Predicting the future can turn out to be embarrassing to those whose prognostications are reviewed under the harsh illumination of hindsight.
But many of the experts who made their 15-year predictions for the capital markets and investment management - as participants in Pensions & Investments' 15-year anniversary issue in October 1988 - seem to have been on or close to the mark.
Among their forecasts that already have been proven true:
Most expected globalization to sweep the investment and financial markets.
Most also expected defined contribution plans to overtake defined benefit plans in size and numbers.
Two other predictions - 24-hour securities trading and a consolidation of the equity market - haven't come true so far.
To mark the halfway point in the 15-year period, P&I interviewed several of the original participants. They are:
George F. Russell, chairman of Frank Russell Co., Tacoma, Wash.;
Robert E. Shultz, former executive at the pension funds of IBM Corp. and RJR Nabisco Inc.;
Burton Malkiel, a professor at Princeton University and the author of "A Random Walk Down Wall Street;" and
Rex Sinquefield, chief investment officer of Dimensional Fund Advisors, Santa Monica, Calif.
The major theme emerging now is their belief that pension plans will accelerate the trend toward passive investing.
More money will be moving into lower cost passive strategies - including pure indexing, asset class investing, enhanced indexing or style indexing - in coming years, most say now.
Here is a sampling of their new predictions, as well as how their 1988 forecasts have fared:
George Russell
Mr. Russell disagrees with the prediction that indexing will become even more important.
"Indexing will never sweep the United States or the globe," Mr. Russell said in a recent interview. "The fortunes of indexing and active management will wax and wane over time. The reasons are simple - arithmetic and rational expectations.
"Let's say there are two types of investors - active investors and indexers. Since the total of the two is the market, and since indexers generate market returns, the gross return to all active investors must be the market return. So, net of fees and transaction costs, active investors as a group must deliver less than the market return. That's arithmetic," said Mr. Russell.
"For professional investors to succeed, they must take advantage of either other professional investors, private individuals trading, or governmental actions. When enough people, especially professional investors, analyze the markets, market prices rationally reflect available information. Active management of any kind is very difficult. When the ranks of well informed professionals are thin, there is more 'room' for professional investors to exploit the pricing mistakes of others.
"So, as we have seen in the past, the relative success of indexing and professional management will vary over time. What will still remain relevant is choosing which professional managers to hire," Mr. Russell said.
In 1988, Mr. Russell said he expected the money management business to become more specialized. He anticipated"more precise benchmarks, style indexes and peer group universes."
That's happening, he said.
The U.S. money management business "has become more specialized as both the complexity of available financial instruments and the complexity of available analytical tools has grown," Mr. Russell noted.
"The lowering of some barriers to investment has made the process of money management more globally competitive. This increasing specialization creates new opportunities for new specialists to replace older generalists," he said.
"A specialization that may be emerging is that of strategic asset management," Mr. Russell said.
Robert Shultz
Mr. Shultz believes many defined benefit plans will be outsourced during the next few years.
"Outsourcing will move beyond what we are seeing in the defined contribution market and will start to have an impact on defined benefit plans as well," he said. Continued corporate downsizing and reorganizations will spur that development.
By outsourcing, Mr. Shultz means that a pension fund will hand off to an external service provider the duties of investment management and administration; the plan's investment committee would continue to set investment policy.
That outsourcing will go "not to the consulting community but to independent contractors who may work for one or more plan sponsors," he said.
At least one of his 1988 predictions is on its way to coming true.
In 1988 Mr. Shultz predicted a "significant consolidation in the money management ranks," and that pension plans would "seek fewer, larger and more all encompassing relationships with investment managers." (The latter has since been dubbed multiproduct managers.)
Mr. Shultz said such consolidation is happening. But now he expects pension funds to turn more toward "asset class investing" for the bulk of pension assets and market neutral strategies for the rest.
Asset class investing is a passive or semi-passive strategy to investing in sectors of the market, based on the risk tolerance of the investor.
Asset class investing involves establishing portfolios of stocks to represent a particular segment of the market or utilizing mutual funds created to represent market segments to replicate the volatility and return profiles of that market segment.
Using such a strategy, Mr. Shultz said, investors are able to "capture the asset class in the most efficient way possible through indexing and then using market neutral strategies or other pure alpha strategies for the value-added portion of the portfolio."
Efficiently managed pension funds that apply this strategy, he said, would have up to 80% of assets indexed to the selected asset classes and the remaining 20% invested in market neutral strategies.
Such an approach, he said, "does not bode well" for many active money managers. "The true active manager needs to get rid of the dead weight in the investment process and earn their fees by taking positions, rather than diversifying their returns away," warns Mr. Shultz. He said asset-based fees must give way to performance-based fees in the future for money managers to avoid rewarding mediocrity.
In the next few years, he said, there may well be "fewer money managers .*.*. because there will be less reward for mediocre managers who now can now bring in more revenue just by bringing in more assets."
Meanwhile, Mr. Shultz concedes that, so far, he was been wrong about his 1988 prediction that pension executives would gain in stature over the years.
At the time, he said the pension executive "will occupy a far more dominant position within the investment management hierarchy than has been the case in the past decade."
