Should SA investors, like US voters, just ‘get over it’?

When National Treasury issued its 90-page indictment on the local investment industry, Charges in South African retirement funds (2013), it exposed a sector that abused its power, and systematically exploited uninformed and misinformed customers, who falsely believe they get what they pay for.

The industry’s response, as always in such situations, was to ‘study the report’ and then apply pressure in the background to make it go away. Had White House Chief of Staff Mick Mulvaney spoken for the industry, he might have said: “We do that all the time. I have news for everybody: Get over it. Our profit motive is going to interfere with investor returns.”

Meaning investors should expect to be abused because that is the nature of the beast. The industry is conflicted between maximising shareholder profits and investor returns. If investors don’t know that, or believe this conflict is resolved in their favour, then shame on them for being so naïve. It’s the industry first, always.

Investors have an alternative, though. Internationally, trillions of dollars have moved from active managers to low-cost index funds. According to a recent report in the Financial Times, the global index fund industry has grown five-fold over the past decade, to $11.4 trillion. Another $6.8 trillion follows index-tracking strategies in sovereign wealth funds, endowments and pension plans.

Locally, only around R100 billion is invested in this manner, despite our pension crises. We lag behind for two reasons: firstly, many fund trustees abdicate their fiduciary responsibility and give members investment choice, although few of them are able to exercise it judiciously. And, secondly, sales commissions are yet to be banned, so brokers can be incentivised to push expensive products.
    
There has been some progress since 2013, most notably the standardised disclosures on fees and mandatory default portfolio solutions in retirement funds. These seek to prevent some of the worst industry abuses.

Also, average fees have fallen slightly. But mainly this is to retain business or meet the default fund requirements. In other words, not because it serves clients.  

Still, it’s enough to convince many customers to stay put. For them, the past profiteering off their savings, the misrepresentation of the industry’s skill, and the concealing of the detrimental impact of high fees does not amount to an impeachable event.

It mirrors the Republican Senator’s stance at Trump’s impeachment trial. "The facts are not in dispute. What he did was wrong, but not wrong enough to disqualify him from office. Let the people choose."

The Democrats reject this, because they know Trump won’t change. He will continue to abuse his power, also to subvert the next election. In that case, letting voters decide is no remedy at all.

Similarly, the local investment industry will continue with self-serving fee structures. It will obscure charges. It will continue to improve the optics of its results by promoting selective performance metrics. It will continue to hint at future outperformance, despite all disclaimers. It will continue to warn investors of market volatility and propose active management as the remedy. It will continue to pretend it is selling skill rather than expensive market access.  

And it will continue to claim the social good of active management.

But let’s be clear: fund managers aren’t in it for the social good. They don’t follow a calling to help people retire with more money, or to discover prices and advance environmental issues.

If they really desired a social good, they would charge less, fly less, confuse less. They would admit to their model’s fundamental flaw, that the bulk of the money invested in this manner will, over time, always return less than corresponding low-cost index funds. That is borne out by simple logic and by numerous studies.

Yes, the market needs active management, to facilitate trading and keep pricing efficient. But it needs much less than we currently have. And yes, investors should be free to choose how their money is managed, provided they can make fully informed decisions, just as Americans should be free to choose their next president, provided they are really free to choose their next president.

As long as both appreciate that if they maintain the status quo, they can tear up the idea that their interests will now come first.