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Is there an optimal pension fund size? A scale-economy analysis of administrative and investment costs

This paper investigates scale economies and the optimal scale of pension funds, estimating different cost functions with varying assumptions about the shape of the underlying average cost function: Ushaped versus monotonically declining. Using unique data for Dutch pension funds over 1992-2009, we find that unused scale economies for both administrative and investment activities are indeed large and concave, that is, huge for small pension funds and decreasing with pension fund size. For administrative activities, we observe a clear optimal scale of around 40 thousand participants during 1992-2000 (pointing to a U shaped average cost function), which increases sharply in subsequent years to size above the largest pension fund, pointing to monotonically decreasing average costs. As regards investment costs we observe an optimal scale for total assets of around € 690 million and larger, without a clear shift over time and without diseconomies of scale for larger funds. The results are very sensitive to the correct functional form of the cost model. Consolidation among especially smaller and medium-sized pension funds would increase cost efficiency.

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Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 376.

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Date of creation: Apr 2013
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Handle: RePEc:dnb:dnbwpp:376
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Web page: http://www.dnb.nl/en/

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  1. Bikker, Jacob A. & De Dreu, Jan, 2009. "Operating costs of pension funds: the impact of scale, governance, and plan design," Journal of Pension Economics and Finance, Cambridge University Press, vol. 8(01), pages 63-89, January.
  2. Dobronogov, Anton & Murthi, Mamta, 2005. "Administrative fees and costs of mandatory private pensions in transition economies," Journal of Pension Economics and Finance, Cambridge University Press, vol. 4(01), pages 31-55, March.
  3. Jacob A. Bikker & Laura Spierdijk & Pieter Jelle van der Sluis, 2004. "Market Impact Costs of Institutional Equity Trades," DNB Staff Reports (discontinued) 125, Netherlands Central Bank.
  4. Jacob Bikker & Laura Spierdijk & Roy Hoevenaars & Pieter Jelle van der Sluis, 2006. "Forecasting Market Impact Costs and Identifying Expensive Trades," DNB Working Papers 095, Netherlands Central Bank, Research Department.
  5. Ippolito, Richard A, 1989. "Efficiency with Costly Information: A Study of Mutual Fund Performance, 1965-1984," The Quarterly Journal of Economics, MIT Press, vol. 104(1), pages 1-23, February.
  6. Michael C. Jensen, 1968. "The Performance Of Mutual Funds In The Period 1945–1964," Journal of Finance, American Finance Association, vol. 23(2), pages 389-416, 05.
  7. Malhotra, D K & McLeod, Robert W, 1997. "An Empirical Analysis of Mutual Fund Expenses," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 175-90, Summer.
  8. Jacob Bikker & Laura Spierdijk & Pieter-Jelle van der Sluis, 2010. "What factors increase the risk of incurring high market impact costs?," Applied Economics, Taylor & Francis Journals, vol. 42(3), pages 369-387.
  9. Michel Dietsch, 1993. "Economies of scale and scope in French commercial banking industry," Journal of Productivity Analysis, Springer, vol. 4(1), pages 35-50, June.
  10. Olivia S. Mitchell & Emily S. Andrews, 1981. "Scale economies in private multi-employer pension systems," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 34(4), pages 522-530, July.
  11. Waldo Tapia & Juan Yermo, 2008. "Fees in Individual Account Pension Systems: A Cross-Country Comparison," OECD Working Papers on Insurance and Private Pensions 27, OECD Publishing.
  12. Lakonishok, Joseph & Shleifer, Andrei & Vishny, Robert W., 1992. "The Structure and Performance of the Money Management Industry," Scholarly Articles 10498059, Harvard University Department of Economics.
  13. Bateman, Hazel & Mitchell, Olivia S., 2004. "New evidence on pension plan design and administrative expenses: the Australian experience," Journal of Pension Economics and Finance, Cambridge University Press, vol. 3(01), pages 63-76, March.
  14. Olivia S. Mitchell, . "Administrative Costs in Public and Private Retirement Systems," Pension Research Council Working Papers 96-4, Wharton School Pension Research Council, University of Pennsylvania.
  15. Sherrill Shaffer, 1997. "Functional forms and declining average costs," Working Papers 95-13/R, Federal Reserve Bank of Philadelphia.
  16. Bauer, R.M.M.J. & Cremers, K.J.M. & Frehen, R.G.P., 2010. "Pension Fund Performance and Costs: Small is Beautiful," MPRA Paper 23556, University Library of Munich, Germany.
  17. Richard Hinz & Heinz P. Rudolph & Pablo Antolin & Juan Yermo, 2010. "Evaluating the Financial Performance of Pension Funds," World Bank Publications, The World Bank, number 2405, September.
  18. James,Estelle & Smalhout, James & Vittas, Dimitri, 2001. "Administrative costs and the organization of individual retirement account systems : a comparative perspective," Policy Research Working Paper Series 2554, The World Bank.
  19. Malkiel, Burton G, 1995. " Returns from Investing in Equity Mutual Funds 1971 to 1991," Journal of Finance, American Finance Association, vol. 50(2), pages 549-72, June.
  20. White, Halbert, 1980. "Using Least Squares to Approximate Unknown Regression Functions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 21(1), pages 149-70, February.
  21. Christensen, Laurits R & Greene, William H, 1976. "Economies of Scale in U.S. Electric Power Generation," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages 655-76, August.
  22. Jacob Bikker & Onno Steenbeek & Federico Torracchi, 2010. "The impact of scale, complexity, and service quality on the administrative costs of pension funds: A cross-country comparison," DNB Working Papers 258, Netherlands Central Bank, Research Department.
  23. D. K. Malhotra & Robert W. McLeod, 1997. "An Empirical Analysis Of Mutual Fund Expenses," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 20(2), pages 175-190, 06.
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