AB's David Hutchins explains why allocation of assets between different passive funds might be more important than the management of those funds.
You don’t have to be living in one of Philip K Dick’s paranoid sci-fi dystopias to wonder if passive approaches are all they are cracked up to be. Many investors take great comfort from the notion that their default pension scheme is entirely invested in passive funds. But that sense of security is palpably false.
We expect trustees or IGCs to keep a close eye on the performance of the fund managers. But who monitors their asset-allocation performance? The answer, unfortunately, is no one
Academic research indicates that even when a pension scheme’s underlying funds are actively managed, up to 90 per cent of the variability in outcome comes from asset allocation decisions made by trustees or independent governance committees.
When the component funds are passively managed, almost all the performance comes from asset allocation. By choosing which indices to follow, those in charge of allocating assets are essentially picking the stocks in which schemes invest.
So allocation of pension assets between different funds or asset classes is much more important than the management of those funds.
We expect trustees or IGCs to keep a close eye on the performance of the fund managers. But who monitors their asset-allocation performance? The answer, unfortunately, is no one.
The people who set the default strategy’s objectives also make all of the key asset allocation decisions. And then they review their own performance on behalf of their members.
Dissatisfaction with this state of affairs is growing. One of the clearest findings in our recent survey of pension scheme members was that there is great appetite for more transparency and increased accountability for the default strategy’s performance.
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Sadly, there is little sign of any progress here. That is a cause for concern. Evidence from other markets shows that improvements in these areas reduce product costs and enhance performance. So we should not take this passively.
David Hutchins is senior vice-president and lead portfolio manager for multi-asset solutions, EMEA at investment management company AB
