You may have heard your consultant or pension fund trustee taking about an asset management’s house view? Or a discussion about whether funds should be invested according to a value or growth mandate? These are investment philosophies.
Steven Nathan, CEO of 10X Investments, and his team explain here why you shouldn’t take investment beliefs too seriously. These philosophies aren’t conclusively supported by empirical evidence, they caution.
What’s more, new research from Oxford University suggests that recommendations from the world’s largest consultants has been poor. Their investment choices have consistently under-performed the market averages.
Few industries produce incredibly wealthy employees like the investment sector does. Huge sums are paid to those who understand how to crunch numbers and present these in a tantalising fashion, like the intermediaries tasked with making investment decisions on behalf of us mere mortals. If you are in awe of these people, pinch yourself now. – JC
SA Retirement industry beggars belief – and accountability
“What is your investment belief?”
This opening gambit is tantamount to a secret handshake. The appropriate response immediately aligns the two parties: yes, there IS a way to exploit the irrational behaviour and inefficient pricing of OTHER investors, and beat the market return.
When investment professionals refer to their investment beliefs, they refer to the secret ingredient – their stock picking or market timing tool – that will help them deliver an above-average return.
By definition, a belief is a personal conviction, not conclusively supported by theoretical or empirical proof. If it were proven, it would be an investment fact. But few facts attach to investing – little on this subject comes with a high degree of certainty. When the industry claims that investing is not an “exact science”, that is precisely what it means – its processes are not exact, and they are not based on science. A course in investment management covers finance theory and behavioural finance, but not finance science.
This is why, in order to make investment decisions, fund managers formulate investment beliefs. Little is disclosed about these beliefs, but they are implicit in virtually every investment decision. They are also implicit in the industry’s marketing: “We do not guarantee our future performance, but we want you to trust in our beliefs and let us wrap our trunk around your savings.”
There is no universal investment belief. Every fund manager will choose their own strategy, set their own rules, execute on their own parameters. Some buy into growth, others into value; some are contrarian, others chase momentum; some favour bottom-up stock-picking, others top-down macro-economic themes – and each will have their own variations on the theme. Every strategy pays off some times, but not all the time, and not all at the same time, because they are all part of the same zero-sum game. The market return is finite over any given period and for one strategy to succeed, another must fail.
Yet each fund manager will imply that their belief system is superior, and will deliver an above–average outcome.
The role of the asset consultant is to weigh up these various belief systems, and recommend which one might actually deliver an above-average return. Given they have no way of knowing, they super-impose their own set of beliefs.
Many trustees – particularly employee representatives in stand-alone funds – appoint consultants to make this decision on their behalf. They believe their asset consultant has the right answer.
Fund members appoint trustees to choose service providers on their behalf. They, too, believe they have chosen the most astute trustees.
In this belief system, each layer abdicates responsibility to the next. No one exercises professional judgement (asset consulting and fund management are not professions[1]) and no one is truly accountable. The word “belief” acknowledges that the outcome is uncertain and automatically disclaims responsibility if it disappoints.
And outcomes disappoint. The Financial Times recently quoted research from Oxford University that the investment recommendations from the world’s largest investment consultants under-performed the market by 1.1% per year between 1999 and 2011. By paying for this poor advice, investors were penalised twice.
Of course, someone else to blame. If the fund manager fails, it is because their investment style does not suit current market conditions – it favoured growth over value, dividends over earnings, index trackers over stock pickers. The asset consultant, in turn, will blame irrational markets, the trustees will nod sympathetically and the fund members will dumbly acquiesce. To do anything else would be to question the adopted belief system and to accept responsibility. But no one likes to question their own beliefs (at least until they discover a new set of beliefs).
Some things are just beyond anyone’s control.
And that is the point – the future market return is beyond anyone’s control or certain prediction, because what we think we know about the future is already discounted. Everyone has an opinion, but no one knows which asset classes, which sectors and which securities will do well over the next year. Even highly informed opinions tend to be at odds with each other, and wrong half the time. We don’t know which half.
But among the many thousands of investment opinions that appear daily, there are some irrefutable investment facts. They offer a compass to any serious long-term investor.
What are these facts?
One, the market return is finite. It is impossible for all investors to earn a return that is higher than the market average. The average investor will earn the average market return – before fees.
Two, no fund managers can reliable beat the market return. And the empirical evidence is that the great majority of active fund managers underperform the market over the long-term.
Three, the annual investment fee % is certain. We don’t know what the future market return will be, but we can be sure of the fee that will reduce it. The higher the fees, the lower the investor return.
The legal and moral fiduciary duty to consider these facts lies with fund trustees and their advisors – they oversee other people’s money and they must serve the interest of investors. If they wilfully ignore these facts, they are either speculating, or acting out of ignorance of self-interest.
In the real world, most trustees and consultants do not fulfil their fiduciary responsibility. They wilfully ignore the facts and back their personal beliefs. They speculate on picking active fund managers that may or may not beat the market and they willingly pay higher fees for the less than even chance of a higher return. Yes, they all believe they will earn an above-average return for the fund members, but they know this is mathematically and logically impossible.
They can afford to indulge these beliefs because they are not held to account for ignoring the facts. This allows them to pursue commercial interests and disregard the long-term interest of retirement savers.
National Treasury is deeply concerned by this. Its July 2013 paper on retirement fund charges criticised several investment practices that favour consultants and fund managers over investors. It specifically referred to under-performing active managers, high fees and conflicted consultants.
The Pension Funds Act places the ultimate fiduciary responsibility onto trustees. They may delegate certain tasks, but not their responsibility. If they rely on the advice of consultants, then they must ensure that this advice serves the interest of fund members. They must monitor the consultant’s performance, just as they would monitor the performance of the fund manager and administrator.
The answer is to hold trustees accountable for neglecting their fiduciary duty. The Regulator may be surprised at how quickly personal liability will wean trustees’ off their consultants’ advice and make them focus on investment facts, and on sensible investment principles, instead.
Only then will retirement investors get what they need, not what the retirement industry wants.
[1] ”A profession is a vocation founded upon specialized educational training, the purpose of which is to supply objective counsel and service to others, for a direct and definite compensation, wholly apart from expectation of other business gain.” (from Wikipedia)
This blog is republished here on Biznews.com with the kind permission of 10x Investments.
