Public Pension Fund Management: Best Practice and International Experience

• Date: 01 July 2015
• Author: Andrew Rozanov
• DOI: http://doi.org/10.1111/aepr.12106
• Published date: 01 July 2015

Public Pension Fund Management: Best

Practice and International Experience

Andrew ROZANOV†

The Royal Institute of International Affairs (Chatham House)

As Japan’s policymakers strive to reform the Government Pension Investment Fund, this paper

reviews the core principles and best practices of public pension fund management, with a particu-

lar focus on governance and investment philosophy, as distilled from the experience of some of the

largest and most advanced institutional investors. It proceeds to compare and contrast three dis-

tinct models of institutional fund management: the Norway model, the Yale/Australia Future

Fund model, and the Canada model. The paper concludes by making some preliminary recom-

mendations for the Government Pension Investment Fund reform.

Key words: best practice, Canada model, Norway model, public pensions, Yale model

JEL codes: F21, G11, G23, H55, J26

1. Introduction

This paper was inspired by the efforts of Japan’s Prime Minister Shinzo Abe and his

administration to overhaul the Government Pension Investment Fund (GPIF) – the

largest pension fund in the world.1As policymakers undertake the Herculean task of

reforming the organization entrusted with managing this massive pool of retirement

savings, we believe it is timely to review the core principles and best practices of public

pension fund management distilled from the experience of some of the largest and most

advanced institutional investors.

The paper consists of two parts. In the first section, we review the theory of gover-

nance and management of large institutional funds, based on seminal works by leading

academics and investment practitioners from Australia, Canada, the Netherlands, and

the UK. If one were to start with a blank canvas and build an “ideal” pension fund from

scratch, how would one go about it? We review the latest thinking (and what appears to

be an emerging consensus) with respect to best practice in governance and investment

philosophy of large institutional asset owners.

In the second section, we look at some specific examples illustrating the practice of

institutional fund management – namely, how the core principles and best practices dis-

cussed in the previous section are actually implemented in real life. Experts often distin-

guish between different “models” of institutional fund management: for example, the

Norway model, the Yale model, and the Canada model. We compare and contrast these

†Correspondence: Andrew Rozanov, The Royal Institute of International Affairs (Chatham

House), 10 St. James’s Square, London SW1Y 4LE, UK. Email: arozanov@chathamhouse.org

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doi: 10.1111/aepr.12106 Asian Economic Policy Review (2015) 10, 275–295

© 2015 Japan Center for Economic Research 275

different approaches, concluding with some recommendations on how they may be used

in the Japanese context, to inform and guide Japan’s policymakers in their quest to

reform GPIF.

2. Designing an “Ideal” Pension Fund

Upon reviewing the academic literature and the existing body of practitioner knowledge,

if one were asked, at the risk of gross oversimplification, to distill the key recommenda-

tions into one single imperative, it would be “to operate the pension plan as if it were a

business.” While there are material differences between pension plans and corporations

that must be taken into account, there are still many useful analogies that can be gleaned

from the rich body of knowledge accumulated over the years in the areas of corporate

governance, management strategy, and organizational economics. It is not a coincidence

that Keith Ambachtsheer, a prominent Canadian consultant and pension fund “guru,”

found his inspiration and built his case for pension fund excellence on the seminal work

of Drucker (1976). Similarly, if one were to trace the origins of the governance and man-

agement model developed in the early 1990s by the Ontario Teachers’ Pension Plan

(OTPP), arguably one of the most successful and sophisticated pension funds in the

world, one would find that “running the fund as a business” was the explicit maxim

espoused by the fund’s senior executives at the time.2And this is not just a Canadian

phenomenon: Clark and Urwin (2010) find British pension plans increasingly adopting

the protocols and procedures taken from the UK model of corporate governance.

Going back to first principles, Ambachtsheer (1997) suggests starting with the notion

of “value”: at the most fundamental level,it is about “providing pension plan stakeholders

with the blend of pension and investment services they want at a reasonable cost.”But who

are the relevant stakeholders and what is the nature of the relationship between them? And

what is the optimal “business model”to service them in a cost-efficient and equitable way?

Careful deliberation on these matters will help lay the foundation for a sound governance

structure that will support long-term value creation by the pension fund.

Pension funds are characterized by the competing interests and claims of at least

three different groups of stakeholders: (i) current retirees; (ii) active plan members; and

(iii) plan sponsors. An even broader interpretation of a pension fund “contract” also

includes future generations. One of the key aspects of ensuring long-term sustainability

of any pension plan is an explicit agreement and clear communication in advance of how

risks and windfalls will be shared among different stakeholders. For example, if there is a

sudden shortfall due to an unexpected rise in inflation or due to a simultaneous decline

in interest rates and risk assets, who bears the costs? Should contributions be raised or

should benefits be cut? Or should there be some equitable combination of the two? Con-

versely, if there is an unexpected windfall after several years of higher-than-expected

returns on plan assets, should the current generation benefit through lower contribu-

tions or should at least some of this good fortune be shared with future generations? And

if the ultimate sponsor is responsible for bailing out the pension fund in case of insol-

vency, how should it be compensated for this contingent liability?

Public Pension Fund Management Andrew Rozanov

© 2015 Japan Center for Economic Research276