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



Related Posts

. The great superannuation swindle

. While repudiating Rudd, here's an idea for Gillard -- keep super at 9%

. The stairway to super

. Most forecasts are crap

Read more >>

An incredible statement

Shadow Treasurer Julie Bishop, today:

JOURNALIST: Does the Opposition have any idea on how to free up those frozen funds?

JULIE BISHOP: If the Government had not put in place an unlimited guarantee in the first place this would never have occurred.

Read more >>

Perhaps the funds should ramp up their advertising...

HT: Harry Clarke

Read more >>

The way out of the mess some say the government created

(I am not one of them)

More managed funds are suspending redemptions every few hours. One of the latest, Colonial First State is actually owned by a bank.

If I was advising the government, I'd tell it to do nothing other than help people put out by the suspensions.

The market-linked funds had a business model that was always going to go south when times got tough. Guaranteeing money in the bank is what matters.

This morning in the Age Tim Colebatch takes a different view:

"Australia cannot afford mistakes in economic policy. Kevin Rudd made one with his hasty, sweeping pledge to guarantee all bank deposits for three years. That mistake was understandable in the circumstances, but the Government's failure since to admit it and fix it is inexcusable.

Let's be clear about what happened. Rudd's aim was to avert a potential threat to the banks; instead, he overdid it, and created a real crisis for the non-banks. The reason 14 of the 20 biggest mortgage funds have now frozen their deposits is because the Prime Minister - with the Treasurer away in Washington, and without even talking to the heads of the Reserve Bank and the Australian Prudential Regulation Authority - dramatically tilted the playing field against them.

The Government had to concede its mistake and back down. Instead, on Friday it dug itself deeper into trouble by reaffirming that any bank account holding up to $1 million would be guaranteed free of charge. The threshold is so high as to be meaningless. Rudd is either getting bad advice, or not listening.

There is only one way out, which Kevin Rudd in opposition did very well: eat humble pie, admit error, fix it, and move on."

In The Australian Michael Stutchbury wants the government to:

"Impose a fee on all guaranteed deposits, not just those above $1 million. And make the guarantee optional for authorised banks, building societies and credit unions."

And on Radio National this morning David Murray, the Chairman of the Future Fund and the former head of the Commonwealth Bank said that he wanted the government to effectively end the bank guarantee after three years by charging (a lot) for it from then on. He also suggested that the government buy in to troubled funds.

I think none of these ideas would help much...

Ending or dramatically curtailing the governemnt guarantee of deposits as Tim Colebatch wants would send a confused message. Everyone knows that bank deposits are effectively guaranteed by the government. Saying that they are not guaranteed when people know that they are would do little to change behaviour, other than adding (somewhat) to fear and uncertainty.

Imposing a fee on all deposits in return for a guarantee as Michael Stutchbury wants would depress economic activity at a time when we need to support it. And the government might say that small depositors who don't pay the fee will be denied protection, but they are entitled to believe they will get protection anyway. Legend has it that the economy-class passengers on the Titanic were told in advance they would not have access to life rafts, but when the ship sank they got that access anyway.

Davidd Murray's main idea pushes the same problems out three years, and does nothing to help now. His other idea - buying into market linked funds - scares me.

It seems to me that none of these ideas will stop the rout on market-linked funds... unless the government buys into them big time as Murray suggests and effectively guarantees them.

Meanwhile, the details of the government's guarantee appear to be evolving by the hour.

Deutsche Bank's David Plank emailed his clients yesterday about details the Australian Treasury had put up on its website.

This morning he has emailed:

"In a short note published yesterday afternoon we commented on the 'Design and Operational Parameters' statement published on the Treasury's website at some point on Sunday. This statement clarified some aspects of the scheme.

However, this statement has now disappeared from the Treasury's website. Instead the website says the statement has 'been archived or updated and is no longer available.'

- At this stage we have been unable to find out why the statement has been removed. When we do so we will comment on whether any of the design features are going to be changed."

Strange days indeed.

Read more >>

Tuesday column: Most forecasts are crap

It’s the time of year to make forecasts - to gather together a group of experts to predict the course of politics, interest rates and the stock market throughout 2007. Most of the papers do it.

I’m here to issue a consumer warning: You would get a better handle on 2007 if you wrote out scenarios on scraps of paper, pinned them to dartboards, blindfolded yourself and aimed the darts.

Think I’m being too harsh?

It is one of the best-kept secrets of punditry that the better known a pundit is, the less likely are his or her forecasts to be correct. That’s right – the LESS likely.

