Friday, April 24, 2009

Are most pension funds ponzi schemes?

Hedge funds, mutual funds, pension funds, pre-need funds…you name it, they’ve all taken a beating these past couple of years. Many are likely one step away from possible liquidation, as security assets across all classes, across all sectors, and across all types have all fallen from their all-time highs. And as fund assets fall, many open ended funds have experienced massive withdrawals, which have resulted in further writedowns, further losses, and further fund deterioration.

We are a long way off from the time when investing in funds were thought of as sensible savings. Now, many types of funds are proving to be major wealth destructors. Could this have been foreseen by more people beforehand?

It seems , for now at least, that the biggest source of growth for many of these funds was not their managers’ asset selecting prowess, but their ability to continually attract more capital into their portfolios. As more money came in, fund values increased, and as more funds resulted in more purchases of security products, it all resulted in the virtuous cycle of investor confidence leading to better results. Now, it’s the other way around. Now, it’s panic leading to the vicious cycle of even worse results.

So just how much of these funds’ previous success was really due to asset selection vis-à-vis funds attraction? Getting at an answer should be crucial in determining whether continuing to have a multitude of funds, all independently striving to attract capital to redeploy towards various assets, really results in increased wealth creation over-all. After all, if it turns out that many of these arrived at their previous stellar returns merely because they were successful in growing their assets under management, then it can lead us to believe that many funds are really giant ponzi schemes – with stellar results only possible for as long as more investors are being attracted into the game.

Another question I keep asking is, just how much higher can we expect the return on investing in funds, on average, supposed to be than over-all growth in the economy? After all, if the general performance of securities assets depend on the fundamental performance of the companies who issued them, and the fundamental performance of companies, on average, depends on over-all economic growth, well….you get the message.

Is it then more sensible to just have one giant fund, one whose performance will correspond to that of the economy, and be divorced from success in attracting capital? To do this, it would be important to make it the only game in town. In other words, anybody wishing to invest in a pension fund will have no other choice but this fund. This fund will grow as the population of premium payors grows, not because a multitude of funds constantly involve themselves in a pyramiding scheme of selling assets at constantly higher rates to one other. Just make sure that those receiving pension payouts are always outnumbered by those making premium payments.
I admit I’m no actuarian, and I haven’t run any numbers. But at a conceptual level, it seems having one giant fund can make sense, more than having a multitude of small funds, many too small to weather major economic storms, to be the arbiter of people’s savings.

For more detailed ruminations on this particular subject, Leo Kolivakis over at Pension Pulse would probably be your best source.

1 comment:

DaveP said...

Henry Blodget's book "Wall St Survival Guide" (if memory serves) kind of makes that point, that since you can't really time the market unless you watch screens full time, you should really just "buy the market" with index funds, and try to control costs...that 1% fee will kill overall by almost half over 50 years.

He said pretty much any tax-free 401k Vanguard fund should beat the pants off a managed fund, with all the trading fees, etc.