Convention has it that the long-term benchmark is the ‘strategy’, and the shorter-term deviations are the ‘tactics’. More important than the label is by whom and how these long-term decisions are made. There was a time when the trustee decision was to follow the herd, and the herd moved at random as balanced managers made tactical decisions. An approach as mad as it sounds.
But that approach arose from something not so mad: a decision by trustees to defer the long-term judgement to their fund managers. The problem was that they were not judged on that decision, not until WM and CAPS started measuring managers and the flocking problem began.
Alright, we are probably stuck with trustees making the long-term decision. But no board has a majority of members remotely qualified to make that long-term judgement on its own. So they must rely on experts.
Yet trustees have received terrible advice from questionable advisers. The worst offenders have as usual been actuaries, as their profession is singularly ill suited to this work.
Actuaries have no theoretical basis for understanding why equities might outperform bonds, indeed they have no real theory at all. They only have ‘history’, a dangerous concept when not backed by theory. Worse, they often think that 10 years is a ‘long-term history’ on which one can rely for judgements. Yet ignoring history, they often use point forecasts – rather than range forecasts – for inflation, thus assuming away the principal risk for a pension fund.
And their approach is unstable. For many years actuaries used a valuation approach which assumed away the principal risk of equities – their short term market fluctuations. Arguably that was a better approach than the current overemphasis on such fluctuations, but that and the use of short-term ‘history’ did overstate the case for equities at the peak of the bubble (a concept actuaries can’t understand).
Now the UK actuaries have come up with a real beauty: the ‘liability benchmark portfolio’ (LBP), which defines away the problem by asserting through voodoo or some such approach that the matching portfolio is entirely fixed and index-linked gilts. Once trustees start looking at LBP, they will have difficulty convincing themselves that they should have any equities.
So whose advice should trustees take? How about economists, historians and fund managers? Or for a small fee – this dark monster.

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