Dear Mr. Beard:
I read with interest an article in the Atlanta Journal-Constitution outlining the woes of your city's three big pension plans for police, firefighters, and other employees. These plans have assets of approximately $2 billion. I understand that investments in these plans are overseen by boards of trustees who retain investment advisers to give them investment advice. According to the article these advisers were paid $8.5 million in 2011.
My guess is these advisers told you how they could add "alpha" by selecting fund managers who could "beat the markets." I am sure the quality of their charts and graphs were outstanding. Their presentation was no doubt stellar. Did it focus on the past performance of the managers they were recommending? It usually does.
It doesn't seem like this process is working out too well for the hard working city employees. Last year, the returns of the three funds ranged from 1.02 percent to 2.80 percent. Over the past decade, they ranged from an annual average of 5.02 percent to 5.52 percent. In order to make up for devastating losses in 2007-2008, these plans need to achieve an annual investment return of 7.75 percent-8 percent over the next 30 years.
I have to admit that I was pretty surprised by your take on this dismal situation. You are quoted as noting that the plans need "... to assume more risk" to make up for lost ground. Despite evidence that the relatively small percentage of pension assets in index funds appear to be outperforming comparable actively managed funds in the plans, you still favor using "a mix" of index funds and actively managed funds. Your reasoning is revealing: "If I think I have a fleet of [active] managers that outperform... it may be worth paying to get that."
I believe you are barking up the wrong tree. The data on the ability of pension administrators to select outperforming active fund managers is pretty depressing. A study conducted by Amit Goyal of Emory University and Sunil Wahal of Arizona State University found that manager hiring and firing decisions made by consultants and board members of retirement plans, endowments, and foundations was a complete waste of both money and time. The study looked at the ten-year period from 1994 through 2003, and examined hiring and firing decisions by consultants and boards at 3,400 plans. It found that hiring fund managers with superior past performance on average yielded post hiring excess returns of "zero." Even worse, when these managers were fired, post firing excess returns were frequently positive and "... sometimes statistically significant." You should read this conclusion of the authors of the study: "Our sample of round-trips shows that if plan sponsors had stayed with fired investment managers, their excess returns would be no different than those actually delivered by newly hired managers."
Frankly, it is beyond me why you believe you have the ability to buck these odds.
I have a bold proposal for you, but first I want to acquaint you with additional data.
Your best plan annualized return was 5.52 percent over the past decade. If you had invested in a globally diversified portfolio of all passively managed funds (using no actively managed funds), in an asset allocation of 60 percent stocks and 40 percent bonds, rebalanced at the beginning of each year, your returns would have been 6.02 percent annualized return for the period ending Dec. 31, 2011. No need to take unnecessary risks by over allocating to stocks.
Your goal is to achieve a return of 8 percent for your plans over the next 30 years. The simulated index portfolio mentioned above achieved an annualized return of 9.82 percent over the past 30 years and 9.55 percent over the past 50 years.. The composition, risk and returns of that portfolio can be found here. Sources, updates and disclosures can be found here.
Here's my proposal:
Fire all of your active managers. Abandon the notion that you have the ability to pick "market-beating" fund managers. You'll be in good company. The Thrift Savings Plan, which is for government employees, has over $270 billion under management. It is all indexed. Our congressional representatives are participants in this plan. That should tell you something!
You can dismantle the huge infrastructure you have for picking new funds and eliminating losers. It's really just a charade. I know the active managers will howl in protest. Here are some questions you can ask them:
1. Can you show me a peer reviewed study where a methodology for picking out performing active managers has been actually implemented and demonstrated to work over a long period of time?
2. If you really had the ability to select these managers, why haven't you done so for our plans in the past with any consistency?
3. Can you show me the returns versus Morningstar Assigned Benchmark for all of your proprietary mutual funds? Logically all, or most of them, should be outperforming their benchmark since I assume your superior manager picking skills would start with the funds that carry your brand.
You really need to focus on the data. There's no shortage of it. You will find it summarized in my books, and in books authored by John Bogle, William Bernstein, Burton Malkiel, Mark Heber and many others. Your police and firefighters put their lives on the line for the protection of the citizens of Atlanta. At the very least, you could educate yourself on basic principles of investing and enable them to retire with dignity.
Sincerely,
Dan Solin
Dan Solin is a senior vice president of Index Funds Advisors. He is the New York Times bestselling author of "The Smartest Investment Book You'll Ever Read," "The Smartest 401(k) Book You'll Ever Read," "The Smartest Retirement Book You'll Ever Read" and "The Smartest Portfolio You'll Ever Own." His new book, "The Smartest Money Book You'll Ever Read," was published December 27, 2011.The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated.
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