The New Zealand Superannuation Fund has done well recently but it lost the lot in 2009. It lost everything earned over its reference portfolio since its inception in 2003 and then some in just one bad year.
The Taxpayers’ Union and other critics of the fund simply say that market reversals are common. The risks of active investing outweigh the returns from chancing the taxpayers’ arm.
If the fund was defending its performance back in 2009, it would say that ‘losing the lot’ was a short-term setback in a 20-year strategy so stick with us.
The majority of the fund is managed passively. The rest, in its own words, is “under active management by a mix of local and international external managers and in-house investment professionals”. Is it still too soon to tell whether it was wise to go beyond passive investing?
The Sharp ratios published by the fund, a measure of the risk added to a portfolio for the return received compared to benchmarks such as a passively invested portfolio, show the fund is earning little in additional returns compared with the extra volatility on taxpayers’ shoulders.
A recent IGM survey found that all but one of a 100 or so top economists in the US and Europe agreed that the returns from passive investing were superior to active investing. I have never seen my profession so united. Warren Buffett also recommends a passively invested portfolio.
The debate within modern financial economics over the role of luck and skill in portfolio investment is pretty much settled. Active investing is not worth the risk. Those that beat the market for a few years in a row are just lucky, and their risk-taking will soon catch up with them.
The pioneering research into the efficient markets hypothesis in the 1960s found a far more than expected number of very good and very bad years at each end of a bell curve-shaped distribution of investment returns over the decades. Booms and crashes are not rare.
If the Super Fund is good at beating the market through active investing, check how many of its investment staff are headhunted by bigger investment houses. You should always ask this question whenever bureaucrats say they can pick winners while still on public service pay rates.
Hedge funds can pay bonuses 10, 100 and even 1000 times what Adrian Orr earned last year as chief executive. His near million-dollar salary is chickenfeed by hedge fund standards.
Rather than succumb to confirmation bias by pointing to a few good years to gloss over ‘losing the lot’ in 2009, the fund should look for evidence that contradicts its beliefs, not what confirms them. Look for inconvenient truths that are strictly forbidden if the fund is as good as it says.
If you employ good investment staff, successful at active investing, your biggest problem is they will be headhunted so you must pay them serious money. To qualify for the annual list of the top 25 hedge fund managers, you must earn at least $400 million a year.
Low staff turnover
The fund’s turnover ratio for its investment staff was 1.8%, 2.5% and 8% in the past three years. Staff turnover this low just cannot be at an investment house regularly beating the market through skill rather than luck.
A few good years can be followed by a few bad years. That is why the fund says it should be judged over 20 years. It had a terrible year recently, ‘lost the lot,’ a few good years since but almost all top economists think active investing is unwise.
The pioneer of behavioural economics and finance, Richard Thaler, said the IGM Forum question about active versus passive investing was, “The annual test to see whether panelists are awake.”
Thaler starred in the 2015 movie The Big Short as the expert breaking the fourth wall to explain how investors were blinded to the risks they were taking before the global financial crisis.
When Mr Orr is paid $10 million per year to retain his services, we can take his claims about active investing is worth the risk more seriously. It is the question asked at American MBA finance classes for decades; “If you are so smart, why aren’t you rich?”
Jim Rose is a research fellow at the Taxpayers’ Union
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