Current issues related to economics, (responsible) investing, pension, and income: Every week, an APG expert gives a clear answer to the question of the week. This time: chief economist Thijs Knaap about the question of whether you can beat the market with active investing. “Not as a private investor. But as a pension fund you are in a fundamentally entirely different position.”
Give a blindfolded monkey some darts, get him to throw a bunch at the newspaper’s stock page and you’ll get an equity portfolio that will yield the same as a professionally assembled one. What Princeton professor Burkon Malkiel meant when he made this claim in 1973 was that stock prices show a random and unpredictable course. In other words, deviating from the stock index by investing in specific stocks from that index - i.e., an active investment strategy - does not provide additional returns without additional risk, and therefore makes no sense.
Does this claim hold water? Knaap says it probably does for the private investor. Does this mean that a pension fund is also better off investing its entire capital in the index? No, the economist asserts, because a pension fund is in a fundamentally different positition. Partially because it has investment options that require scale, professional knowledge, and staying power. These types of investments, which a private investor does not have access to, are a source of extra revenue for pension funds.
Not the only smart investor
Knaap: “Malkiel was right in the sense that so-called stock picking does not make sense for private individuals. You are not going to be the only smart investor who analizes a company and tries to predict the price movement of that stock based on that analysis. Information is usually factored into prices - prices reflect expectations. With that assumption, it is not possible for a private investor to beat the market with active investing. In that case, it is better to invest in the entire stock index. And that is possible today with inexpensive index trackers.”
However, there is a world of difference between investing in equities as an individual and investing as a pension administrator, which invests total assets of 620 billion euros for its clients. First of all, because a pension fund must match its investments to the (payment) obligations to participants, a process called asset-liability management.
“If you let the proverbial monkey invest in stocks, the choice to invest only in stocks is already made. But do you want to invest in shares at all, and if so, how much of your capital do you want to invest in them? Two thirds of our investment portfolio consist of other investment categories. These include bonds, real estate, commodities, infrastructure and loans to companies. As a pension fund, you have to decide which categories you want to invest in, and in what proportions. In such a way that you can pay out the right pension amount to each participant at the right time. This requires a great deal of analysis, because it is quite complex and there is no one right method.”
A pension fund also differs from a private equity investor because its position is better in terms of information, and because participants expect more from their fund than just a market return.
Knaap: “We talk to the companies we invest in about sustainability and good corporate governance - by voting at shareholders’ meetings and denouncing any abuses, for example. We are familiar with companies as shareholders, as discussion partners, and also from the debt market. And the same applies to their competors. Compared to the private investor, you therefore often have better information and can perform better analyses. Of course, that also involves costs, but in this way we think we can beat the benchmark - the index. And if you look at it over a longer period, our stock and corporate bond investors are doing the same, by a wide margin.”
And thirdly, perhaps the most fundamental reason why you can’t compare APG to a private investor: An investor of this scope can invest in assets that are not an option for the individual. Knaap: “You can only invest in asset categories like infrastructure and loans to companies if you have enough capital for that. In addition to scale, you must also have the required knowledge to be able to invest in them. For certain assets, in China for example, you must have considerable local knowledge. There are no lists of such investments to choose from, as there are at a stock exchange. You really have to look for them. Our stake in the joint venture with KPN for the rollout of fiber optics only becomes an asset once we have established the joint venture with KPN. But there is an entire process that precedes that. And you wouldn’t send a monkey to Rotterdam for that.”
Knaap continues: “Moreover, you invest in such assets for the long term. You don’t just sell illiquid investments like that overnight. As a pension fund, you are in an excellent position to invest in a certain asset for a long period of time. It is precisely in the markets where patience is required that we are currently seeing the best opportunities. As a pension investor, you can beat the index by investing in the more illiquid, less accessible markets. Liquid markets, such as the stock market, still have a function, because you also need assets that you can sell quickly if necessary. But for large pension funds, active investment in illiquid assets is currently a major source of return. And this works out in the favor of the participants in the long run.”