The villains of the financial crisis, whose aftershocks are now forcing austerity on millions of Europeans, are many and varied. Groups singled out for blame include bankers, investment bankers, rating agencies, politicians, central bankers, “no touch” regulators, and credit-hungry consumers and corporations.
But there is one group whose role has not yet been fully recognized or explored: the fund managers. Arguably the so-called “intermediated” model of asset management—whereby the beneficial owners of assets (i.e. individual savers and investors), outsource decision-making to specialists (such as Fidelity, Axa Rosenberg, Natixis, Pioneer, and Mirae) who take annual fees ranging from 0.3% to 2% of the sum invested for the privilege—played a big part stoking up the crisis.
After all, it was the intermediated fund management houses—many of which are owned by banks and life insurers—that drove the corporations in which they invest, including banks, to pursue unsustainable and self-destructive growth strategies.
The problem, as so often with this credit crisis, is linked to flawed incentives. Often the end users (the ultimate savers and investors who own the capital) have long-term liabilities to meet. But the fund managers are incentivized to produce the highest return over short periods, often three months and never longer than one year.
The end result, whether unwitting or not, is that the industry, and its suppliers such as institutional stockbrokers has a tendency to enrich itself (for example with unproductive trading) whilst impoverishing its clients.
It's therefore gratifying that there are currently several initiatives underway aimed at persuading fund managers to abandon their short-termist mindset and to start prioritizing their clients’ long term needs.
One comes from Dr Paul Woolley, a former fund manager who has set up centers for the study of capital market dysfunctionality at the London School of Economics and the University of Toulouse.
Woolley has launched a radical 10-point manifesto which he would like to see adopted by the world’s biggest public, pension and charitable investment funds. Under the plan, these players would agree to keep portfolio turnover below 30% per year; avoid any dealings with hedge funds or other forms of alternative investment; and refuse to pay their asset managers performance fees, among other things. As the Economist’s financial columnist “Buttonwood” wrote:
Some will argue with the details but the thrust of the argument is simple. If the big funds in effect own the market in aggregate, then frenetic trading activity is fruitless, even before costs. Perhaps they are chasing a chimera: they all wish to be above-average performers. Perhaps they are bamboozled by an asset-management industry that competes not on price but on the basis of (probably unrepeatable) past performance.
Another timely initiative comes from Douglas Ferrans, chairman the UK-based Investment Management Association.
Also a former fund manager, Ferrans has pushed through an ideological shift at the IMA since taking over as its chairman in May. Instead of purely focusing on the prosperity of the fund management sector, as in the past, he wants to add the objective of ensuring positive financial outcomes for end users—individual savers and investors.
Ferrans believes that, under the current system, conflicts of interest are tolerated and “a disproportionate share of the spoils of capital investment is going in financial intermediation—a dangerous form of agency capitalism if you like.”
In a speech given on June 9th [PDF, 27 KB], he said more must be done to challenge excessive intermediation in the financial system, which is currently structured in a way that enables it to enrich itself whilst impoverishing many of its clients.
The industry has created a new body, the Institutional Investor Council, to represent the owners of capital (pensions funds and the like) which is seeking to force investment banks to reduce the fees they charge for underwriting rights issues (the cost of which is ultimately born by shareholders). The fees have risen from below 2% of the sum raised before Lehman Brothers' collapse to to as high a 4% since.
Colin Melvin, chief executive of Hermes Employee Ownership Services, is confident the interests of fund management firms can be realigned with those of end users, and is encouraged by the fact that many funds and asset management firms have signed up to the UN’s principles of responsible investment. He told the Zermatt Summit on Humanizing Globalization in early June:
“The best fund managers are rethinking their relationships with their clients, the duration of mandates, the products they’re offering, how they’re incentivized, and how that drives their own behaviour. That should culminate in longer-term mandates and better behaviours on behalf of the end users and the ultimate shareholders."
Further reading on future of the asset management industry, fund managing and financial intermediation
- Viewpoint: Anthony Bolton, Savings is a Growth Industry
- Viewpoint: Roger Steare, The Morals of Money—How to Build a Sustainable Economy and Financial Sector
- Money Managers, by David Pitt-Watson
Tags: asset management , financial crisis , fund management , hedge funds , private equity , stocks and shares