Being a part of the passive or evidence-based investment community can be very isolating at times. It is a constant uphill battle against a financial services industry that is largely built on an illusion that some investors have a skill that allows them to identify when securities are unfairly priced. Most of the stories written by active managers or financial journalists are gnawing at human tendencies of fear and greed and giving "advice" that further perpetuates this illusion. Few investment professionals provide an education on how financial markets really work. But there are more frequent success stories for passive investors that often go unmentioned and we believe deserve their own spotlight.
Certain public pension plans have taken a leap forward in revising their investment policy statements and governance practices. Most recently, the City of Fort Lauderdale, Florida, City Commission unanimously approved an investment policy for one of their pension trusts that explicitly directs its assets into low-cost, passively managed mutual funds.[i] Further, they crafted their policy to create a fiduciary standard for all of their consultants/advisors and managers, prohibit revenue sharing and commissions, and enhanced transparency by requiring detailed and comprehensive performance and fee reporting data.
In moving to an evidence-based, passive investment policy with low-cost and diversified index funds, the city has now incorporated my analysis and the research of Nobel laureates like Eugene Fama, Harry Markowitz, Paul Samuelson, William Sharpe, and Merton Miller and the advice and writings of Warren Buffett, Burton Malkiel, John Bogle, David Booth, Ken French, Charles Ellis, William Bernstein, Larry Swedroe, Jason Zweig, and Richard Ferri.
In addition to Fort Lauderdale, similar successful initiatives that deserve praise have recently been taken by:
- Orange County, Florida 457 Retirement Plan
- Nevada Public Employees Retirement System (NVPERS)
- California Public Employees Retirement System (CalPERS)[ii]
- Montgomery County, PA Pension Fund
That said, while these policy modifications seem like common sense and are supported by some of the world's foremost financial and economic experts, such policies have only been adopted by a handful of pubic pension plans or institutional funds.
The laudable changes in these retirement systems as well as legislation taken up by some state and federal governments, have come in the wake of a glaring retirement crisis that this nation currently faces. Public state and local pensions are underfunded by more than $1 trillion, according the Retirement Security Initiative, a pension advocacy group. Yes, that's $1 trillion. Some experts even put this gap at $4 trillion -- and taxpayers are on the hook for it all.
While public pensions face the risk of not realizing various assumptions, such as expected returns and future liabilities, the historical returns of state pension plans across the entire country have been below that of passively managed portfolios. We have captured this analysis in our article "State Pension Plans - A Deeper Look at Performance." While certain assumptions about future employee compensation, tenure, and inflation are all additional model risks to be concerned with, investment underperformance and higher fees have been equally damaging to the funded status of most public pensions.
Back to the good news: many public pensions around the United States are starting to embrace the symbiotic relationship of fiduciary duty and low-cost, evidence-based investing. With the overwhelming amount of research that has documented the superiority of such passive investing strategies, trying to speak of fiduciary duty in any other context is beyond comprehension. As stewards of public interest, many boards are waking up to the realization that it is not just the retirement security of public employees that are at stake, but all taxpayers. As Merton Miller said, "...Any pension fund manager who doesn't have the vast majority -- and I mean 70% or 80% of his or her portfolio -- in passive investments is guilty of malfeasance, nonfeasance or some other kind of bad feasance!"
Underperformance in public pensions puts pressure on community leaders to reduce pension benefits, raise taxes on their citizens or cut spending to other public programs like education, emergency response, policing and infrastructure.
We applaud the groundbreaking efforts of citizen pension activist William F. Goetz, MD, the pension boards and the administrators in Fort Lauderdale who made these modifications to their investment policies that incorporate evidence-based investing.
[i] City of Fort Lauderdale City Commission: http://www.fortlauderdale.gov/home/showdocument?id=14671. March 2016.
[ii] Kephart, Jason. "Largest pension fund considers dumping active management." Investment News. March 19, 2013.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.