A game of co-opetition: exploring the benefits of asset owner collaboration

It may seem like a hidden truth but the reality is that asset owners are in competition with each other. They are in competition for the best alpha ideas, the best manager products and the best research – all with the aim of improving risk-return trade-offs to increase the likelihood of meeting their liabilities. As a result, many asset owners find it difficult to collaborate, even in initiatives that may prove mutually beneficial. At the Thinking Ahead Institute’s recent Sydney roundtable event, asset owner attendees highlighted the top three barriers to successful peer collaboration: (1) difficulties being transparent; (2) lack of time and resources available; and (3) difficulties in aligning interests. At the same time, attendees agreed on the value to funds of collaborating productively on industry structure and regulation, and on a universal owner / alignment of interest agenda. 

The word ‘co-opetition’ was described in Brandenburger and Nalebuff’s 1997 book of the same title and refers to the ability of competing businesses to cooperate with each other with the aim of generating mutually beneficial outcomes, taking insights directly from game theory. Game theory can also be seen to apply to the myriad of investment decisions needed to be made by pension fund boards who aim to fulfil the requirements of several potentially misaligned stakeholders. The pursuit of rational but non-collaborative strategies generally produces poorer outcomes (prisoners’ dilemma) whereas better payoffs can often be produced through effective methods of collaboration or government influence. There are numerous academic articles and research projects that prove this assertion and below I point to just three examples:

In their 2009 paper titled Improving pension management and delivery: an (im)modest and likey (un)popular proposal, Bird and Gray argue that excessive competition among retirement savings providers has undermined their key objective of maximising net returns to members in three main ways, namely:

  1. Inefficient pricing: The race to outperform each other (largely but not exclusively through listed equities), forces asset managers to often rely heavily on momentum and other non-information-based strategies. This causes significant mispricing away from fundamental values, leading to sub-optimal capital allocation, which lowers long-term returns.
  2. Agency costs:  The growth of intermediaries and other agents has led to increased complexity, uncertainty and substantial increases in costs. And given that active management is effectively a negative-sum game after fees, aggregate returns are reduced.
  3. Excessive choice: Bird and Gray refer to Fear and Pace's 2009 article Australia’s ‘choice of fund’ legislation: success or failure? to argue that despite the plethora of investment strategies available, a large portion of Australian institutional retirement savings funds were essentially identical with little investment choice exercised. Therefore members bear the direct and indirect costs of competition-induced excessive choice. Additionally the average fund size was seen to be well below that needed to benefit from economies of scale [1] (including lower fees). Better outcomes would have been achieved if there was better default design for workers who ‘choose not to choose’.

Bird and Gray suggest that these leakages can be plugged by rationalising the retirement savings industry and its agents and by greater cooperation (such as through joint research efforts) while retaining the genuine benefits of productive competition.

In his 2011 paper, Pension funds as universal owners: opportunity beckons and leadership calls, Urwin argues that it is in the interest of universal owners (who, through their portfolios own a slice of the whole economy and the market) to collaborate with other asset owners to ensure the health of the investment ecosystem as a whole. In a nutshell, while universal owners adapt their actions to try to directly enhance the value of their portfolios they indirectly help the whole economy to secure a more prosperous and sustainable future.

And finally, in its recent (2017) survey of 15 best-practice asset owners carried out on behalf of the Future Fund, Willis Towers Watson observed the following trends:

  1. Some participants had developed more strategic partnerships and have seen benefits in sharing information in areas like operations, human resources and technology. All participants agreed that peer collaboration had proved valuable to some extent, but noted that further work needed to be done to crystallise these opportunities.

  2. The group was very cognisant of their external profiles, and greater success was aligned to where their profiles had been very deliberately and carefully cultivated, often through proactive and highly visible strategies. Willis Towers Watson noted that there were growing expectations on leading asset owners in cooperation with others to exercise positive influences in pursuit of their financial goals, and to consider environmental, social and governance issues through their ownership interests. Peer relationships and collaborations are particularly helpful in this regard.

  3. Many participants outlined explicit goals to enhance collaboration, whilst some described instances of co-investment success, although most saw this as more limited in reality than they had initially hoped. Several are now looking to be more discerning and targeted in their collaboration activities, making one or two relationships much richer and deeper. The limits to senior time and bandwidth are clear constraints.

Effective collaboration, without sacrificing the genuine benefits of competition, requires clearly-defined objectives and goals. Moreover though, at the very base level it also requires a mindset shift among asset owners which recognises that these strategic partnerships have the potential to be mutually beneficial.

[1] There is a trade-off involved here, between economies of scale enjoyed by larger funds, and the ability of smaller funds to express conviction and flexibly alter their positions.