The FCA’s Asset Market Study is written with certain corrective bias’ and it should not be taken as the last word on the active/passive debate.
A central focus is on the allocation of savings, particularly long-term retirement savings, to active fund managers.to the financial disadvantage of consumers and to the great advantage of everyone in the “value” chain from the fund manager to the investment consultant.
The Asset Management Study is a concerted attempt to reduce the cost of intermediation (between the achieved and received return on money) from its historic level of 2%pa. That 2% figure may surprise but it is the percentage that the American economist Thomas Phillipon has shown to be the historic “cut” taken by this value chain.
Active management is the most obvious place to start, but equally vulnerable are those billing directly to the fund, platforms and advisers. 2% appears to be the natural tolerance of investors.
The more fundamental question that both Phillipon and the FCA fail to address, is why people are prepared to pay such a high price for the management of the money. The answers cannot be attained through rational economics, they arise from behavioural economics. People do not like paying other people to manage their money, but through the twin drivers of need and greed, they feel they have no choice.
We need the security of advice because we cannot countenance the consequences of not talking advice. I read last night of a couple who handed the keys to their family home to their children in the hope that this might prevent its value being dissipated in payment of nursing fees. If they had taken the advice (of those recounting the story), they could have kept the property and have only been liable for £23,500 of savings. The detail is not important, the moral of the story was that the finances (that of those due to inherit the property) had been wrecked by not taking advice.
People read stories like this and then take advice because they need to – in behavioural terms, they herd out of fear. Active managers play to this fear, the thought that “experts” look out for you is comforting in two ways, it acts as a placebo and, should the medicine fail, it gives the patient someone to blame. Intermediation acts as an emotional cushion and in extreme cases as a safety net – people are increasingly taking recourse to law.
Need is part of it, but greed is also part of the process. It is natural for people to compete to be considered experts. People take pride in being able to afford wealth management and they enjoy the anticipation of seeing their fund managers outperform not just the market, but other fund managers. This is more than “beggar thy neighbour”, this is a hard-coded behavioural instinct of the human species at work. People herd out of greed as well as fear.
The question is whether Government should intervene to prevent these herd instincts sucking sufficient money out of the financial system that Britain is the poorer. I think there is a limited case for intervention, – we might say there is a case for “reasonable force”. Workplace Pensions, which are typically the second line of defence against illiquidity in later years, should not be exposed to unnecessary risk. Money spent through auto-enrolment is not discretionary spend, the Government can reasonably apply a requirement to demonstrate value for money based on rational rather than behavioural economics.
But the discretionary spend on fund management that is indulged on advisers, platforms and active fund managers is another matter. In a recent article, the Financial Times spoke disparagingly about the flows of money through Hargreaves Lansdowne’s SIPP platform which were almost entirely into passive funds. This was described by the editor of another publication as “propaganda”. I tend to agree.
The Asset Management Study needs to make a clear distinction between money allocated to meet fundamental liabilities (activities of daily living) and money allocated for discretionary spend. It has a right to drive down the cost of intermediation well below 2% pa on “default investments” into workplace pensions. It should pursue any slippage and ensure that it is included in a cap on charges. This money is not advised, it is money that is being extracted from people’s wages on a semi-compulsory basis and it is the business of Government to exercise a high level of control over its management.
But intervention into areas of discretionary spending is the Government’s business and while the press can point to the economic advantages of passive funds, they should be careful not to brand active management immoral. That judgement is for the reader – the consumer – to make.
We have actively managed funds, because many people prefer them to passive funds.