Friday Follow-Up

Relatively Right, Absolutely Wrong? 
Nobody but Rekenthaler thinks that mutual fund managers have enough skin in the game, to use the terminology of Nassim Taleb. The most successful counters to my claim were those that emphasized the importance of absolute performance. Writes one reader (who wishes to remain anonymous):

"As you correctly argue, fund managers are concerned about relative performance and do things to minimize the chance that bad relative numbers will threaten their livelihood. But … that's not nearly enough to discourage them from engaging in the kind of stupidity that puts capital and, in extreme cases like the financial crisis, the system at risk. So, if you had something that put managers on the hook in absolute terms, then and only then would they really have skin in the game. Managers have it pretty easy, this attracts them to the business, they fall into line (herd, essentially) with the indexes acting as a sort of organizing principle, and this creates systemic risks, the costs of which are borne by society as a whole."

That's a strong argument. I'm not fully convinced that forcing managers to think more about absolute returns would lead to better investment outcomes--but it might, and it also might help to ease the systemic risks that occur due to herding. It's certainly a topic worthy of further discussion.

On Taleb, another reader wrote:

"Here are the CliffsNotes on everything [Taleb] has ever written:
1) His friends are really smart;
2) He's really smart;
3) Everyone else is really dumb;
4) Stuff happens."

In other words, Taleb is the most honest man on Wall Street.

Shell Game
The response to my article on what 401(k) plans truly cost was total confusion. Some people believe that my information was complete and correct, others think that it surely was not, and another group isn't certain. The upshot is clear: 401(k) plan pricing is a disaster. It's complex, rife with behind-the-scenes deals, and distrusted by plan participants. This situation cannot persist. The 401(k) is at the heart of American retirement. It can't act like the finance department of a car dealership.  

No Smiles Allowed, Only Frowns
Today's New Consensus holds that the traditional rule of a 4% withdrawal rate on assets during retirement is unrealistic. Bond yields are down and equity values are up, thereby suggesting lower future returns on investments, which would reduce the permitted withdrawal rate. The New Consensus, however, fails to appreciate the details of the 4% rule. The rule assumes unchanging, inflexible behavior on the part of the investor, as well as the need for 100% success over all 30-year horizons. Loosening these strict and unrealistic assumptions will raise the accepted withdrawal rate.

Some readers were surprised to see me take the optimistic view. Speaking for them, cgajowski wrote: "Hey, where's the curmudgeon who usually writes this column?" 

Hey now! The financial services industry portrays the glass as half empty. It advertises: 1) The need to spend at a high level during retirement, thus the silver-haired gent in his yacht, and 2) The need to withdraw at a low rate, thus the warnings that we might live to be 110 years old. Build a big nest egg, and tap into it only very carefully. That advice is no fun for the investor--but it maximizes assets under management for the financial services industry. 

To answer the question: The curmudgeon never left. To the industry that I cover, saying the glass is half full is bad manners indeed. 

Nearsighted
Yesterday's column was an exercise in data analysis. I claimed that a recent study on fund investor behavior would have reached a different conclusion if it had used a longer measurement period than a single year. Specifically, it would have found that fund investors reward managers who fare relatively well during bear markets, rather than (as the study maintains) ignore that evidence.

Bill Bernstein has a useful term for my argument: "measurement point myopia." Bill points out that the same logic holds true of stock-market price/earnings ratios. Market P/E ratios are famously unhelpful at predicting next year's returns, but quite useful when forecasting for a decade. The moral of the story is to be careful about concluding that a factor is not meaningful; that can't be said without testing time periods of various lengths.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.