Given his background, Michael Johnson is about the last person you’d expect to be hostile towards the City. He trained with JP Morgan in New York and spent 21 years in investment banking before working as a policy adviser to David Cameron. But Michael is a staunch campaigner for pension reform, and an arch-critic of the active fund management industry. In a recent paper for the Centre for Policy Studies, he said 80% of the industry is surplus to requirements, and that, to misquote Sir Winston Churchill, “never has so much been taken by so few from so many, and for so little in return”. We recently interviewed Michael at his North London home and started by asking him, what exactly is wrong with the industry?
Michael Johnson: In a nutshell, you have an industry of fund managers who are trying to out-compete one other in a giant negative-sum-game. They are extracting charges and fees on an annual basis which erode the capital of savers. There are bound to be winners and losers every year. Some will claim that they add value, that they win more often than they lose, but if one examines the data in detail, which I and others have done, it is nigh on impossible to work out who is going to outperform the rest on a consistent basis. Therefore, for virtually all investors, making a decision as to which active fund to invest in is a pure lottery.
SITV: You’ve described the report by Hymans Robertson for the UK Government, which advocates the use of passive funds for the Local Government Pension Scheme, as a seminal moment in the history of fund management. Why is that?
Michael Johnson: Because it really lifts the lid on what is largely an industry that adds no value to anybody. Very few people enter that industry with the express purpose of enriching others, and they’re very good at what they do, which is enriching themselves. The LGPS is far bigger than any other pension scheme in the UK, but it is staggeringly inefficient. This has been recognised by the Department for Communities and Local Government, and they’ve decided to do something about it. The Government’s decision to publish (the Hymans Robertson) research is a brave one, because it challenges a lot of vested interests, in the City of London in particular. The implications are very significant indeed.
SITV: The UK isn’t the first country to move away from active management for public sector pensions. Australia, Norway and of course the State of California have done the same. What’s driving this trend?
Michael Johnson: The driver for this momentum is that governments are realising that to the extent that pensioners have small pensions, they ultimately fall back on the state for assistance. So there is a very strong economic rationale to have pension funds perform better. It hasn’t helped the industry that we’ve had such low interest rates for so long. The tide has gone out, as the saying goes, and you can find out who’s not wearing swimming trunks. Costs, when expressed as a percentage, look very big in an interest rate environment of only 1 or 2%. So the general economic background is part of the reason why people have come to realise this is not sustainable.
SITV: You recently said we can do without 80% of the active management industry. That’s quite a statement to make.
Michael Johnson: 80% is actually not dissimilar to the sort of number you can pick out of the Hymans Robertson report. We don’t need them. We just need passive management, and by that I mean putting an end to the ludicrous amount of asset churning that goes on. If you’re an active manager, that’s a sense of, “I must be doing something to justify my existence… I must sell this and buy that.” This turnover of assets incurs costs every time it’s done, and that erodes capital. This is an industry that will go the way of some parts of heavy British industry from the early twentieth century. It is redundant.
SITV: You’ve also written papers questioning the wisdom of tax relief on pension contributions. Why is that?
Michael Johnson: The Government spends an inordinate amount of money incentivising people to save into a pension through tax relief. (In 2013) we spent a total of £54 billion in incentives. That predominantly goes into the hands of the fund management industry and makes the Treasury the industry’s biggest client. That’s nonsense. It is a subsidy from the Government for probably the second highest paid industry in the world.
SITV: What do you say to the argument we often hear from politicians and people in the City that the City of London is crucial to the UK economy?
Michael Johnson: It’s such a bizarre perspective to adopt without any evidence. They may be referring to the large amounts of income tax that are collected from people who work in the City. But I’d like to see more evidence and to factor in, for example, the hundreds of billions of pounds of taxpayers’ money that was used to rescue the banking system. I think we are in real danger of being convinced by our own rhetoric that, for the interests of UK PLC, the City of London is “crucial”. I don’t agree.
SITV: You say that politicians are finally waking up to the shortcomings of active fund management. But the media continues to give the impression that picking “top funds” is easy and that, if we do our research, there are “star” managers out there who can make us rich. What do you make of the media’s rôle in all this?
Michael Johnson: I’d like the media to be more inquisitive. I’d like to see higher quality journalism - articles written by people who have the time and the curiosity to dig under the surface. There’s not enough of that. This is an area that’s full of technical gobbledegook, and the media could usefully attune itself to the level of technical understanding of the man in the street in an explaining rôle, as well as an inquisitive role, instead of merely reporting the stories that it’s given by highly paid PR agents acting on behalf of very wealthy clients.
SITV: If there is to be change in the fund management industry, might it come from within?
Michael Johnson: Pretty unlikely. Underneath the surface, individuals in the City realise that they’ve had it too good for too long. But the trade bodies are masters at doing just enough to keep the show on the road - hinting that change is around the corner. Are they really delivering? I don’t think so.
You can follow Michael Johnson’s blog on the Centre for Policy Studies website. Michael will also feature prominently in our upcoming documentary, How to Win the Loser’s Game.