Our journey is almost done.
We’ve explained how the odds are heavily stacked against the ordinary investor - and how, by settling for an average return, and refusing to pay a small fortune in charges, you can end up as one of the winners, saving yourself a great deal of time, effort and worry in the process.
But there is a much bigger issue here. It’s not just we as individuals who are losing out. The whole world faces a pensions crisis. We’re living longer, and although most of us will work longer, there’ll be huge numbers of people retiring without enough funds to sustain them through their later lives.
In deciding to dispense with active management for its Local Government Pension Scheme, the UK has joined a list of governments - including Australia, Norway and California - which have started to question the traditional way of doing things.
Michael Johnson from the Centre for Policy Studies says: “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.”
The investing sector has become a key component of the global economy. Here in Scotland, for example, hundreds of fund managers, brokers, advisory firms and consultants have concentrated around Edinburgh, now Europe’s fourth largest financial centre.
Yes, the sector does make a key contribution to economic wealth and tax revenues. But, as we’ve seen, it also takes a great deal from ordinary investors through the charges it levies. So, has the investment industry just got too big for our own good?
Merryn Somerset Webb from MoneyWeek says: “The fund management industry needs huge reform - of course it does. There are way too many funds, there’s too much attempting to produce difference out of nothing. This is a huge problem in the financial industry. If you want to sell things you need to differentiate yourself from the next guy along. But in fact investing is remarkably simple - not necessarily easy, but simple, straightforward. It doesn’t need so many different products, it doesn’t need so much differentiation, it doesn’t need quite so many people, and it doesn’t need to be so expensive.”
David Tuckett from University College London says: “I think the real problem is that there are far too many expectations in this whole area. This will be disappointing news for people in finance in a way, but really we’ve got too many people employed in it, doing too much, trading too much, for very small amounts of gain for the population as a whole, but of course a very large transfer of finance into the hands of the people doing it.”
The industry says it accepts that passive approaches to investing are likely to become more popular but, not surprisingly, it doesn’t like the idea of the active fund sector contracting.
Daniel Godfrey from the Investment Management Association says: “I don’t fear for the future because I think active will maintain a very strong role in investment management as a whole. But I think it would be detrimental to the operation of the market, to capital investment in corporate UK, if active were to become too marginalised. And I don’t believe that that will happen.”
It’s true that the market system needs active managers to function.
But the academic consensus is that a global fund industry just 20% the size it currently is would be more than sufficient to maintain market efficiency.
Many of our experts also believe that the huge financial rewards on offer to fund managers are counter-productive in that they incentivise very short-term outperformance when most people are - or at least should be - investing for the much longer term.
In 2013, the average Wall Street bonus rose 15%, bringing the overall industry total to a staggering $26.7 billion. And remember - that’s not salary - that’s bonuses.
Somerset Webb says: “The bonus system is absolutely ridiculous. The very idea that we should be paying people extra if they perform well I always find absolutely infuriating on the basis that we are already paying them for them to do their best. If they do do their best, why should we have to pay them more?”
If there were fewer fund managers earning more modest pay packages, perhaps more of our brightest graduates would shun the City, and pursue careers instead in sectors where they really can make a difference.
As John Bogle likes to say, it’s not the speculators or the markets that add value. Ultimately it’s successful businesses that drive investment returns.
And despite the lazy way which in which business and the markets are often lumped together by journalists and politicians, those are in fact two very different things.
John Bogle says: “The function of the securities markets is to allow new capital to be directed to its highest and best use. Thats true, but think about the maths for a minute. We probably have about $300 billion a year that goes to new and additional offerings. We trade $56 trillion, and that means something like 99.5% of what we do as investors is trade with one another. And 0.5% is directing capital to new business. There is a system that has failed society. Period.”
So, there’s wide agreement that the investment industry needs to change. But where will change come from?
Michael Johnson says: “I believe the industry realises a lot more than it’s ever willing to fess up. Underneath the surface, the individuals in the City in general realise that they’ve had it too good for too long. Now will change come from within? Pretty unlikely. The trade bodies, of which the IMA is one, are masters at doing just enough to keep the show on the road - in terms of hinting that change and improvement for the consumer is around the corner.”
Richard Wood from Barnett Ravenscroft Wealth Management says: “The IMA - the Investment Management Association - is a trade body that is there for its members. It is financed and supported by the members, which is the fund management industry and the banking industry. Is it doing a better job of protecting the investor and making things more transparent for the investor? Definitely not.”
Michael Johnson sees a key role for journalists and educators in bringing about change for the better.
He says: “There’s a strong campaign for example to increase financial education and in schools - financial literacy - and the media could usefully attune itself to the level of technical understanding of the man in the street in an explaining role, 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.”
Ultimately, though, it’s up to us, ordinary investors, to demand a better deal.
Yes, we need to put more into to our pensions and other long-term investments.
But we also have to start questioning why the industry is taking so much out. To start insisting on a fairer share of investment returns… Especially as those returns, in future, are likely to be smaller than they have been in the past.
We need to wise up. To be more realistic. We have to be less gullible and, yes, perhaps a little less greedy as well.
There are no magic short cuts to successful investing.
But, over the last 120 years so, we’ve learned so much about how it works that we simply no longer need to pay expensive “experts” to gamble with our money.
Together, we will win this game in the end.
John Bogle says: “There’s this great quote from Adam Smith in The Wealth of Nations that says theres one principle that’s so simple and so universal we don’t even need to defend it. And that is, the ultimate object of all business should be to serve the consumer.”