Yesterday’s blog entry set forth the text of an e-mail that I received from a community member named “Larry” on November 2, 2009. Set forth below is the text of an e-mail that I sent to Larry later that same day (there were several short e-mails sent between us prior to this one).
I understand the need for pension funds to adopt more reasonable assumptions. If you think it helps, I think I could dig up an editorial that Rob Arnott wrote for the Financial Analysts Journal several years back highlighting this very concern.
They’re just not investing rationally. They are using assumptions that make no sense. For example, the most likely 10-year return on stocks in January 2000 was a negative 1 percent. They were using high positive numbers.
I view this as a political/competitive problem. If one pension fund manager used realistic numbers, he would be fired. That fund would be so far behind all the others in its assumed returns that it would not be tolerated. If ALL the pension funds used accurate numbers, all the pension fund managers would be greatly relieved. My guess is that they would feel much better about themselves if they could use accurate numbers.
But the process of getting from where we are to where we need to be is a political problem, in my assessment. It’s like trying to solve the deficit problem. There is universal agreement that it needs to be solved but it is in neither party’s interest to be the one that takes it on. We need some player at the table who is able to take the GENERAL interest into consideration.
This is what the economists call “The Tragedy of the Commons.” Every single pension fund benefits from using realistic numbers. But not one pension fund manager dares to be the first one to employ accurate numbers because it would make his fund look so much worse in relative terms. The problem is either solved across the board or not at all.
One thought is that there might be an opening to solve the problem when we go to valuation levels far below fair value (after the next crash). At that point, using accurate numbers would mean using numbers MORE favorable than the Passive Investing numbers rather than less so.
Once word gets out about how stock investing works, I believe that there would be enough books written about the Rational model that we would not go back to Passive. My concern is — Can our economic and political system bear another stock crash?