by Norm Leahy
The headline news is that Virginia and Florida are suing Bank of New York Mellon for “…cheat[ing] pension funds in those states by choosing improper prices for currency trades the bank processed for the funds.
But the real headline story that, so far, I’ve only seen posted here, is how Virginia’s public employee retirement system is paying handsomely — with retirees’ money — for investing in actively managed funds:
The Virginia Retirement System, or VRS, pays millions to Wall Street, as well as highly-paid internal managers, to oversee its $55 billion fund. The state paid $125 million more to fund managers in 2010 than it did in 2005, when the system first embraced a “more active” investment strategy. The strategy yielded results in 2011, as the fund grew nearly 20 percent, still $3.4 billion short of its pre-recession high.
The fund needs a 49 percent gain to make up for recession losses.
“The reason the fees are so high is because 89 to 90 percent of our investments are under active management,” VRS Director Bob Schultze said. “We have to go to outside firms that put out all of these results.”
This feeds into an old debate: whether actively-managed funds perform better over the long term than index funds:
The VRS could achieve similar long-term investment gains with an index fund, a computer generated investment scheme designed to react to market trends, according to Andrew Biggs, a retirement scholar at the conservative American Enterprise Institute.
“The whole point of active management is to try and outsmart the market,” he said. “But 75 percent of the time, active managers don’t beat the index funds. You can’t outsmart the market.”
Some large index funds have been able to churn out results similar to the system’s performance.
I remember having a long-running argument argument with the retirement fund managers at a former employer. They weren’t keen on index funds, preferring to stick with actively-managed funds that carried higher fees.
So I asked for information on the active funds’ holdings. When that data was provided, it was not surprising to find that funds which, by their names alone, would seem to have vastly different investment goals also tended to own shares in the same companies. But we could only see what the top ten holdings were — in the past. A complete list of current holdings was unavailable, nevermind how long those holdings had been in the portfolio. And tax considerations? Fuggedaboutit.
So what did active management provide? The promise of greater returns, but rarely greater than the index used as a benchmark. And at a far higher price, with less diversity, than those same benchmark index funds. But the idea that smart people were watching the market like a hawk every day, as opposed to a dumb index that just sat there, gave some of my colleagues great comfort.
It’s the same with the VRS. The state’s retirement plan took a huge hit coming out of the 2008-2009 market swoon. They turned to active management to try to cover the losses because they believed the smartest guys in the room would give them an edge. But that move has cost them a great deal — arguably, far more than the monies in question in the suit pending against Bank of New York Mellon.
So why does the VRS stick with active managers that cost a heckuva lot more? Sen. Roscoe Reynolds offers the classic response:
“If something went wrong, could you imagine the response from the public if we were relying on a computer? I can tell you it wouldn’t be good.”
Is SkyNet running the Russell 2000? Or the Wilshire 5000? Not yet. But there’s also no indication that the bright minds behind active investment strategies — and the costs they bring — do any better than the far cheaper, and in many ways far smarter, index approach.
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