A few weeks ago I wrote here about what makes a company a social enterprise rather than just a company. Many people wrote setting me straight on the definition of a social enterprise. This was remarkably unhelpful for the simple reason all their definitions were different. Everyone agreed it is a company that does good in the course of business. Very few agreed on a reasonable definition of good. It’s tricky.
However it moved me on, as I’m afraid almost everything does, to the inadequacies of the fund management industry. You could argue there isn’t much wrong. It takes vast amounts of money and does a more or less adequate job of making sure most people over most periods of time don’t end up with significantly less than they started with. Maybe that’s fine.
You could also argue there’s a lot wrong with it. We work. We save. And then we hand our money to fund management one way or another to be protected and grown so it can finance our houses, our children’s educations and our retirement trips to Norwegian fjords. Fund managers are managing hopes and dreams as much as they are managing money.
If that were done well it would be to the benefit of the client and to society as a whole. It would do good. And fund management would be a social enterprise. But it isn’t.
There are too many actively managed funds — think 4,000. Most underperform their indices (despite surreptitiously tracking them). Most trade more than they should and persist in overcharging while denying they do. I have lost count of the managers who insist I just don’t understand how expensive fund management is, what with the regulation. It is a point. Regulation is expensive.
But you know what? It isn’t the only thing in the life of a mainstream fund manager that is expensive. Offices in Mayfair are expensive. Broker research is expensive. So is in-house catering (journalists are often lectured about expensive regulation after a nice lunch in the boardroom) and the art you see on every City wall: most fund manager founders are great art lovers or great show-offs.
And let’s not forget why the volume of regulation keeps rising. I’ll accept it is partly to do with there being too many politicians with too little to do (regulation expands exponentially relative to the number of people sitting in any given parliament). But it is also a direct result of industry behaviour: if everyone was happy, the majority of rules apparently hampering the sector’s ability to operate at what everyone else thinks of as a reasonable price would never have been invented.
What else is wrong? The bonus system is just as overactive in fund management as elsewhere in the corporate world. And it skews behaviour in the same way. Pay someone on the basis of quarterly performance and you’ll see them distorting behaviour to create quarterly performance.
The good news is things are changing. The underperformance of most funds doesn’t necessarily reflect the performance of the average investor: the poorest funds tend to have fewer investors so the average investor does better than the average fund.
At the same time the challenge raised by cheap trackers to the active industry is huge. It will, in the end, push the rubbish active funds out of the market, leaving it polarised between a slush of passive money that sometimes does better than actively run money and sometimes doesn’t, and a smaller better active sector. That wouldn’t be all bad. There is also a rise in the chatter about taking a more long term and sustainable approach to investing. Note the Investment Management Association has just set up an Investors Forum with exactly this in mind.
But what could make things better faster? There are technical methods to force long-termism in professional investors. You can introduce stepped voting rights and enhanced dividends for long-term holders of shares. You could also have a go at reversing the new focus on quarterly results by companies by changing pay packages to make anything quarterly utterly irrelevant: given most people invest on a five to 20 year frame and it is impossible to tell if a manager is good or lucky for at least five years (some say 20), paying them for performance over any smaller amount of time is just silly.
There might also be scope for the creation — perhaps even the state sponsoring — of one huge, well diversified fund offered to everyone as a default fund for all their savings. That would give everyone else something average and cheap against which to prove themselves superior if they want to stay in business. It’s a model that works well as a way of maintaining excellence in private health care.
But in the end it all comes down to attitude. Fund managers really need to see their end clients. By that I don’t mean the independent financial advisers and pension funds who contract out their investment duties to the Blackrocks of the world. I mean you.
I sit on the board of a few investment trusts. Not many people turn up to our AGMs. But last year one pensioner came to one. He pointed out that the directors’ fees looked very high. “I expect you all have other jobs too,” he said.
That particular board is a good board but nonetheless this is an excellent reminder that being involved in the business makes you responsible for the finances of people who will suffer if you muck it up.
All fund managers need more of those: perhaps every house could have an annual open day for all retail holders of its funds. A small part of the bonus pool could be diverted to pay for warm white wine and the managers could circulate among the masses to see for themselves the joy or lack thereof they have created in other people’s lives. No one will be allowed to be away skiing in Whistler or collecting Vitamin D in the Maldives during the week of the event.
Otherwise I have surprised myself by becoming a fan of the idea of a short Hippocratic Oath for fund managers: perhaps something along the lines of: “I promise to put my clients’ interests first and not to steal their stuff to finance my collection of modern British artists.”
This happens at a fund manager in Edinburgh which does very well — something that might or might not be a coincidence. I have, inevitably, more thoughts on this matter and I’d like to return to it in a future column. All your thoughts are very welcome.
— Financial Times
