Of course, the active strategy for allocating and managing assets implies higher risk and possibly higher returns, while the passive implies lower risk and possibly lower returns. These respective, conventional characterizations have recently been the subject of considerable dispute as several research studies have shown low-cost indexing to yield robust financial performance, especially in bullish public securities exchanges. Regardless, pension funds can be grouped according the to extent to which they combine these two investment management styles or prefer one to the other within a portfolio. Today, there is more active management of Canadian pension assets (e.g., stocks) as compared to the United States.
It has been argued that the active strategy thrives where there is relative inefficiency in capital markets. It is in this environment that the experience, skills and applied techniques of a manager familiar with the functioning of a certain asset class provides an edge. Passive strategy adherents might argue in response that particular knowledge and craft is less meaningful in mainstream North American capital markets featuring liquid securities where publicly-available pricing data ensure efficiency. The capacity to add value through specialized, management-intensive investment may be more relevant in somewhat less efficient segments of these markets, such as small-cap public equity of less than $1 billion (though passive proxies are also on offer here).
For the purposes of long-term investment strategy, pension fund organizations can be structured in multiple, innovative fashions. To implement and administer a strategic plan for the portfolio, governing fiduciaries must identify and agree upon an appropriate fit concerning teams of managers, agents and advisers. Depending on size, available resources and other factors, teams may be situated within the pension fund (or, in the case of some private and public sector funds, their money management institutions), externally or both.
Naturally, very large pension funds frequently try to acquire reputable management personnel with different or complementary skill sets and locate them in-house to gain the advantage of maximum control over operating costs, flexibility, technical direction, monitoring and performance assessment. As the Benefits Canada survey of the Top 100 Pension Funds indicates, however, this is no uniform pattern among large peers (see Figure 2). For assorted reasons, some large funds prefer an investment strategy that utilizes external balanced and specialty money managers. Not surprisingly, this is the only option for the majority of pension funds that are small or medium-sized.
The balanced money manager undertakes diverse asset allocation tasks on behalf of pension clients based on their individual policy prescriptions. Alternatively, pension funds may select an array of management firms that can give concentrated and specialized attention to asset classes or sub-classes that are market-specific (some multi-product balanced management firms also house this capability). Distinct financial specialization can effectively address niche investment activity, from small-cap stocks to emerging capital markets in the global economy. Whichever the pension client selects - balanced, specialty or a mix of money management styles and companies - different approaches will place different demands on the pension fiduciaries who must oversee and evaluate external performance.
Active asset management and specialization are watchwords when a pension fund attempts an above- average risk-earnings ratio through portfolio diversification into the illiquid transacting of private capital markets. In these, relative inefficiency may be taken for granted (see Pension Participation in Selected Capital Markets, page 23) and there is an obvious need for qualified, value-adding management professionals (situated internally or externally) who can negotiate inherent costs and risks.
Pension participation in private capital markets is often described as investing in alternative or non-traditional assets and usually entails modest dollar amounts found at the extreme margins of portfolios. Illustrations include term lending, venture financing and other forms of privately-placed debt and equity. While real estate is a more traditional asset class for pension funds, it also constitutes a small portion of total asset allocations due to its predominantly private and illiquid nature.
Statistics Canada profiles of pension funds have included investment data and analysis over a forty-year period. Such information is also provided for the largest funds in the nineteen annual surveys published by Benefits Canada. Both sources highlight long-term portfolio shifts among the core asset classes, such as stocks and bonds, both domestic and international, as well as mortgages, real estate, cash and short-term investments. Because of comparatively low levels of exposure to them (e.g., less than 1 percent), alternative or non-traditional assets (with the exception of real estate) tend not to register as items for precise and systematic reportage.