Less Is More: What Small Investors Can Learn From a Pension Giant
This past week, the biggest public pension fund in the U.S., the California Public Employees’ Retirement System, or Calpers, said it plans to cutthe number of outside money managers it uses to approximately 100 from 212.
That move came after Calpers announced last yearthat it would get rid of its hedge-fund portfolio. With $305 billion in assets, the giant retirement plan is trying to simplify its structure and lighten its load—an objective all investors should aspire to.
“We’ve been working for several years to reduce the risk, cost and complexity in the portfolio,” says Calpers spokesman Joe DeAnda. “This is the next step in that effort.”
Calpers has saved about $300 million in investment expenses over the past five years, says Mr. DeAnda, by moving the management of more portfolios in-house and by negotiating better terms with its remaining external managers.
About two-thirds of Calpers’ roughly $160 billion in stocks is passively rather than actively managed—using computers to replicate the market’s return instead of using human judgment to try to beat it. That saves money, too.
As the new plan takes effect over the next five years, Mr. DeAnda says, the 27 outside managers running Calpers’ portfolios of publicly traded U.S. and international stocks will likely shrink to 20.
Calpers spends approximately 0.34% of its assets on management fees, down from about 0.48% three years ago.
That is a reminder that today, individual investors are in perhaps their best position ever to perform at least as well as the biggest institutions. You can buy a simple portfolio of exchange-traded funds holding an encyclopedic set of all the world’s financial assets from firms including Charles Schwab Corp., BlackRock’s iShares and Vanguard Group forwell under 0.1%.
Above all, the key to earning more is doing less.
All too many investors still build their portfolios by bringing on board anything that seems to be working, with little regard for where it belongs or whether it duplicates what they have already.
Lane Steinberger, chief investment officer at Redwood Wealth Management in Alpharetta, Ga., which manages about $400 million, says “plenty” of clients have come to his firm with portfolios consisting of more than 1,000 different stocks bought at different times in small amounts.
“You can have an awful lot of stocks or funds and still not have much diversification at all,” he says—especially when nearly all are larger stocks based in the U.S.
The word diversification comes from the Latin “diversificare,” to make different. To be diversified, you have to own stocks, bonds and other financial assets from around the world that differ by type, size and price.
With its latest move, Calpers is tacitly admitting that hiring many people to do the same thing doesn’t improve results. Going to 30 private-equity fund managers from roughly 100 is likely to improve its results by lowering fees and increasing competition, Mr. DeAnda says.
Individuals should note that lesson, says Patrick O’Shaughnessy, a portfolio manager at O’Shaughnessy Asset Management in Stamford, Conn. Once you hire too many fund managers, he says, “you end up owning something that looks like the overall market at much higher fees, and that’s just nuts.”
He adds, “Active management can only be worth the higher costs if the portfolios are distinctly different from the overall market.”
Investors should resist the temptation to act like “squirrels that bury different assets in a bunch of places” without an overall plan, says Gary Karz of Los Angeles-based Proficient Investment Management, a firm that provides second opinions on portfolio diversification.
As you add similar fund managers, he says,your chances of outperformance shrink toward zero. “The higher the expenses, the longer the time and the more managers you have, the worse your odds get,” he says.
So take Calpers’ move as a pretext to ask yourself and your financial adviser what you can do to streamline your investing plan.
Do you still own five different growth-and-income mutual funds, all with annual expenses greater than 1% and none with a rationale that compels you to keep them? Did a broker years ago put your individual retirement account into hundreds of different stocks, none of which you pay attention to anymore? Is a financial adviser trying to get you to buy “liquid alternative” funds that engage in complicated techniques at 20 or 30 times the cost of basic ETFs?
If so, cut your expenses and simplify your choices. Sell the funds or stocks that offer duplication instead of diversification, and shun newfangled ideas that cost too much. Then sit back over the years to come and watch the world’s biggest investing institutions try to catch up with you.
