Intelligence Is Not Enough

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It is not enough to have a good mind; the main thing is to use it well.
—Rene Descartes

I cringe whenever I hear someone say, “But he/she is soooo smart” or “He/she is so much smarter than so-and-so,” as if that’s the end of the conversation.

The market is incredibly efficient in how it prices stocks because a lot of smart people trade a lot of stocks for the mutual funds they manage. But only 8% of them have been able to beat a “dumb” index like the S&P 500 over the past 15 years.* Good minds not used well.

A Nobel Prize–winning economist Joseph Stiglitz was a huge fan of Hugo Chavez, who all but destroyed Venezuela’s economy. Yet Stiglitz once asked an academic colleague whether Paul Volker (arguably the greatest Federal Reserve chairman in history) “is as smart as us.”

I was reminded of this again recently when I read an article about the race for the office of New York state comptroller. As the writer points out, the current comptroller, Tom DiNapoli, has many responsibilities, from auditing state agencies to serving as the state’s accountant. But his most important job is as the sole trustee of the New York State and Local Retirement System, which has $207 billion in assets and funds the retirement of 1.1 million people.

A complex financial job, right? Well, according to the article, “no comptroller in living memory has had a background in finance,” and DiNapoli is no exception. Before he took over the office 11 years ago, he was in the state assembly, and his last private-sector job was 30 years ago when he was a telecommunications manager. Smart, no doubt, but is that enough?

Evidently not. According to Jonathon Trichter, the person who ran against him in the current election cycle, DiNapoli authorized $6 billion in fees to hedge funds, private equity funds, and other “alternative” funds over his tenure (including $818 million in 2017) for subpar performance—5.4% annually on the $35 billion in alternatives versus 7.5% for an S&P 500 index fund. This is an opportunity cost of almost $8 billion on top of the massive fees.

Trichter, on the other hand, has spent a career in finance and was involved in restructuring some of the most mismanaged pension funds in the country (like Jacksonville, Florida’s plan). His solution for New York? Get rid of the expensive, underperforming hedge funds, private equity, and other opaque and complex strategies and invest in index funds. A good mind used well? I think so.

But he lost the race. A lifelong member of DiNapoli’s political party, Trichter switched parties to run for the comptroller’s office so he could institute positive, evidenced-based changes. DiNapoli was not held accountable by voters, nor is he likely to be sued for his obvious disregard for established principles of prudent investing. He clearly cares more about his friends on Wall Street than he does the workers of New York or its taxpayers (who are likely to be the ones who ultimately pay for his gross ignorance).

Unfortunately, this is how most public pension plans are managed today. As a result, after nine years of a powerful up market in stocks, most public pension plans remain grossly underfunded. This will either result in cuts to promised pension distributions for workers or large tax increases to cover the shortfall—or both.

When government officials screw up, they often get reelected or move on to other lucrative careers and we, as taxpayers, pay the price. This is the opposite of progress.

When corporate retirement plan sponsors and trustees ignore the evidence and make expensive mistakes, it’s employees, shareholders, and other beneficiaries who pay the price. But these stake-holders are looking increasingly to the courts for appropriate remedies. This appears to be the only way meaningful progress can occur in our industry. Equius has taken steps to become more involved in this effort. Please contact us if you know of a situation where we can help.

*S&P Indices Versus Active (SPIVA) report ended June 30, 2018, on the performance of all U.S. large-cap funds.

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