Financial Times (Leaders & Letters), 2nd June 2006
Sir,
John Plender’s article “Failing grade? How a pension fund punt could undermine UK universities” (Financial Times 30th May 2006) quotes John Ralfe as saying, quite correctly, that taking credit in advance for the outperformance of equities, while ignoring the risk, is a flawed though widely used methodology.
There is an additional problem today, when it is highly likely that investing in equities will give very poor returns to pension funds and other investors. This is because equity returns are not random, but exhibit negative serial correlation. Having given exceptionally high returns over the past 10 to 30 years in virtually all markets, a rational person, who is aware of this, must expect that they will give very poor returns over the medium-term, such as the next five to ten years.
Those giving advice to trustees should be properly trained in financial economics and, if they are, they will be aware of the negative serial correlation of equity returns. If they are not aware of this, they should not be giving advice on asset allocation; if they are aware of this, they should, at the very least, draw the attention of trustees to it.
Two questions therefore spring to mind. Were those advising the trustees of the USS aware of the general agreement among financial economists that equity returns exhibit negative serial correlation? If so, did they draw the attention of the trustees to the consequences?