Stuart Dunbar, Partner, Baillie Gifford
Followers of our Actual Investors campaign will by now be familiar with our view that the increased so-called ‘sophistication’ of the industry in recent decades is nothing of the sort. It’s a slide ever-further from the fundamentals of capital deployment into activities designed to generate returns and create wealth.
As we’ve rolled out that message around the world, it is striking how differently it has been received, depending on the type of investor and where they work.
With their location, an inverse correlation applies. The closer an investor is to a global financial hub the more focused they are on trading, dynamic asset allocation and near-term valuations. The further from those hubs, the more they care about fundamental investing. Admittedly this is a view from an investment firm in Edinburgh, but I’m pretty sure it reflects our experience.
In Singapore, Bangkok and Cape Town our message has been greeted with perplexed, albeit welcoming, responses from a mainly private wealth management audience. It had never occurred to them that investing might not be about the fundamental deployment of capital. Why were we labouring this self-evident truth?
In London, Frankfurt, Berlin and Zurich, on the other hand, the response, mainly from the pension funds, was altogether more mixed. In some cases, it was “Great that you like to mix things up a bit, even if you’re totally exaggerating”. In others, it was more “What do you mean CAPM is complete nonsense with no relation to the real world?”
The attitude in those financial centres seemed to me an odd one: It’s OK to question the conventional wisdom of structuring portfolios according to CAPM, mean-reversion and volatility. But it’s definitely not OK to expect investors or regulators to even consider doing things differently.
I know for a fact that many professional investors invest their own capital with a much longer time horizon than the one they employ for their clients, despite sharing similar investment goals.
We know that DB pension schemes are more about managing risk than about long-term investing. This is certainly the case for private sector schemes that are navigating a minefield of vastly expensive promises they didn’t mean to make.
We know too that (in developed markets) DC schemes must allow for investors’ short-term behaviour and focus relentlessly on cost. This isn’t intended as a criticism: lots of pensions scheme managers have to deal with problems in a pragmatic way that reduces risks to scheme members. But the net results are pensions systems where long-term wealth creation takes a back seat to the management of balance sheet risk and the mitigation of sub-optimal behaviours.
In his 2012 book Antifragile Nicholas Nassim Taleb wrote about how, in some systems, constant small failures make for robust outcomes. I consider this a useful lens through which to view pension schemes, none of which can be allowed to fail to meet promises. Thus DB schemes have become too expensive and have closed, while DC schemes focus on costs and volatility over ‘actual’ investment. With less risk-taking comes commensurately lower wealth creation, at significant long-run cost both to investors and to society.
Meanwhile private investors the world over have no such qualms. In most cases, we find they intuitively understand the nature of long-term investing and in practice are more aligned with actual investing than are the institutions.
I know for a fact that many professional investors invest their own capital with a much longer time horizon than the one they employ for their clients, despite sharing similar investment goals: What more evidence do we need of a well-intentioned system undermined by misaligned advisor-client interests and inappropriately specified objectives (often driven by regulations)?
We are now entrenching a structure that means pension scheme members are less likely to get good results than the much smaller, already wealthier, cohort of private investors. That can’t be a good outcome in terms of social and generational equity.
How do we address these shortcomings? Collective Defined Contribution pensions might be an answer, though the temptation to pay out lots today and assume away future shortages via heroic returns assumptions is as old as pension funds themselves. The actuarial arbiters of what can be paid out now versus what should be kept back for future beneficiaries will need to be very robust to make this work. But it’s worth thinking about.
Other suggestions for putting the pension fund focus back on the real job of long-term wealth creation, on a postcard (or email) please.