By Bob Campion
There is no longer any excuse for institutional pension schemes running up enormous annual bills in fees and charges to investment managers. With the possible exception of very large pension schemes who have the resources to research and invest in illiquid alternative investments, passive funds can, and should in many cases, make up entire pension fund portfolios.
That may sound a surprisingly strident statement, but the reality is that today, good, safe, passive funds are available in all global asset classes, including liquid alternatives. They are low cost, often extremely efficient trackers, and need far less research and monitoring than active funds. They often perform better than the average active fund and because selecting them and monitoring them is less labour intensive, trustees of occupational pension schemes are freed up to focus on what matters far more – getting their asset allocation right.
Not convinced? Consider the facts. US asset manager Vanguard researched active managers across a wide range of equity and bond asset classes over the last five, 10 and 15 years in a report entitled, The case for index-fund investing for UK investors. The report discovered that over the last five years to the end of December 2012, the proportion of eurozone equity, global bond and European bond managers who beat their benchmark was 0%. That’s correct – zero. Active managers were more successful in UK equities, where a massive 52% beat their benchmark over this time period, but in fixed income and other equity asset classes over all time periods rarely does the proportion that beat their benchmark rise above 30%.
In fact, we calculate that the likelihood of a trustee board choosing a portfolio of four equity and four bond managers that all beat their benchmarks over the last five years is 42,480 to 1 against, compared with finding a four-leaf clover on the first try, which apparently stands at 10,000 to 1. By contrast the chance that less than half of these eight managers beat their benchmarks was 21 to 20 – odds on! Our own studies back up this research.
A look at the performance of UK equity funds over five years to the end of June 2013, taking account of the sort of fee reductions that an institutional pension fund would be able to command, shows that the median active fund underperformed its index by 4.6%. A typical passive UK equity fund would have performed much better – one passive fund we have used for client portfolios fell short of its index by just 2.4% over the same period. And that is not surprising, because active funds are heavily burdened with costs – the cost of large research teams and expensive systems that weigh heavily on its performance. It is quite possible to build a highly diversified portfolio containing all flavours of government and corporate bonds, emerging and developed market equities, property and commodities exclusively using passive funds for an overall annual cost of 0.2% or less, compared with 0.6% or more for a portfolio of active funds. And by saving 0.4% a year a £50m pension scheme would cut their annual costs by £200,000 a year – or more than £3m over the course of 10 years, if the scheme is growing at 6% a year.
What really matters is not which fund you use, but what your asset allocation is. That is why pension funds are turning away from time-consuming active funds towards simple, efficient passive funds which allow them to focus more attention on getting their strategic asset allocation right and monitoring their ongoing allocations on a more regular basis.
This, in our view, is the future of institutional portfolio management.
Bob Campion is institutional business director at Evercore Pan-Asset
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