I had a little moment listening to an investment guru yesterday which convinced me the future did not belong to him (nor his like).
I wouldn’t quite call it a Damascene moment. “I’m no Saul and I won’t be a Paul”. In fact, as for who’s up and down among gurus – I’m not that bothered.
First Actuarial’s Monkey League shows that monkeys and humans are pretty interchangeable as football team pickers and I don’t see stock picking as any harder.
But the future (for investment gurus) is about the management of the vast inflows of money from auto-enrolment. They earn lots and trail a wake of acolytes and collectively they are “very much bothered”.
The gentlemen was representing a consortium of active fund managers who have clubbed together to publicise the value of diverting the money their way so they can continue to enjoy the sinecure that investment management fees can provide.
Being of independent mind, I turned to one of the publications that he had been reccomending . It has the odd title The Prodigious Use of Passive Funds in UK DC” , it is an immensely well written document;- and it contains the warning
Over-allocation to index management may well be to the detriment of plan participants.”
This kind of talk does bother me. I wanted to find out what was wrong with index management and the default strategies that employ it- not least because I reccomend them and I am one such “plan participant”.
The document is confident, well-written but it is fundamentally flawed.
It’s flawed in stating that what has happened in the USA will happen in the UK and it is flawed in it’s assumption that even if active management became popular in UK DC, it would be active fund managers who’d profit.
Reading this document and listening to this fellow produced my quasi-Damascene moment. For all their fancy suits and City offices and Gravitas, they are fundamentally wrong. Their self-belief sustains their delusion they have a divine right to manage our money; but it flies in the face of reason.
The five “killer” arguments that UK active pension fund managers use, can be characterised like this;-
- Because the US invests more in active funds and the UK more in passive funds, there’s a structural imbalance which will revert to a mean position (somewhere between the two)
- The “imbalance” has occurred because of poor decision-making by those designing DC default investment options.
- The poor decision-making was due to “poor governance” with decision making insufficiently “risk-based”.
- The Americans regulations (ERISA) demand greater diversification and don’t concentrate as much on keeping costs down.
- DC should be managed like DB and employ “more thoughtful investment technologies -risk focussed, liability driven”.
There is a good argument that more can be done by asset managers to improve DC outcomes, but they are not in this paper. This paper focusses on the wrong problem.
In the USA, the only thing that DC has to do is to provide wealth in later years. How this wealth is drawn down is no business of a 401K plan manager. So all that manager has to do is provide the best growth with the lowest volatility.
Money can be accessed through these plans prior to retirement so it’s important that from month to month, there’s stability in the value of the individual account.
That why the Erisa “Diversification Rule” is there. But the risk it mitigates is not a UK DC risk.
In the UK , a DC plan doesn’t just have to build up money, it has to provide options to decumulate the wealth via a pension (a regular income stream). Money cannot be drawn from an individual’s account until this “point of decumulation”.
This essential difference is not on the radar of the consortium of fund managers but it is such a fundamental difference that not considering it invalidates the integrity of the entire paper. By extension it renders less than credible the current hopes and ambitions of the traditional active fund managers. Do I mean they are incredible? In that I cannot believe them – yes!
Far from being “poor”, the decision making of those creating and managing DC defaults, has been – so far – SPOT ON!
In the absence of reasonably-priced diversified growth funds, defaults have concentrated on getting “best-diversification per buck” and have settled on passive global equity funds for growth and gilts and cash for the pre-annuitisation glide path.
Nobody said this was perfect, but it was the best that could be done in the early years of the last decade when this consensus emerged.
The approach accepts a high degree of volatility in the growth phase of DC accumulation and runs….
“Pounds cost averaging” mitigates – over time-the impact of volatility. “Time” is the one thing most investors have got in abundance.
Over time, “cheap and volatile” trumps “expensive and smooth” in my and most people’s books.
It’s not a perfect statement of investment beliefs but it’s pragmatic, communicable and has common sense on its side.
The active managers should not be blaming poor governance among those designing these defaults. Instead they should look to their lack of invention in creating solutions to the real problem – how to protect members against the ever-rising price of annuities. With the exception of Alliance Bernstein and their Retirement Bridge (which is employing an active approach to managing passive funds) none of the active fund managers have addressed the problem – let alone cracked it.
Indeed, their current desire to introduce LDI is based on an assumption (implicit in closed DB) that the members account will be “bought out” by an insurer.
The problem is that the cost of an insured buy-out is as prohibitive for DC customers as it is for DB customers. For “deficit” read “small pot” and for “full buy-out cost” , read “Is that all I get – I can’t afford to live on that!”.
DB and DC are currently alike, at least in not being able to afford buy-out. They differ in that DC accounts have to be annuitised while DB funds can tough it out or seek a safety net.
Recommending LDI as an alternative glide path to lifestyle is not focussing on the problem. It screams “More fees- same outcome”.
The lack of empathy from most active fund managers is staggering. They seem to have no empathy with the people who rely on their funds, I wonder if anyone in the “funds community” needs bother with annuities.
Rather than talk about things that matter, they continue to tell us they can add value “after fees” by taking bets either on stocks outperforming or by guessing the markets by asset, class, region or sector. But they have consistently failed to do this. The people who have been waiting for something better are still waiting. Rome burns- the active managers discuss whether they should be offering daily or weekly pricing (note to managers, have you considered the implications of weekly pricing for those running lifestyle transitions?).
