Why Fund Managers Can't Be Trusted with Your Pension

Entrusting pension funds to professional fund managers is a widespread practice, underpinned by the assumption of expertise, fiduciary responsibility, and financial prudence.

However, repeated instances of underperformance, high fees, lack of transparency, and misaligned incentives have cast doubt upon their reliability. This essay critically examines the reasons why fund managers often fail to serve pension investors' best interests, focusing on systemic inefficiencies, incentive misalignment, and evidence of suboptimal performance.

 Systemic Inefficiencies and Poor Performance

Despite widespread claims of professional expertise, empirical evidence consistently highlights fund managers' inability to outperform basic market indices. According to the S&P Indices Versus Active (SPIVA) report, over 80% of actively managed funds consistently underperform their benchmarks over 10-year periods.

Over 80% of UK active fund managers underperformed their benchmarks over a 10-year period (Source: SPIVA 2023)

These results question the notion that active management provides superior outcomes compared to passive investment strategies.

The inherent inefficiencies within the active fund management sector are exacerbated by excessive trading, which not only generates significant transaction costs but also reduces net returns. Barber and Odean (2000) highlight how excessive trading can erode investors' capital, demonstrating that high turnover rates correlate negatively with returns. Consequently, the frequent buying and selling executed by fund managers often erodes potential gains rather than enhancing them.

Misaligned Incentives

Fund managers' remuneration structures commonly involve significant fees based on assets under management rather than performance. Such fee structures incentivise asset gathering rather than the maximisation of client returns. Consequently, fund managers often prioritise marketing, sales tactics, and asset accumulation over effective investment management. Research by French (2008) and Bogle (2005) underscores how high fees associated with active management directly reduce investors' net returns, undermining pension growth.

Expense ratios – Active Funds cost significantly more than Index Funds or ETFs

Additionally, the principal-agent problem, as described by Jensen and Meckling (1976), manifests clearly within the pension fund industry. Fund managers acting as agents often pursue their interests—securing management fees—at the expense of pension holders' long-term financial goals. The divergence between managers' short-term performance targets and investors' long-term retirement objectives creates an environment where fiduciary responsibilities can easily be overlooked.

Over 30 years, a 2% annual fee can drastically reduce pension wealth compared to a 0.2% passive fund

Lack of Transparency and Accountability

Transparency remains alarmingly inadequate within the fund management industry. Investors often find it challenging to obtain detailed information about the actual composition of their investment portfolios or to clearly understand the rationale behind particular investment decisions. This opacity impairs investors' ability to hold fund managers accountable, allowing underperformance to persist unchecked.

The complexity and obfuscation of investment strategies further compound this issue. Terms such as “active blended solutions” and “strategic asset allocations” often mask poor decision-making and underperformance.

Such deliberate opacity, as highlighted by Kahneman (2011), exploits investors' cognitive biases and information asymmetry, reducing their capacity to make informed choices about pension management.

Practical Alternatives: Empowering Pension Investors

In light of these shortcomings, passive investment strategies such as low-cost index tracking funds or Exchange Traded Funds (ETFs) offer viable alternatives. Empirical research supports the superiority of passive management regarding net returns, lower costs, and increased transparency.

Passive pension strategies like index funds historically outperform active funds over the long term

Pension investors can thus significantly improve their retirement outcomes by adopting a more self-directed or passively managed approach, diminishing reliance on fund managers whose interests often misalign with their own.

The behavioural difference between active and passive investors can be dramatic — particularly during volatile markets.

Here’s a simplified comparison of how each typically reacts at different stages of the market cycle:

Typical Emotional Responses – Active vs Passive Investors Across Market Cycles

Conclusion

Fund managers' consistent underperformance, systemic inefficiencies, misaligned incentives, and lack of transparency strongly indicate they cannot reliably be trusted to manage pensions.

Rather than delegating pension savings to fund managers incentivised primarily by asset accumulation, pension investors should adopt passive investment strategies characterised by low fees, transparency, and aligned incentives.

Only by critically reassessing reliance on traditional fund management can pension investors safeguard their long-term financial interests.

References

• Barber, B. M., & Odean, T. (2000). Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Journal of Finance, 55(2), 773-806.

• Bogle, J. C. (2005). The Battle for the Soul of Capitalism. Yale University Press.

• French, K. R. (2008). The Cost of Active Investing. Journal of Finance, 63(4), 1537-1573.

• Jensen, M. C., & Meckling, W. H. (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, 3(4), 305-360.

• Kahneman, D. (2011). Thinking, Fast and Slow. Penguin Books.

• S&P Dow Jones Indices. (2023). SPIVA® U.S. Scorecard.

Disclaimer: Past performance is not indicative of future results. Investments can fall as well as rise, and you may get back less than the original amount invested.

This article is for educational purposes only and does not constitute financial advice. Always consult a qualified advisor before making investment decisions.

Individual pension needs and outcomes will vary. Examples shown are for illustrative purposes only. Readers are encouraged to conduct their own research and seek professional advice before acting on any information provided in this blog. The author is not responsible for any investment decisions made based on the content of this blog.

Alpesh Patel OBE

www.campaignforamillion.com