He said the pension executive would serve as the "master manager" in overseeing the pension fund operation. He believed the pension officer's job would evolve into a significant corporate managerial occupation on the same scale as the treasurer's.
It hasn't evolved to that point entirely yet, Mr. Shultz now acknowledges, but "it should have, and the trend remains firmly in place."
"There are a lot of reasons why it hasn't happened that would make a story unto itself," he said. "The capital markets have done so well in the past few years that the pension officer can be viewed as sort of a maintenance function.
"From a cynical viewpoint, one thing that will elevate the pension officer's position would be a major bear market. The age old proposition still exists that people still don't look at the value of the pension dollar the same as the corporate dollar," said Mr. Shultz.
"My contacts are telling me the pension plan sponsor's job is just not as much fun any more. It has evolved into musical chairs in many cases. As downsizing has taken hold and with the trend toward mergers and acquisitions, each time there is one more chair being pulled out when the position is filled from within," he said.
Burton Malkiel
Mr. Malkiel is foremost among the believers that passive investing is the best strategy for the bulk of pension assets. His position hasn't changed over the years.
"To me the evidence over the last 20 years is very dramatic: there are very few active money managers who can beat the indexes. More accurately, something like 70% of money managers are regularly beaten by the indexes. Even when they do outperform the index there is no guarantee that they will continue to do so on a consistent basis. There is regression to the mean," he said.
"Clearly indexing is, or should be, the way that professional investors have gone."
Today, however, Mr. Malkiel is more emphatic regarding portfolio diversification than he was in 1988.
"My view now is that everyone should have between 15% and 20% of their portfolio invested in emerging markets," he said. "That may seem paradoxical, given the risky nature of the emerging markets and because these stocks have more volatility than U.S. markets."
But the correlation between emerging markets and developed markets is "reasonably low .*.*. and you can in fact increase your performance and reduce overall risk in many cases through diversification, (rather) than simply by sticking with domestic stock markets," he said.
"There is more, very much more, scope for investors who venture outside traditional domestic markets."
In fact, Mr. Malkiel is working on a new investment volume tentatively titled: "Emerging Markets: The Investment Frontier for the 21st Century."
In a recent interview, Mr. Malkiel, as he did in 1988, debunked the entire idea of measuring risk using beta. And, he criticized the capital asset pricing model as "not having done well."
"I'd say there is increasing evidence suggesting that you can't make good predictions based on what has happened in the past. I would have to say, even more so than eight years ago, the very simple measures of risk like beta are just not likely to work," he said.
Nor does he put much more credibility in the arbitrage pricing theory which, he said, simply considers several elements of risk other than beta.
"We haven't developed the single measure of risk; it's still a very open question," said Mr. Malkiel.
He said diversification remains one of the best methods of reducing risk. "If we have learned anything about limiting risk it's the time honored principal of diversification, particularly international and emerging markets and different asset classes," Mr. Malkiel said.
"Right now real estate may be a very good asset class for diversification .*.*. Real estate is not highly correlated with stock returns, and I wouldn't be surprised to see real estate swing around after a near depression."
Like Mr. Shultz, Mr. Malkiel advocates asset class investing.
"If you decide you should have real estate in your portfolio, you invest in a real estate index. If you want small-cap stocks in your portfolio, you invest in a small-cap index. If you want European, Japanese and far eastern stocks, you invest in an EAFE index," Mr. Malkiel said.
Rex Sinquefield
Mr. Sinquefield, a market researcher and author in addition to being a CIO of Dimensional Fund Advisors Inc., which manages a portion of its assets in asset class portfolios, is a fatalist when it comes to active money management:
"The days of active management are numbered," said Mr. Sinquefield. "They may be numbered in decades, but active management is slowly fading away." He also predicts "asset class investing will continue to grow."
"Indexing has grown substantially from essentially nothing in 1973 to well over $1 trillion now, and indexing has invaded nearly every asset class and is a part of every new asset class," he said.
In 1988, Mr. Sinquefield worried about the autonomy of the pension fund executive as the pool of pension assets continued to grow.
Now, he seems less concerned about that than he is with the general decline of the defined benefit pension plan in favor of the defined contribution plan.
"We've seen a substantial decline in defined benefit plan growth and I think there are major problems in 401(k)s," said Mr. Sinquefield.
"Decisions are too often made by human resources people who are professionally untrained and incompetent to do the job," he said. Major decisions regarding structure and investments of 401(k) plans should be left to professional investment and corporate treasury staff members, he said.
The main focus of the human resources department, he said, is "ease of administration." As a result, employees are frequently presented with portfolio selections that may be "too risky or hard for them to understand;" employees also are left to make investment choices without a full understanding of the investment process or of long-term financial planning, Mr. Sinquefield said.
"The cost of that over a 30-40 year period means potentially large or even tragic problems for some participants," he said.
"The average employee is not professionally competent to decide which fund to buy .*.*. Pension people are more qualified to do their job than the individual participant."
Defined benefit plans, he said, are "vastly superior" at retirement.
What can be done to turn the picture around?
"Government should not get involved except to encourage the development of defined benefit plans as an alternative and somehow make it attractive to corporations to offer defined benefit plans as a viable and competing alternative to defined contribution plans. But no one should underestimate the greed or stupidity of government in this regard," said Mr. Sinquefield.
