Wednesday, November 16, 2011

Super is a con, perpetrated by people who con themselves

Wednesday column

Whatever happens in Europe we can take comfort from the knowledge that our money is being handled by professionals - experts who’ll know what to do.

They do, don’t they? It’s about to become more important.

Wilful blindness by the government and spinelessness by the opposition have ensured the amount of compulsory super we are forced to hand over to money managers will climb from 9 per cent to 12 per cent of our salaries by the end of the decade (unless we run self-managed funds and try to make a go of financial markets ourselves, something that won’t happen on a large scale and would unmanageable if it did).

Many of us will have to take out larger mortgages than we would have and hold them for longer in order to feed the money management machine. We won’t have the income we would have to pay them off.

Henry recommended against it. He didn’t buy the fiction that the extra super contributions would come from employers (who would presumably get them from thin air). Neither does anyone else, when pressed. The money will come out of future wage increases, giving us less control of what should be our own money.

And giving fund managers more. Even if we have to borrow to give it to them. The Coalition opposed the move for the right reasons - it is financially reckless, costing the budget more in tax concessions than it will raise from the mining tax intended to funded it, it eats into the income of hard-pressed Australians at the times when they need it, and it is paternalistic on a scale that makes mandatory precommitment for poker machines look inoffensive.

And then the Coalition backed down. It’ll tear apart the carbon tax but according to Abbott “national savings and retirement incomes are a significant issue particularly with an ageing population and that’s why the Coalition has decided that we won’t rescind the legislation should it go through the parliament”.

Which pushes us into the hands of fund managers, and in many cases the union-dominated boards who appoint them. They might just be worth their fees if they could get us a better return than we could get ourselves paying off our homes.

The latest Superratings table shows they can’t, over a sustained period of time...

For the past five years the median “balanced” fund has returned an average of just 0.92 per cent per year. Over each of the past ten years the return has averaged 5.16 per cent. Since compulsory super began back in 1992 the return has averaged 6 per cent. The first is way below below inflation, the other two don’t match the return from paying down a mortgage.

Rewarded with generous fees and a leglislatively-directed (increasing) flow of our money into their hands regardless of performance it would be reasonable to imagine fund managers had something special.

They do. Nobel Prize winning psychologist Daniel Kahneman calls it the “illusion of skill”.

Kahneman won the 2002 economics Nobel for groundbreaking research into the way we make decisions. He saves a special place in his new book Thinking, Fast and Slow for “stock pickers”, who he says attempt to make much of their money buying and selling from each other.

“Most of the buyers and sellers know that they have the same information; they exchange the stocks primarily because they have different opinions. The buyers think the price is too low and likely to rise, while the sellers think the price is high and likely to drop. The puzzle is why buyers and sellers alike think that the current price is wrong. What makes them believe they know more about what the price should be than the market does? For most of them, that belief is an illusion.”

University of California Berkeley professor Terry Odean examined the trading records of 10,000 private investors over a seven-year period, sifting data on more than 160,000 transactions.

On average the shares the private traders sold did better than those they bought by a very wide margin of 3.2 percentage points, an “achievement a dart-throwing chimp could not match”. Private traders feel compelled to lock in gains by selling good stocks and don’t like taking losses by selling bad ones. Men are worse than women because they act “on their useless ideas significantly more often”.

The winners, on the other side of trades, are fund managers who are less likely to make those mistakes because they are less emotionally committed. But that doesn’t mean they are especially skilled.

As Kahneman says: “The diagnostic for the existence of any skill is the consistency of individual differences in achievement. The logic is simple: if individual differences in any one year are due entirely to luck, the ranking of investors and funds will vary erratically and the year-to-year correlation will be zero. Where there is skill the rankings will be more stable. The persistence of individual differences is the measure by which we confirm the existence of skill among golfers, car salespeople, orthodontists, or speedy toll collectors.”

Study after study over 50 years - including those done by Kahneman himself - has failed to find any significant year-to-year correlation in the perfomance of US fund managers. Some do well for a while, some do badly - but no more so than would be expected by chance. In Kahneman’s words, “for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. Typically at least two out of every three funds underperform the overall market in any given year. The year-to-year correlation is very small, barely higher than zero. The successful funds in any given year are mostly lucky; they have a good roll of the dice.”

Fund managers don’t see themselves that way. Like most of us, they think we’re better than average. “The subjective experience of traders is that they are making sensible educated guesses in a situation of great uncertainty,” Kahneman writes.

But if the way markets work mean their guesses are no better than blind guesses I don’t feel particularly good about entrusting my financial future to them. I certainly don’t feel good about being forced to entrust them with more.

Published in today's SMH and Age

"There have been many good books on human rationality and irrationality, but only one masterpiece. That masterpiece is Daniel Kahneman’s Thinking, Fast and Slow." - Financial Times

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