How government worsened inequality by ignoring the EMH
By Scott Sumner
I often do posts defending the Efficient Markets Hypothesis. Sometimes it’s just fun to debate these ideas. But there are also serious real world costs to ignorance of the EMH. Government pension funds have wasted large amounts of public money, and worsened inequality in America, by paying hedge fund billionaires to manage public pensions:
New York City’s largest public pension is exiting all hedge fund investments in the latest sign that the $4 trillion public pension sector is losing patience with these often secretive portfolios at a time of poor performance and high fees.
The board of the New York City Employees Retirement System (NYCERS) voted to leave blue chip firms such as Brevan Howard and D.E. Shaw after their consultants said they can reach their targeted investment returns with less risky funds.
The move by the fund, which had $51.2 billion in assets as of Jan. 31, follows a similar actions by the California Public Employees’ Retirement System (Calpers), the nation’s largest public pension fund, and public pensions in Illinois.
“Hedges have underperformed, costing us millions,” New York City’s Public Advocate Letitia James told board members in prepared remarks. “Let them sell their summer homes and jets, and return those fees to their investors.”
The move is a blow to the $3 trillion hedge fund industry where managers like to have pensions as investors because they leave their money in for longer than individuals, sending a signal of stability to other investors.
Hedge fund returns have been lackluster for some time. The average fund lost about 1 percent last year when the stock market was flat, prompting institutional investors to leave.
Research firm eVestment said investors overall pulled $19.8 billion from hedge funds in January, marking the biggest monthly outflow since 2009.
Performance at some of the funds with which New York City invested was far worse. Luxor Capital Group, a long-time favorite with many pensions, lost an average 18.3 percent a year for the last two years.
Of course if they’d asked me they could have avoided those losses, merely by putting the money into index funds. And the poor performance of hedge funds is not just due to the past couple years, the hedge funds have been doing poorly since the famous bet with Warren Buffett:
After eight years of the 10-year bet, Buffett’s chosen index fund holds a commanding lead over a collection of hedge funds even though the hedge funds performed slightly better in 2015. . . .
The low-cost Vanguard S&P 500 Admiral index fund Buffett chose is up 65.7 percent since the bet began. Protege picked five funds that bundle hedge funds that are collectively up 21.9 percent, on average.
It’s not often that a public policy change is such a win-win. Having the public sector exit hedge funds will (slightly) improve the nation’s underfunded public pensions, and also reduce inequality at the top. It’s been a depressing year so far, in fact it’s been a depressing millennium so far, but here’s one tiny ray of hope.