IN CONVERSATION

What investors lose to their fiduciary ‘agents’

Jack_gray_nlThe flow of capital absorbed by Australia’s superannuation industry is something that irritates academics Ron Bird and Jack Gray, who just received research funding from the ICPM, particularly since super fund members are forced by law to put their money into the hands of their fiduciary ‘agents’, writes Simon Mumme.


Bird opens an iconoclastic discussion on agency costs with a verbal jab at the free-market thinking that has dominated pension industries of Anglo-Saxon countries.

Reflecting on the financial crisis, Bird says, Alan Greenspan turns to George Soros and claims: “The benefits of markets are so great that we need to pay the price”, to which the hedge fund manager replies: “Yes, but the people paying the price never get the benefits.”

So begins Bird and Gray’s comeuppance to the funds managers, superannuation fund chiefs, asset consultants and industry media, whom they chastise as “agents” responsible for collectively reaping 3 per cent of super fund capital from members each year, the academics claim. This is in addition to the indirect, but enormous, costs of asset bubble bursts and their impacts on economies.

It’s worth mentioning here that Bird and Gray are ex-GMO funds managers-turned-academics, although Gray also works for an Australian alternatives placement firm, Brookvine, and is therefore still an agent, as he openly admits.  

Bird and Gray are part of the Paul Woolley Centre research effort, which funds programs on market dysfunctionality at the London School of Economics, University of Toulouse and University of Technology Sydney (UTS). Bird is a professor of finance at UTS and Gray an adjunct professor. The PWC provides the bulk of their funding. Paul Woolley is also a former GMO executive, having set up that firm’s UK business in the 1990s.

Super fund members are “over-serviced,” Bird says. “Jack and I have an idea of the problems, but no idea of the solution. But one thing we know is that competition rarely works for the benefit of the member.”

They have just received more than $130,000 in funding, including $70,000 from the International Centre for Pension Management, to research pension systems in Scandinavia and elsewhere as they canvass ways to reduce these agency costs and deliver better outcomes for fund members.

According to economic theory, competition should drive the prices of goods closer to the cost of production. But this did not apply to active funds management, Gray says, which remains expensive no matter how many competitors brought products to market. “And why would a manager compete on costs? It’s a symbol of poor quality.”

He qualifies this observation by saying that some active management was necessary to create a decent level of price efficiency in markets.

An “alignment of agents” exists in the industry, Gray says, because the consequences of a super fund straying from the pack and, say, running a different asset allocation, or campaigning asset management fees, are perceived to be great. Funds attempting such initiatives find themselves “wrong and alone” and are pulled back into the agency orbit. To overcome this, funds should assert their collective power.

“Fiduciaries have the members’ money. They should say: ‘We don’t want two and 20. We want 5 basis points’. And if the managers don’t like it, where are they going to go? There’s nowhere else to go. But that won’t happen because there is competition [for access to top managers].”

Bird says opportunities for agents are greatest when consumers have limited time or expertise: agents provide knowledge and can often perform tasks conveniently, resulting in a premium being paid for their services. And the vast information asymmetry in superannuation – in which members have little idea of what is happening with their money – provides many opportunities for specialist service providers.

“It’s particularly good to be an agent if the principal is uninterested,” Bird says, explaining that super fund members are forced by law to put money in the system – an admirable feature of Australian legislation, but one which can be abused by agents – and the benefits of doing so are almost intangible to many because retirement, for many, is a long way off.

He flags a recent survey by GESB, an A$10 billion ($8.7 billion) super fund, finding that 21 per cent of its members did not know which fund their retirement savings were invested in, and 50 per cent did not know their account balance.

This situation is hazardous because, in a defined-contribution pension system such as Australia’s, these uninterested members bear all the risk of their retirement incomes. This leads both researchers to argue that a defined-benefit system is superior because pension fund executives owned the risks of investment outcomes, and their captive memberships meant they can run truly long-term asset allocation strategies.

“If you can’t do that, rationalise. How does Australia justify 400 legacy superannuation funds? We can’t. But we all have an interest in it,” Gray says.

He dismisses attempts to improve members’ financial literacy outright. “What we can do is educate [fund executives] about what’s going on in their own industry.”

Like Bird, he is scathing of the free-market ideology championed by Greenspan and others, but uses a classical reference to back his view, quoting economist Adam Smith: “A free market left to its own devices will ineluctably result in collusion and corruption”.