Back two decades ago psychologist Philip Tetlock of the University of California Berkely began an ambitious project. He set out to test the forecasts of 284 famous Americans who made their living pontificating about politics and economics. They were the sorts of people who opine on chat shows, or get quoted in the newspaper on days such as today...

It wasn’t easy to test the predictions that they made in the media, because they were loaded with get-out clauses: words such as “remote chance”, “maybe” and “odds-on favourite”. As he says in his book Expert Political Judgement: How Good Is It? How Can we Know?, the word “likely” could mean anything from barely better than 50/50 to 99 percent.

So instead he asked them his own questions, each time offering three alternatives. One was the status quo, the second was a move in one direction, and the third was a move in the other. In Australia right now such a question would be: How will the Coalition fare in the next election? Will its proportion of the vote (a) stay the same, (b) increase, or (c) decrease?

He asked his experts to assign a probability to each outcome and examined how they fared a year later.

Over two decades he accumulated 82,361 testable forecasts.

He found that not only were the experts predictions not particularly good, but that as a group they had performed WORSE than if they had just assigned an equal probability to each of the scenarios presented to them. That is to say the experts would have done better by ignoring what they knew and assigning option (a) a probability of 33.3 per cent, option (b) a probability of 33.3 per cent, and option (c) a probability of 33.3 per cent.

Put more bluntly: the professional pundits would have done better had they used dartboards.

Tetlock asked the experts both about topics about which they knew a lot (for instance, economists were asked about interest rates, political scientists about elections) and about topics about which they knew little (economists were asked about politics, political scientists about the stock market). He expected the experts to perform better when asked about areas within their fields of expertise. Instead he found no statistically significant difference.

His conclusion: beyond a certain level of general knowledge, the kind you can get from reading the newspaper, extra specialist knowledge doesn’t seem to improve your ability to make predictions.

And there was one group of pundits that performed particularly badly when their predictions were put to the test – the pundits that were the most popular on the chat shows.

Tetlock found that their forecasts were the most extreme, the most attention getting. They rarely forecast the status quo. (Which is perhaps why they kept get invited back to appear on television.)

The problem facing experts is that they have the tools (and often the incentive) to convince themselves that their pet theories are right even when a rough glance at the evidence suggests that they are wrong. They know enough detail to convince themselves of things that you or I could not.

When I worked for ABC radio I would from time to time interview fund managers about the likely course of the share market and particular stocks. I had a couple of favourite interviewees. They were the entertaining ones. But I assumed that they would at least have a better idea about the future of the market than would a person off the street. They were after all employed for that expertise.

And yet year after year, in aggregate Australian fund managers have performed worse for their clients than they would have had they just left the money in the top 100 stocks and done nothing.

Without putting too fine a point on it we would have been better off if we had we paid the experts not to manage our funds but to twiddle their thumbs.

The last financial year was actually a particularly good one for Australian fund managers. Super Ratings reports that superannuation funds on average made 14.5 per cent. But the share market itself climbed by 19 per cent.

Daniel Kahneman, the first psychologist to win the Nobel Prize for economics, has coined the phrase “delusional optimism” to describe the way in which most of us convince ourselves that we are better at what we do than we really are.

One of the techniques is to simply not look at the evidence. Foreign exchange dealing rooms, funds management houses, hospitals collect masses of data that should enable us to work out just how good each surgeon and each screen jockey really is. But most of it lies unread. Teachers resist attempts to measure their performance.

Another technique is to draw the wrong conclusion when confronted with evidence that we have got something wrong. Each time we are so confronted we make a mental note of the cause of the mistake, so that we don’t make it again. Often repeatedly. We think that this means we are learning from our mistakes.

The more likely conclusion, that we are not very good at the task in hand, rarely occurs to us.

My own view is that we need delusional optimism in order to survive childhood. And when we become adults we often join corporations (or public service departments) in which delusional optimism is encouraged.

In most jobs it counts against you to admit that you don’t know, or are not sure, or that you have doubts.

Whoever has the least doubt gets promoted, becomes manager and gets their optimistic proposals accepted, often with disastrous results.

Kahneman says three quarters of corporate mergers and acquisitions “never pay off”. Yet grander and grander ideas get proposed each year.

The grandest proposed in 2006 was the takeover of Qantas. The grandest completed in 2005 was Sydney’s Cross City Tunnel, now in receivership

But I’m not making predictions about 2007. I don’t have the expertise.

Read more >>