How the EMH can reduce government spending, taxes, and inequality
By Scott Sumner
Long time readers know that I am a huge fan of the Efficient Markets Hypothesis, mostly for pragmatic reasons. (As with all social science theories, I do not believe it is literally true—just approximately true.) Now it appears that the EMH might be even better than anyone had imagined.
In economics, there can be an “efficiency/equity trade-off”. I believe that most economists overstate how often this trade-off occurs, but it can certainly arise in some situations. The nice thing about EMH-based policies is that they improve both efficiency and equity. Patrick Sullivan sent me to this WSJ article, which provides a good example:
Steve Edmundson has no co-workers, rarely takes meetings and often eats leftovers at his desk. With that dynamic workday, the investment chief for the Nevada Public Employees’ Retirement System is out-earning pension funds that have hundreds on staff.
His daily trading strategy: Do as little as possible, usually nothing.
The Nevada system’s stocks and bonds are all in low-cost funds that mimic indexes. Mr. Edmundson may make one change to the portfolio a year.
So far his approach seems successful, just as predicted by the EMH:
From his one-story office building in Carson City, Mr. Edmundson commands funds whose returns over one-year, three-year, five-year and 10-year periods ending June 30 bested the nation’s largest public pension, the California Public Employees’ Retirement System, or Calpers, and deeply-staffed plans of many other states.
Nevada’s $35 billion plan is “dramatically smaller” than California’s roughly $300 billion, notes Calpers spokeswoman Megan White. “That said, Nevada demonstrates the benefits of reducing the complexity, risk, and costs in a portfolio.”
His success is being copied by others:
Now many public pension funds are embracing Nevada’s do-nothing approach as they wrestle with dwindling cash and low interest rates. Calpers is severing ties with roughly half the firms handling its money. New York City this year slashed its hedge-fund commitments.
And it’s paying off by reducing government spending in Nevada:
When Mr. Edmundson joined the Nevada plan in 2005 as an analyst, roughly 60% of its stocks were in indexes. He turned it even more passive after becoming chief investment officer in 2012. He fired 10 external managers, and, by 2015, all of its stock and bondholdings were in passively managed funds.
Its outside-management bill is about one-seventh the average public pension’s, according to Nevada plan documents and Callan Associates, which tracks retirement-plan expenses.
If Nevada consumed a typical Wall Street diet, it would pay roughly $120 million in annual fees. In 2016, Nevada paid $18 million.
When thinking about that $102,000,000 annual savings, keep in mind that Nevada has less than 1% of the US population. We are talking serious money.
So that’s the efficiency part—what about equity? A number of people on the left have pointed out that the growing importance of our finance sector has contributed to increasing inequality in America. As states switch from hedge funds to index funds, the finance sector will earn less money. This will allow states to reduce taxes, and/or boost spending on more worthy projects, such as infrastructure.
The WSJ portrays Steve Edmundson as a modest fellow:
He brings lunch in Tupperware. “Great days,” he says, are when his wife makes lunch–a BLT or tuna-fish sandwich. Otherwise, it is leftover fish or salads. “I don’t want to spend $10 a day for lunch.” . . . He generally doesn’t work outside 8 a.m.-to-5 p.m. hours. He commutes in a 2005 Honda Element with over 175,000 miles on it. His 2015 salary was $127,121.75, according to a Nevada Policy Research Institute database.
With no one else on his investment staff, Mr. Edmundson rarely uses his conference table and four extra chairs. He volunteered his office to pension-fund employees who work for accounting or benefit calculations.
Last month, a wall went up dividing the room. “I’m not going to complain about my office,” he says. “It was too big.”
America has holidays honoring moms, dads, veterans, workers, etc. How about a national holiday honoring the key role that “beta males” like Steve Edmundson have played in “Making America Great in the First Place”.