One of the more regrettable aspects of the investment industry is that much of its focus is on the top 10% — and in many cases, the top 1% — of income earners. It is perhaps inevitable given that the wealthiest clients provide the richest pickings. But the sad reality is that those who most need active fund managers to do what they’re supposed to do and provide healthy returns are those who can least afford the fees.
Take public pension schemes, for example. The UK’s Local Government Pension Scheme is designed to pay the pensions of local authority employees, including some of the lowest earners, such as social workers, library assistants, rubbish collectors and dinner ladies.
Last year an independent report commissioned by the Government found that, over the ten-year period ending in March 2013, active fund managers consistently provided the LGPS with very poor value for money. Although, as you would expect, some active managers used by the LGPS did outperform, the report found “there is no evidence that, in aggregate, the Scheme has outperformed regional equity markets”.
In many cases active funds used by the LGPS were trounced by passive funds. Passive North American equity funds, for example, delivered average returns of 2.6%, as opposed to 1.7% delivered by active funds. Passive Japanese equity funds recorded average returns of 2.6%, compared to 2.0% for active funds.
What makes these figures so alarming is that they don’t even take into account the impact of investment charges. The report found that in 2012, asset management costs for the LGPS amounted to £790m — the vast majority of it paid to active managers. Switching from active to passive investing would save a staggering £660 million a year.
For cash-strapped local authorities like my own, Birmingham City Council, paying for active fund managers in return for consistent underperformance makes no sense whatsoever. Last year the city was asked to stump up £80 million to the LGPS in asset management fees — money that could be used for far more useful purposes than swelling the profits of some of the wealthiest fund houses in the City of London.
Nor is this a problem that’s confirmed to the UK. The Maryland Public Policy Institute recently released a study into the performance of US state pension funds in the five-year period ending in June 2014, and found that the states which paid the highest fees recorded significantly lower returns than those that paid the lowest. An MPPI spokesman summed it up when he said: “The investment policies (of most state pension funds) suggest either a lack of numeracy or a decision process not driven by the best interests of the pensioners and tax payers.”
Thankfully, there are signs that plan sponsors are finally waking up to what’s been going on. Several US states are following the lead of California and adopting low-cost, broadly passive investment strategies, while several councils in the UK are looking to do the same. Norway and Australia have also seen the light.
There remains, though, a huge obstacle to positive change in the form of vested interest. For fund management companies these public pension funds are big business and they won’t loosen their hold over them without a struggle. This is not meant in any way as a party political point, just a statement of fact, but many of those companies also happen to be major donors to parties such as the Conservatives in the UK and the Republicans in the US.
Of course you would hope that such donations don’t have any impact on public policy, but in New Jersey, for example, State Governor Chris Christie stands accused of handing big pension contracts to the Wall Street firms who contribute to his campaigns.
Something tells me we’ve only just scraped the surface of this story. It behoves policy makers and politicians of all persuasions to ensure that investment strategies are guided by one consideration alone — what’s best for scheme members and for the tax payer.