Investing, which has grown in international prominence under the firm hand of professor George Athanassakos.

I had to sneak in the back door because I'm a card carrying "agnostic" when it comes to investment style. So, rather than talk about price-to-book or discounted cash flow, I focused my talk on how our industry makes it hard for money managers - value, growth and otherwise - to do their job.

Under one heading "Size Kills," I talked about how scale in investment management is a big impediment. The time and cost of executing trades for multibillion-dollar firms is considerably higher than for their smaller brethren. They have fewer stocks to choose from (that are big enough to invest in), and yet they need to hold more stocks to fill out their portfolios. And large managers often can't take a big enough position in the stocks they really like to have a meaningful impact on their clients' returns.

But in the face of this argument come recent statements by Ontario's mega-pension funds - the Ontario Teachers' Pension Plan and the Ontario Municipal Employees Retirement System (OMERS) that they are not big enough. Both organizations, which manage $87-billion and $44-billion respectively, are opening their doors to other pension plans in hopes of adding to their scale. Smaller funds will be able to tap into the expertise and capability of these large organizations.

The pronouncements by Teachers and OMERS are in response to recommendations by Ontario's Expert Commission on Pensions, which was led by Harry Arthurs. In its report, the commission stated that "the cumulative effect of the several advantages that large plans have over small plans is extremely significant. These include lower investment fees, in-house investment expertise, private placement capabilities, ability to spread investment risk through diversification, reduced administrative unit costs, and enhanced availability of education, information and service."

In light of this statement, the students are left to wonder. "Who is right - the experts or Bradley?"

Well, we both are actually.

The big plans have a lot to offer the little guys. Teachers is a leader in terms of investment management and pension administration, and has been partly responsible for moving other public funds up the sophistication ladder (whether they'll admit it or not). Today, Canada's mega-funds, including the Canada Pension Plan and some of the provinces, are at the forefront of institutional investment management in the world.

In addition to Mr. Arthurs' list, there are other benefits that come from hooking into a mega-fund.

The first is leadership, which is a big issue for small plans. Many organizations just don't have the right mix of executives and employees to effectively manage a plan. They don't have people like Jim Leech at Teachers, Leo de Bever at Alberta Investment Management Corp. or Doug Pearce at British Columbia Investment Management Corp., and the teams behind them.

The second is time frame. The big funds are better able to take a long-term perspective. With all due respect to Prem Watsa and Fairfax Financial, Teachers is probably the closest thing we have in Canada to Warren Buffett's Berkshire Hathaway. It is unconstrained in the type of investments it will consider and has less need to worry about reporting to clients quarterly.

But there is another side to the Teachers/OMERS sales pitch.

The big guys' capabilities and sophistication are fallible. The Caisse de dépôt et placement du Québec proved that last year (down 25 per cent), as did some high-profile U.S. funds like Harvard University.

Small plans with capable leadership have advantages the mega-funds will never have. They have access to asset classes that Messrs. Leech, de Bever and Pearce can only dream about - small-capitalization equities and Canadian corporate bonds to name two. And of note, these categories carry considerably lower fees than the increasingly grounded world of alternative investments, which command a 2-per-cent base fee plus a 20-per-cent performance bonus.

They have a much broader range of managers to choose from and can give them assignments that are more aligned to their plans' needs. While equity management in the pension world is overwhelmingly focused on the indexes, smaller managers have the flexibility to run more concentrated, less benchmark-oriented portfolios.

Small plans can apply common-sense risk management as opposed to the more sophisticated and, dare I say, complicated practices of the big financial institutions (including the global investment banks), which have proven to be less than reliable.

Teachers and OMERS give the "big is better" message a loud and credible voice and their case has some merit in the pension world. In private wealth management, however, where the banks and CI Financial CEO Bill Holland are constantly talking about the need for scale, the argument is less convincing. Their "scale" businesses are not offering real estate, private equity, hedge funds or benefit administration. Their clients are investing in good old stocks and bonds.

Students, please take note, in those areas, size does kill.