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Another public body blow to active management

The anomalies of language can often be instructive. What Americans properly call “pensions”, British call “schemes”.

The Brits claim to speak English, and we Americans find their accents quaint and, if you consider the rampant overuse of British accents in US media any evidence, vested with a soupçon of sophistication. So it was with interest that we read in the Financial Times, Britain needs local authority pension revolution. Americans particularly like revolutions that involve the British.

It seems the Department for Communities and Local Government had the good sense to retain the consulting firm of Hymans Robertson to review the pension operations & results of funds managed by Local Government Pension Scheme, which is one of the largest public sector pensions in the UK, managing some 99 pension funds for more than 4.6 million members comprising some £178 billion. It’s a pretty big deal.

The conclusions are also a big deal: they found that the active management of listed assets (i.e. the publicly traded stocks & bonds) of the funds added no value. Let’s repeat that: the active management of the funds added no value. An excerpt from the DCLG report follows:

4.20 Hymans Robertson considered the performance before fees of equities and bonds in aggregate across the Scheme over the 10 years to March 2013. This new analysis, evaluating the funds’ investment as one Scheme, showed that there was no clear evidence that the Scheme as a whole had outperformed the market in the long term. They concluded that listed assets such as bonds and equities could have been managed passively without affecting the Scheme’s overall performance. [emphasis added]

The table below is reproduced from Hymans Robertson’s LGPS structure analysis of Dec 2013, p.20 (the link is to the full 105 page report). As you can see below, the cost of active management is frequently higher than the excess returns it is supposed to generate. Oh, and, yes, excess returns are supposed to be positive. You can see that two of them aren’t.

 The DGLC summary goes on to note non-trivial savings in management fees:

In their report, Hymans Robertson quantified the fees savings achievable from moving to passive management of listed assets as £230 million per annum, assuming that all funds participated.18

 but wait there’s more!

In addition to the savings arising from lower fees, a move to passive management

will also reduce the level of asset turnover. This occurs as investment managers buy and sell assets within an asset class. Both passive and active managers buy and sell assets, but turnover is generally much higher, and therefore more costly, under active management. Hymans Robertson estimated that if all of the Scheme’s UK and overseas equities had been managed passively in the financial year 2012-13, turnover costs would have been around £190 million lower.19

Hmmm... that makes £420 million of savings per annum for the investors... that’s a lot of bananas for merely eliminating unproductive active management fees and reducing turnover by transitioning to a passive, indexed approach.

None of this is new, particularly not to us or our clients. These findings merely freshen & confirm what many other studies have found (see the footnotes to the Hyman report and pretty much anything Vanguard publishes). What is new is the scale of this initiative and the transparency in the institutional sector. LPGS manages significant size, gets excellent execution, and has access to the “best of breed” active managers globally. Unfortunately, it seems that breed isn’t getting it done, seems to generate only management fees for itself. No doubt this public confirmation will add pressure on pension & institutional portfolio managers in the US as well as the sponsors & administrators of 401k plans. We note there is a whole, costly bureaucracy & supporting infrastructure that accompanies the active management.

If large scale institutional investors can’t make active management of traditional asset classes work, what chance do medium & small institutions have? Retail investors? Slim to none we suspect. If you’re paying for active management of traditional asset classes, you’re likely not getting value.

Watson Wilkins & Brown, LLC, designs risk efficient portfolios and executes with low cost, tax efficient indexed product. It is what we have done since inception: indexed based asset allocation.


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