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Wednesday, March 19, 2014

Australia Does Retirees No Favor

Matthew C. Klein over at Bloomberg View argues that the most recent move does:

The biggest pension fund in Australia is planning to directly manage 30 percent of its assets by 2018, rather than outsource the task to expensive external managers who rarely justify their high fees with superior returns. This should help the fund cut costs and boost retirement benefits.

While the basic premise—actively managed funds usually don't justify their high fees—is correct, this proposed reform is likely to make things worse rather than better, at least for the putative beneficiaries, for two reasons:

First, while it is true that few (if any) investment managers can, on an expected value basis, beat the market and those few which may be able to will not share the rents of their talents with the average investor, it is possible—easy, even!—to do worse.

Now look at the crop of managers these funds are going to hire at a fraction of the salary that people with similar skill sets and resumes earn at financial institutions (they have to pay much less or there wouldn't be any fee savings). Some of these hires will doubtlessly be motivated by idiosyncratic factors to take a big pay cut and do fine work. The rest, however, will be the ones who cannot get a job at a private financial institutions. This may be due to incompetence or ethical issues. In either case, that is not who I'd want to manage my funds, even at a cut rate.

Second, there are advantages to having an outside investment manager who is shielded from the whims of a political master and is only periodically called to account on the basis of performance. Inside managers under direction of a political master, be it a government or a union, will make investment decisions to punish the master's political enemies or prop up the master's boondoggles. This may happen under express policies—"No Money for Scab Companies!", "We Invest Green!"—or sub rosa—the business partner of the nephew of the governor's chief of staff has a wonderful business idea on which we can get in on the ground floor!—but it invariably happens. Again, this is not how I'd want my funds invested.

Australia should take what even Klein agrees is the first best solution: Invest in index funds and let the market do their thing.