34 funds. In house rnanagement is restricted to bonds. New entrants, only recently permnitted, can only invest new inflows. Accordingly, trust banks charge 60-180 basis points, while life insurers charge 2-5% of the inflow.<sup>56</sup> However, even more than administrative costs, the crucial influence on pension funds' costs is of course the efficacy of asset management. Here again, the countries with uncompetitive fund management sectors may lose out; for example in Japan the asset return target is fixed (8%) and there is little incentive to exceed it. Similarly in Switzerland there are few rewards for exceeding a low return (and considerable costs, given the accounting system, in holding volatile assets that could put the fund below actuarial balance).

Where fund management is a competitive sector, as in !he Anglo-American countries, portfolio managetnent is typically a two stage process, with traditionally a strategic decision regarding allocation to different assets and national markets being followed by a lower level decision over the precise assets to be held within these categories. The latter may include passive indexation of the market. (However, more recently, there is evidence that fund mangers are picking core holdings of stocks at a strategic level, and picking national markets at a tactical level, with the use of tock index futures (see below, also Davis (1991) nd Howell and Cozzini (1991).) The traditional strategic choice, typically taken jointly by managers and trustees, is illustrated by the data in Sections (b) and (c). The results suggest that there is a tradeoff, as would be expected, between return and risk and considerable benefits from diversification. This in turn points to the need for appropriate measures of risk-adjusted returns and identification of sources of portfolio performance in order to evaluate fund managers' performance (Blake (1990), Tamura (1992)).

As regards the traditional short term asset allocation decision, which tests ability of active management ("stock picking") to outperform indices inclusive of fees and transactions costs, the evidence is almost uniformly contrary to the efficacy of active management of funds within asset categories. This is in-ine with the efficient markets hypothesis, which suggests that, given prices already incorporate all available information, there is no net benefit from spending extra cash to try to beat the index. Nevertheless, as noted by Grossman and Stiglitz (1980) and Cornell and Roll (1981), the efficient markets hypothesis does not rule out small abnormal returns as an incentive to acquire informaticn, but those acquiring costly information should have only average net returns after the costs of acquiring information are taken into account. In practice, as shown below, active managers underperforn.

Data for the UJK are shown in Table 26. These show that even in the home market, funds tend to underperform the index, but underperformance is particularly severe in foreign markets. This in turn justifies an indexed approach to national stocks, where the fund manager's skill is employed in picking undervalued markets rather than stocks, and employing stock index futures to gain rapid exposure to such markets. As discussed below and in Howell and Cozzini (1991), this is increasingly the approach adopted by large international investors in countries such as the UK. Table 27 shows that average returns are lowest for external managers, which is in turn inversely correlated with turnover. These are consistent with the principal-agent problems set out above; managers least under control have higher turnover and lower returns.

Similarly, Lakonishok et al (1992) show that most US investment management is again active, and that fund managers consistently und ¢rperform the market, for example the equity proportion of US funds (excluding the management fee) underperforms the S&P 500 index by an average of 1.3% pa over 1983-9, or 2.6% if returns are value weighted. If managers overperform in some periods this is virtually never sustained. The authors suggest that the persistant use of active management despite such evidence is related to agency problems. In particular, they suggest that these may arise within the management structure of the sponsor; corporate treasurers seek to bolster their own positions visa vis their managers, and hence seek fund managers that can offer good excuses for poor performance,