Pension Fund Insourcing: Building a Modern Pension Fund Operating Model

Pension fund investment management is in what feels like a constant state of flux since the pandemic. Fund managers are surfing a sea change in how pension funds operate compared to 10 or 15 years ago. The 20-year mean compounded return fell steadily from a little over 12% to 7.3% from 2000 to 2024. The higher-for-longer rates environment, digital transformation, and shifting demographics have inspired funds to diversify in aid of driving yield. From 2019 to 2022, the share of allocations in alternative assets grew from 27% to 35%.ⁱ

Pension funds have been diversifying heavily into alternative strategies and private credit, private equity, real estate, and infrastructure but are running behind in shifting away from outdated tech platforms. Strategies have evolved from simple external manager tracking to complex, multi-asset class management. In the past few years, pension funds have charged headlong into more asset classes and sophisticated strategies, which sent them out to employ a broader set of external asset managers. Now, funds are looking to reverse this trend to take more control over costs, strategies, and data.

Pension funds deal with declining margins, outdated solutions

Managers have grown weary of the outdated offerings of securities services, banks, custodians, and fund administrators that cannot handle the needs of diversified funds and complex hybrid pension structures. Additionally, margins have declined by three percentage points in North America and five percentage points in Europe over the past five years, while technology costs have grown disproportionately.ⁱⁱ

Institutional investors are moving to a risk-on sentiment, seeking yield in hedge funds and higher risk fixed income strategies, led by private infrastructure debt and private real estate debt. Forty percent report broadening their selection of asset managers to better align with growing complexity and specialization within private markets.ⁱⁱⁱ They seek managers with diverse expertise not only in private markets but also alpha-generating hedge strategies like long/short equity, leveraged alpha, quant, and convertible arbitrage. A robust 36% of institutional allocators with oversight of hedge funds will commit new capital, and 43% will invest opportunistically.^iv

For these reasons, large pension funds are increasingly bringing asset management and investment operations in-house rather than relying solely on external managers or traditional securities services at banks. Consequently, the insourced teams need to be able to run an investment strategy, end to end. And this means new platform needs.

Pension funds’ tech debt, itemized

Pension funds are asking for modern operations technology that alleviates operational pain points from multi-asset class complexity, the structural overlap between defined benefit (DB) and defined contribution (DC), multiple administrator feeds, and increasing stakeholder demands for transparency. Alternatives and private markets bring diversification and performance. But there’s a cost of doing business, measured in a choice between time and technology, manual and automation. Private credit is infamous for its unstructured data problem that gums up workflows.

Pain points:

• Funds are frustrated with their reliance on spreadsheets and manual data extraction from PDFs. 
• Legacy systems have trouble transforming external vendor nomenclature data from parties like credit administrators, property managers, and fund administrators.
• They also struggle to track external manager positioning as well as aggregate strategy, sector, and position risk and performance across external managers.
• Unstructured datasets come in via GP statements, capital calls, distributions, holdings, term sheets, and loan tapes.
• Pension funds are challenged with generating NAVs with multiple books of record across multiple systems. Having humans go heads-down translating each book of record into the fund’s data model is not only onerous but prone to errors.
• All of these speed humps cascade downstream to reporting, a function no fund can afford to have perform as anything less than a well-oiled machine.

Teams need a single view of positions, cash flows, and valuations at close instead of shuffling through multiple versions. Their ability to gain single, consolidated exposure views means successfully ingesting and processing unstructured data, aggregating issuer exposure across multiple portfolios, and aggregating counterparty exposure.

In‑house investment management for more control

From a front-office perspective, the push for pension fund investment insourcing and modernization goes way beyond operational efficiencies and free flowing data. It is the linchpin of growth, liquidity management, and alpha generation. One way pension funds want more control is through keener oversight of external managers. Instead of collecting their high-level monthly or quarterly reports, risk teams are now building the technical in-house capacity to monitor positions, performance, and attribution with higher frequency.

Moreover, funds’ foray into private markets has come with an illiquidity premium and “delayed distributions have strained cash-strapped pensions’ ability to fund new commitments and manage uncalled capital.”^v No matter how tantalizing an investment opportunity is, if it exerts pressure on concentration risk, results in cash drag, doesn’t fit within risk limits, or is inefficiently spread across multiple vehicles, that opportunity may be counterproductive.^vi Oftentimes, a lack of capacity to take on new business is more damaging than macroeconomic headwinds. Bringing more asset management in-house means more tactile control of exposure, timing, and liquidity management.