A few notes before I begin for the evening.  First, I have two piles of books sitting next to me — one pile of mediocre books, and one pile of lousy books.  Should I review them, at least in summary form, or should I leave them unreviewed?  It’s ten books in all.  I never know what to do with books that are marginal at best.

Second, with the aid of one of my children, I have completed categorizing my book reviews.  All of my book reviews are ranked within their categories, with links to my reviews, and commentary on who the books might be useful to.

Onto tonight’s thoughts with an email from a reader:

I’m a big fan of your blog and have kept up with it since I started in the investment industry 3 years ago.  I was wondering if you had any advice on standing out in the Defined Benefit world as far as process and investing goes.  I’m on a team that has developed an investment style and philosophy that is highly unique to retirement planning for individuals/families, but it has become very difficult to translate that into the DB world.

I’ve been on both sides of the table here.  I’ve worked with DB plans, Trustee-directed DC plans, 401(k) and similar plans, and individuals.  Personally I would like to work with more DB plans myself, but I will share with you what I know or believe.

The first distinction with DB plans is do they retain a investment consultant or not?  If the answer is not, it means that they might not be slaves to modern portfolio theory, and might think about investment in a more businesslike way.  They would probably be more responsive to the way you do things.

If they have a consultant, then you have to approach them through the consultant.  The consultant is in a tough spot.  Most of them don’t know much about investing, but they have a wide variety of quantitative tools that have been developed by academics that allow the consultants to protect themselves while delivering little-positive-to-large-negative results for clients.

All of the statistics that the fund management consultants calculate assume a world where risk is equivalent to variation, rather than permanent loss of capital.  The consultants would rather see someone that outperforms by a tiny bit each period, than a manager that outperforms by a lot over the same set of periods, but with a lot of variability.  They are the opposite of Buffett’s phrase, “I would rather have a lumpy 15% than a smooth 12%.â€

With DB plans, all they care about is investment results versus their benchmark.  They don’t care so much about winning, because they can blame and remove underperforming managers who consistently miss by a little.  What they do care about is those that miss by a lot, because that could cost them their cushy jobs.

This is one area of investing that I would purge if I could; in general, the fund manager consultants do little for the plans they serve.  Far better if the consultants actively analyzed risk, and encouraged plans to take more/less risk when circumstances favored/disfavored it.

Instead, they propagate views that are risk-neutral, as if all styles are equally valid all of the time, and all asset classes are equally valid all of the time.

Now with individuals the game is different, because there are ways to add value through tax-management, and in some cases, ethics management.  With pension plans, those issues are moot.

Now, if you have a good track record of delivering alpha with little variation versus some sector of the market, or the market as a whole, advertise that to the fund management consultants.  Get in the databases.  It’s all a performance game, and one with little tolerance for variability versus their benchmark indexes.

So, part of the reason for your difficulty stems from this: the market to serve individuals is a free market, albeit one where there are a lot of charlatans plying their trade.  The market for DB plans is a bureaucratic market for the most part, one where sponsors who don’t know investing abandon their responsibility to other who have modest math skills, but who also don’t know investing.

That is your problem, and mine as well.  More is the pity for the sponsors of DB plans.  They are the ones who get hurt in the long run.  A pity they never learn, but only terminate.


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