Small and medium-sized pension funds (e.g., $1 billion in assets or less) encounter fairly major challenges to entering private capital markets. This has been described as the "critical mass" barrier. Due to insufficient size, smaller pension funds may be less able to take advantage of some of the rewards of wider diversification of portfolio assets or handle the substantial costs and risks associated with private debt, equity and quasi-equity. Certainly, the only way this can be done is through external pooling vehicles wherein costs and risks can be spread among multiple suppliers and specialty managers retained. A related obstacle for smaller pension funds may be lack of awareness of the selection of external partnerships and syndications available to them.
As Figure 22 illustrates, a total of 59 percent of PIAC respondents rated this barrier as important (31 percent) or very important (28 percent). Small and medium-sized pension funds gave it considerably more emphasis (68 percent important/very important).
In general, PIAC respondents fully appreciated the barrier implicit in small size. Not surprisingly, comments of respondents from small and medium-sized pension funds stressed its importance. In particular, the transactional and management costs discussed earlier as the highest-rated barrier are very frequently prohibitive for such funds. Given that outsourcing of asset allocations is the only option for them, this includes specialist fee structures and related partnership costs. Even more restrictive may be the smaller fund's inability to allocate staff time and resources for the purpose of oversight. Respondents also argued that the potential downsides of investing in high-risk, illiquid securities cannot be easily absorbed by funds of low critical mass. This said, some respondents believe challenges can be overcome if viable Canadian externally-managed pools exist or are initiated in future.
It should not be assumed automatically that pension participation in Canadian private capital markets is the realm of large funds, strictly speaking (though the investment dollar volumes of these certainly leave this impression). Many participants that are much smaller in size also currently subscribe to syndicate operations for investing in the middle market and the venture capital market (not to mention real estate). Incidence of their involvement may be greatest in regions where the number, depth and scope of limited partnerships and other pools is also greatest (e.g., British Columbia, Ontario, Quebec) or may otherwise be on the rise.Endnote 149
Also of consequence here is the emergence of money management institutions (e.g., Alberta Treasury's IMD, British Columbia's OCIO and the New Brunswick Investment Management Corporation) emulating somewhat the function of the Caisse de dépôt in creating critical mass through multiple public pension fund deposits (as well as deposits from other sources). As the Caisse de dépôt has demonstrated, provincial sub-markets may be among the chief beneficiaries of such syndications.
See Of Pools and Pooling and What's an ETI? for details of some private capital market developments in the United States relevant to this barrier. Of special interest to Canadian small and medium-sized pension funds may be the still fairly new fund-of-funds model given its unique capacity to assist in the investment portfolio diversification of the former at a reduced cost while dealing effectively with other barriers. Many prominent, long-standing American ETIs are also based on the assets of differently-sized funds.