Saturday, November 1, 2008

Tales Told By Idiots

To-morrow, and to-morrow, and to-morrow,
Creeps in this petty pace from day to day,
To the last syllable of recorded time;
And all our yesterdays have lighted fools
The way to dusty death. Out, out, brief candle!
Life's but a walking shadow, a poor player
That struts and frets his hour upon the stage
And then is heard no more. It is a tale
Told by an idiot, full of sound and fury
Signifying nothing.

Shakespeare of course (Macbeth - Act 5, Scene 5, lines 17-28). He understood the narrative fallacy - a tale told by an idiot - long before Nassim Nicholas Taleb. Shakespeare's acerbic attitude towards life's storytellers came to mind as I read a commentary from one of the pension fund providers we invest with. It came with an annual benefit statement and included an analysis of the fund's performance. The prose was not exactly Shakespearean, though it showed some of the same capacity for the playful manipulation of words and their meaning.

Amidst the usual turgid obfuscation there was one chart that stood out in particular. It showed average annualised returns (1st July 1999 to 30th June 2008) for the fund we invested in compared with others. It turns out the geniuses we gave our money to had not only underperformed the average for all managed funds over the same period, they had even underperformed the average return to cash. In other words, we would have been better off a) not contributing to a pension since 1999 and b) sticking the contributions in the post office instead. For all the utter waffle in the commentary on the fund's performance, for some reason this dismal comparison was neither referred to nor explained. But at least it was there for all to see in a chart.

Nevertheless the really galling thing about the dismal performance of our pension fund is the 5% 'administration charge' levied on contributions to the pension fund regardless of the performance of the fund. That post office deposit account is starting to look more and more attractive ...

Just over half (52%) of all employees have pension coverage in Ireland (pdf) - mostly in the form of occupational pensions. By definition, nearly half don't. I very much doubt if most pension contributors take the time to read the details about their pension fund's performance (you don't have to, of course, if you are in a defined benefit scheme or employed in the public service - but I'm referring to the rest of us mere mortals here). It is also remarkably difficult to get comprehensive and up-to-date comparative information about the performance of Irish pension funds. Finfacts provides some, the Irish Association of Pension Funds provides little and the Irish Pensions Board provides none whatsoever.

The fundamental problem is that we entrust pension fund managers to invest our pension contributions for us. That's their job: they follow market trends, identify opportunities and seek to maximise returns. In theory, anyway. After all, most of us are too busy with the day job to be second guessing financial markets and adjusting our portfolio accordingly - we leave that to the experts (and pay them 5% of our contributions for their troubles).

But what if they're not up to the job: what if they are all victims of narrative fallacies - nothing but tales told by idiots? There is a premium on prescience right now as forecasters and prognosticators seek to call the bottom of the market, the best time to pile in with your investments (and pension contributions) to maximise long term returns. But they're probably wasting their time. As 'Undercover Economist' Tim Harford explains:

The efficient market hypothesis states that historical information provides no help in forecasting share prices. That would mean that examining graphs of a share’s performance, even reading this morning’s FT, would not produce a reliable strategy for judging the price of a share tomorrow or next year. That is because all useful information would already have been assimilated in today’s price ...

If the efficient markets hypothesis is true, then sensible economists will admit that they simply do not know what the outlook is for the stock market. How dull! It is much more fun to have somebody predict the future ...

Belief in efficient financial markets suggests a three-pronged investment strategy. First, ignore advertisements (and newspaper articles) that tout the past performance of particular sectors or funds. In an efficient market, past performance is not only no guarantee of future performance, it offers no clue whatsoever. Second, don’t try to pick stocks and don’t ask others to pick stocks for you: in other words, choose a low-cost index tracker. Third, don’t try to time the market: get in and out gradually.

All of which suggests that we may be paying our pension fund managers too much - way too much. Maybe we need to employ those with a better grasp of economics to look after our future welfare. People like Peter Schiff who is similarly inspired by the Bard:

When inexplicable events perplexed our early forbears, village wise men concocted elaborate and colorful explanations to soothe the populace. Earthquakes, hailstorms, and solar eclipses were all ascribed to root causes that made sense to the villagers and increased the esteem of the story tellers. The recent, unexpected surge of the U.S. dollar has led many Wall Street witch doctors to conjure a series of logic-defying tales to give reason to what is surely the random scramble of a confused herd. Wall Street spun similar yarns during the dot.com and real estate bubbles as investors groped for reasons to justify sky high prices ...

Earthquakes are caused by the fundamental shifts of tectonic plates beneath the Earth’s surface. A similar move is underway in the global economy. Describing either event without a basic understanding of either geology or economics will simply result in a tale being told by an idiot.

I expect a growing number of Irish pension contributors to weary of the tall tales spun by overpaid fund managers. Which may lead us down the road of Pensions 2.0: more of a do-it-yourself approach along the lines of Wikinvest. It will certainly be a lot more responsible than the passivity encouraged by the present system, and maybe more rewarding as well.

1 comment:

  1. I like that quote, 'tis all random.

    I think a lot of people like to have someone else manage these things for them as if it all goes wrong they can blame someone else, whereas if they manage their own affairs they've no one to blame but themselves. Indeed, there must be a good market for a low cost index tracker, nice and simple, no frills. Like the Ryanair of financial planning.

    ReplyDelete

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