Perspectives 2019 2020 Public Sector

80 Asset Owners’ Appetite to Insource 1) The need to contain costs Fees paid to external managers are under scrutiny as it can be higher than comparable internal costs, and when these managers fail to outperform consistently, asset owners are likely to question their value-add. In the previously cited survey of 485 global investors, external manager fees were a key source of cost savings opportunity for over half the respondents. 3 2) The need to align with investment horizon and purpose Demographics are evolving with time, resulting in new expectations from asset owners’ underlying participants (e.g. citizens, including pensioners, savers and students). Asset owners take a long-term view for their investment targets to benefit these participants; whereas, asset managers have short- term performance targets, potentially creating an inconsistency between an asset owner and external manager’s investment horizon. Asset owners also seek to align their investments not only with their funds’ philosophies, but also with their beneficiaries’ beliefs. This is especially relevant to investors who prioritize environmental, social, and governance-based (ESG) investing principles and actively engage with portfolio companies by proxy voting, shareholder filings and on-site due diligence. 3) The need for oversight, risk management and transparency Trustees and regulators, as well as beneficiaries, demand that asset owners take steps to strengthen their fiduciary duties. Firms want to ensure they have oversight of their trades and associated costs in the value chain, with robust risk management. They seek a holistic view of their investments which are spread across managers, asset classes, strategies and geographies. By internally managing their assets, firms can minimize agency risk — this includes direct market access, less latency to respond to market movements, reduced information asymmetry, quick turnaround time and decreased time lag to resolve operational issues. Moreover, with fewer external managers, asset owners can monitor them with more diligence. 4) The need to build scale As the fund grows or diversifies assets and strategies, the existing external managers may not have the capacity or expertise to support the new investments. High-performing managers are especially prone to this as they reach caps for new money. Furthermore, if one asset owner represents a large proportion of an investment manager’s business, it can pose high business risk for the manager and investor. 5) The need to develop expertise As the investment strategies become more complex, firms are keen to build expertise for a self-sufficient business that reduces dependency on third parties. Firms are increasingly diversifying their investments in search for returns — in the survey of 485 investors, two-thirds of investors entered a new asset class or strategy in the last three years, and this trend is likely to continue as almost another 10% plan to in the following year. The most popular additions are private debt, infrastructure, real estate, emerging market equity and alternative risk premia. Five forces driving Public Sector Asset Owners to manage investments internally The insourcing trend is likely to continue as asset owners navigate a web of complex drivers shifting their business models. Firms are internalizing investment management to get closer to their investments, enhance oversight and risk management, and develop internal expertise, while combating rising costs and building scale. Canada’s 10 largest public pension funds’ expenses are roughly 0.3% of their total assets. Much of this low cost base can be attributed to internal asset management — the top 10 manage 80% of their investments in-house, while other pension funds manage roughly 20% of their investments in-house with a 1.0% expense-to-asset ratio. 4 3 bfinance — Asset Owner Survey: Innovations in Implementations, September 2018 4 Healthcare of Ontario Pension Plan — Canada’s Top Ten Pension Funds, Helping Drive National Prosperity