Who can you trust to manage your pension?
Another World Cup over and we can now thankfully go back to four more years of misery and bitterness about England s latest catastrophic attempt to recapture the trophy since whenever it was. For the neutral spectator though there were moments of excitement from the prominence of hitherto low key performers such as Thomas Mueller, Asamoah Gyan, Diego Forlan and of course Paul the Octopus, who accurately predicted the results of a number of games during the tournament.
A strong individual performance on the World Cup stage doubtless increases the value of the performer and those individuals can probably look forward to tempting offers from suitors keen to benefit from their skills. All of them of course except Paul the Octopus, which is a shame as there are probably no end of fund management groups who could benefit from Paul s predictive skills.
But let's face it, that s a ridiculous suggestion. When funds produce a poor performance in a period, the managers will usually talk about performance over the long term. Unfortunately, Paul despite his predictive skills probably hasn't foreseen that he can t have a long term perspective on anything. Infact his outlook is distinctly short term and probably involves being sliced and deep fried in batter to satisfy the momentary whim of some peckish office worker.
I know what you re going to say. Here he goes again criticising fund managers. He s obsessed. Well I can assure you I'm not obsessed, and I definitely do not have any obsessive compulsive type disorder. I ve checked. Many, many, many times infact. And the only reason I wash my hands so often is that when you travel frequently on the Waterloo and City line all you can think about for the rest of the day is the rapidly multiplying fauna growing quietly on the palms of your hands where you ve touched the travelator handrail or, heaven forbid, another person. Thank goodness that more and more buildings are providing alcohol gels at Reception.
Importance of Fund Managers
So, I m not obsessive but everywhere I look various news stories lead back to the importance of fund managers; not just their importance to the City but their importance in all of our lives.
For example, this month the self-styled Public Sector Pensions Commission, which is funded by the Institute of Directors and a number of think-tanks (no relation to Paul the Octopus and his water-filled think-tank), including the Institute of Economic Affairs and Policy Exchange, issued a report (1) discussing the issue of public sector pensions. In the short term they propose some minor tinkering including public sector employees paying an extra 2% of salary, but their long term proposal includes the switch for public sector employees into funded defined contribution schemes.
Difficult to argue with when people are living longer and the liabilities for the taxpayer are unlimited and unfunded, and of course the IoD represents companies which would rather pay less tax. But if there are to be funded schemes then who will run them? Of course it will be existing fund management groups, to whom a higher percentage of the population will then look for delivering strong performances to fund their pensions.
As far as delivering strong performance is concerned, another interesting publication this month was a report called Exploiting Uncertainty in Investment Markets by Create Research (2) but funded by Citi Group. If you can get past the rose-tinted view of the fund management industry and the business school style of writing with phrases such as "The credit crisis is in the rear view mirror" then it is well worth a read. The report predicts that the share of indexed funds out of total global assets will rise from around 15% to 25%. That means that funds which are currently actively managed may move to a passive index model. One fund manager was unsurprised, being quoted as saying that "Most of our clients no longer subscribe to the idea that active managers deliver excess returns". As well as reducing volatility for the investor this passive approach should also reduce fees. But will it? It s been a fairly open secret in the City that many funds claiming to be active are largely passive (so called closet trackers) but by claiming to be active they can charge higher fees to their investors, supposedly for the expertise they provide in cleverly picking the right stocks.
Closet Trackers
To back this up, in June 2010, the Financial Times, using data provided by Morningstar, the business news and data provider, used a metric and identified 19 funds that were highlighted as potential closet trackers. The list included funds run by well known names such as Standard Life, Royal London and Santander. Some of the funds were found to have a very close correlation with the FTSE All-Share over three and five years despite having charges almost double those of a typical passive fund. The loser, of course, is the investor, although if you are invested unknowingly in one of these funds through your pension you are none the wiser, and you rely on your pension trustees to not be hoodwinked by such funds.
It's no wonder then that more and more people choose to manage their own investments; the SIPP industry for example has grown rapidly in the last few years, driven by the public s growing distrust of professional investors and also by the ease of online SIPP accounts. Infact, half a million of us choose to use SIPPs for our pension provision and those SIPP accounts contain over £50 billion of assets.
When we consider how successful some fund managers are at stock picking let s not mention the proverbial monkey throwing darts at a dart board because that anecdote always upsets fund managers. But perhaps we are all better off if funds just invest passively? And, frankly if a monkey is so talented that he can throw darts and select stocks for high alpha then he deserves a fund manager's salary.
In search of better performance
Stories of monkeys or school children or pensioners running active funds that perform better than fund managers appear frequently. We all think we can pick stocks better than the professionals in the same way that we could all manage the England football team better than the incumbent England manager. The sad truth, however, is that most of us probably can't. Even if most private investors withdrew their Ocado applications last week realising they were investing in a company which not only has never made a profit but also which without the fundraising was heading towards insolvency faster than a shopping trolley towards a display of stacked baked bean tins, it may be that the fund managers who did invest know better. Time will tell.
So if we're better off not entrusting the UK s pensions management to individuals like me who manage our pension portfolio on a wet Sunday afternoon, we had better ensure that the Government and its agencies make the fund management industry work more effectively, efficiently and fairly. That isn t going to be easy but its probably preferable to trying to find our very own cephalopod mollusc with paranormal powers to choose our stocks.
(1) http://www.public-sector-pensions-commission.org.uk/wp-content/themes/pspc/images/Public-Sector-Pensions-Commission-Report.pdf
(2) http://www.create-research.co.uk/pubRes/pubResearch.html
(c) Ash Mehta 2010
This article first appeared in Aimzine, www.aimzine.co.uk
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