If they are to get “market traction”, it is unlikely to come from the same old failed strategies; top down,bottom up,value and growth. Nor will they come from diversification into alternatives , fund of hedge funds, private equity funds or commodity funds or forestry funds or funds that invest purely in emerging or frontier markets, or infrastructure funds or currency funds. All these funds , managed by the big fund managers or their mates and former colleagues who have set up boutique fund managers are great for the “Wealth” fund platforms (Hargreaves Lansdown and the like) but are too expensive for DC defaults.
The active managers point to the prices people will pay for their funds in their SIPPs, implying that if we could get American standards of engagement into bog-standard DC, fees would not be such an issues. I imagine that SIPP customers accept high fees for the same reasons they pay for Gucci or Hermes- out of vanity. The RDR requires greater fund price disclosure which is already leading to pressure on fund platform’s margins (follow the Hargreaves Lansdown share price) so even here the active fund managers will be on the back foot.
The chances of SIPPs and their fund platforms becoming mainstream AE vehicles are slim – witness comments from the DWP this week on dis-Qualifying expensive DC schemes from AE (the pricing benchmark looks like the 0.50% AMC on NEST). Try applying a 0.50% TER cap on your average funds platform and you wouldn’t get many (if any) funds to chose from.
And here is the real problem for the bloated old fashioned fund managers. The argument is always about the cost of these funds. The only way that I can see the general public affording active management is by super-buyers driving down the cost of the “activity” of the manager, so that investors get something for “next to nothing”. This is what employers can do for them by chosing the “supertrusts”.
You will always hear cries at this point about “value” rather than “price” but unless you can demonstrate “value” you can’t demand a (high) “price”! .
If Norma Cohen of the FT’s analysis is right, the transaction costs of a typical actively managed pension fund (107 bps) are at least twenty times those of their passive counterpart (<5 bps)and the “factory gate” management fees around five times as high, It is clear that efficiencies achieved will need to match Cameron’s demands for cuts in EU administration (a good comparator!).
And of course this is not going to happen so long as the active managers expect to occupy expensive office space, get paid a quarter of a million plus and splurge money on advertising and lavish corporate freebies . Nor will the consultants let it , now they are being weaned off reliance on brand awareness (rather than proper research) or the soft-comissions from corporate freebies.
And even the argument that some market require active management and that properly diversified strategies need exposure to these markets is fragile. I can now buy diversified beta through LGIM’s MSF at not much more than the cost of their global equity fund. When the efficiency of developing markets catches up , the value of the active diversified growth fund dilutes to nothing.
Which is why there is currently no opportunity for these active managers to dominate UK DC (at the margins they want and need).
Look at the facts. With the exception of Fidelity , none of the “grand marque” houses have made a success of branding their own bundled DC proposition ( I include Black Rock). Most active managers that have tried – Invesco, Schroders, Gartmore and Threadneedle have had to sell their DC books after finding themselves “distributors” for passive (default) funds. Even Fidelity can’t get their own funds into most defaults on their platform.
These active managers now have to sit on the “subs bench” of insurance platforms and hope for the scraps that aren’t digested by the “Prodigious” passive defaults.
Their “play” is to get the default back under their management but this is yet to happen.
There is a chance that they will participate (in defaults) , but their participation will not be obvious and their fees massively reduced. If they have a role in DC, it is as sub-managers of parts of the massive industry defaults that will build up over the next twenty years. These funds will be managed by NOW and NEST and the largest insurers who will compete with each other on thin margins and with no cross-subsidy to the fund management industry.
Where there is demand for the active managers’ skill sets (other than from retail “wealth” platforms) is in developing post-retirement decumulation products or to work in the one area where demand for their skills is growing – the enhanced beta market that is creating better indices for DC funds to track. It will be to this market that progressive DC governance committees will be turning their attention in months and years to come.
I understand the frustration of the large asset managers. From the early days of their careers they have been told they have only each other to compete with in the carve up of pension’s asset management. The arrival of passive managers and the collapse in DC fees has been as unpleasant as the disappearance of much of the DB cash flows.
The Tsunami of new money from auto-enrolment only makes things worse. They see the new flows going to passive funds or the new “superfunds”.
The wider trade body for these managers – the Investment Management Association (IMA) is now lobbying against these collective arrangements as well. The link takes you to what I hope is an ironic piece of reporting from the excellent Will Robbins.
Responding to calls for more collective DC schemes, where several members pool their contributions into one set of investments, the IMA warned such schemes would be caught between DC and defined benefit (DB) regimes, offering the benefits of neither.
I’m tempted to add “to its membership”…
I suspect they have cottoned on that once they get to super-size, they are gong to manage investments directly and the fund managers will once again be out of the picture.
The sad reality is that despite beautifully produced documents such as the Prodigious use of Passive Funds in UK DC. or the best efforts of the fine fellow I was in conversation with, their game is up.
Like landed salmon , they flap around on the bank, hoping they may get thrown back in the water. Why would we do that?
- Why I support Labour’s attack on pension charges (henrytapper.com)
- Kensington announces the appointments of Eamonn Mcconnell and John H. Walker as Managing Directors (prnewswire.com)
- Fund Managers Styles (sandyyadav.com)
- Australian “Super” – not an answer – a new question. (henrytapper.com)
- “2007-2013” Recession over. A discussion with Darren Shirlaw [tom osborne] (ecademy.com)
- Ethics in the City: Vince Cable wants regulators to define ‘act in good faith’ (telegraph.co.uk)
- Fire Your Active Mutual Fund Manager! (seekingalpha.com)
- Pension companies fail to deliver (telegraph.co.uk)
- Excuses pile up for active management failures (cbsnews.com)
- Passive vs active investment management (telegraph.co.uk)