The Money Flood: How Pension Funds Revolutionized Investing

Michael J. Clowes | Michael J. Clowes

1 An excellent survey of the US pensions business
As a UK-based observer of the asset management scene (my book "The City: Inside The Great Expectation Machine is due out in November: details on Amazon.co.uk) I found this comprehensive analysis of the development and current state of the US pension fund industry both extremely clear and interesting to read. It explained many things to me that are barely understood on this side of the Atlantic and, I suspect, insufficiently well understood even in the USA by professionals who are not pensions specialists let alone the American investing public. For example, the precise origins and intentions of the 401(k) plan, the way in which ERISA and its refinements changed the investment management industry, and the profound influence of defined benefit pension funds on venture capital activity and foreign equity investment. Anyone who is interested in what makes stock markets tick should be interested in what this book has to say about pension funds, the people who manage them and the impact that they have.

2 A Fascinating Read about the Financial Revolution
In The Money Flood, Michael Clowes, Editorial Director of Pensions & Investments, presents an instructive and entertaining overview of the pension fund industry and its effects on financial markets. The book begins with the National Labor Relations Board's 1948 holding that contract negotiations between employers and employees had to consider pensions-a watershed decision, Clowes argues, because it encouraged the growth of pensions funds and thus fostered their largely beneficial effects on markets and the economy. In the 50 years since, pension assets grew from $14.3 billion to almost $9 trillion, and the business itself matured from a small-club dominated by a few large corporations, bank trust departments, and insurance companies invested mostly in bonds to a diversified industry encompassing money managers, consultants, and mutual funds with investments in equity, real estate, commodities, start-up ventures, and overseas markets.

Clowes' chronological approach to this story is held together by several major themes. Primary, of course, is the fact that the growth in pension funds raised a vast flow of capital and unleashed it into America's markets. However, the effects of this new capital might not, Clowes suggests, have been as salutary, had not this flow of money encouraged the development of the investment technology and the investment professionals to manage it.

The "professionalization" of pension fund management had at least two beneficial effects. First, it allowed for the spread of pension money beyond bonds into more growth-building investments, including equity and venture capital. Second, it allowed for the spread of capital beyond the corporations that actually sponsored the pension funds. Clowes makes the interesting point that this has not been the case in Japan or Germany, say, where pools of pension money (smaller to begin with) have been generally confined to the sponsoring company and its affiliates, hence have not generated the wealth, for pension beneficiaries or the overall economy, that America's system has.

The book highlights the major turning points and participants in the development of the industry. These include the work of Harry Markowitz, Bill Sharpe, Fischer Black and others in financial technology; the efforts of Meyer Melnikoff at Prudential and Anders Voorhees at U.S. Steel to expand pension investing to stock; George Russell, Jr. and the development of the pension consulting business; Harrison Smith and the early moves to international pension investing at Morgan Guaranty; David Bronner's experiments with social investing at the Alabama Retirement System; and John Bogle and the growth of mutual funds.

A leading role throughout is played by the U.S. government. Sometimes it comes out as hero, as with the Employee Retirement Income Security Act of 1974, which Clowes sees as enhancing the good effects of pension investing by replacing the old "prudent man" standard with a "prudent expert" standard more suitable for pension professionals. In recent years, however, the government has played the villain, by passing legislation that has stifled defined benefit plans. Clowes makes a convincing argument that their replacements-401(k)s and other defined contribution plans-will not be able to offer similar benefits in the way of retirement security and incentives to overall economic growth.

The Money Flood is a well-deserved pat on the back for those pension plan sponsors, consultants, investment advisors, and academics that have, over the past 50 years, created a financial revolution that benefited all Americans. It is "must" reading for all who seek to understand the development and workings of the pension fund industry.

Bruce I. Jacobs, Principal, Jacobs Levy Equity Management.