A template for fixing flawed fund management
The actions of companies and governments shape the world around us and the society in which we live
T HE deal on the table for Greece is a timely reminder that the development of economics and financial theory today is roughly where medicine was 300 years ago. Back in the 18th century, no one really understood how the body worked but their limited knowledge persuaded them that bloodletting would be the cure for everything. Today, not many people understand how a modern economy works so our leaders have seized on the simple idea that austerity is the cure for everything.
A bit harsh perhaps but if the theories underpinning natural sciences had led us to a disaster equivalent to the financial crash of 2008, the world’s physicists and chemists would have recognised how their theories were wrong and gone in search of something t hat worked better. With few notable exceptions, this has not happened in the investment world. When challenged, market practitioners might accept that financial market theory failed in 2008, but they carry on using it.
This is arguably adding to, rather than solving, the problems caused by the crash. The saddling of a mountain of debt on the world’s taxpayers has led directly to the bankruptcy and scalingback of social security systems. Even mature political systems are under strain from disaffected voters. Growing inequality leads many to question what the financial system is for.
Not many of these questions are asked by the people who actually work in finance but there are exceptions. Saker Nusseibeh is in charge of Hermes, one of Britain’s biggest pension managers, an organisation that began life as the Post Office pension scheme and today runs billions of pounds of BT pension monies and provides services for other pension funds.
In a paper published this week on the website of the 300 Club — a group of like - minded asset managers from around the world — Nusseibeh makes the case that the modern fund management industry, wedded as it is to these outdated ideas, is failing to meet the real needs of its customers or of society as a whole.
His starting point is to acknowledge that financial theory and neoclassical economics are flawed. But he suggests that concentrating on purely nominal financial returns, as the asset management industry does, is also flawed.
Thi s is compounded in a worl d where interest rates are being kept deliberately low by the central banks, as they have been for the past six years. Assets are valued in terms of the returns they generate.
If the returns are distorted, as today’s are, the valuation models don’t work so there are no reliable yardsticks to drive investment decisions. Capital is not being allocated correctly and the system is therefore failing in its fundamental purpose.
This leads him to the bigger point that the actions of companies and governments shape the world around us and the society in which we live. Asset man- agers need to remember that the people whose money they invest — the ultimate owners of the shares — live in a world shaped by these companies. So the impact they have on people is not just a matter of the profit they make as investors but also how comfortable they feel in the world the company and others like it have shaped in making those profits.
The public c an shape thi s world through the pressure asset managers can exert on companies on their behalf. So in engaging with boards, Nusseibeh suggests asset managers and investors “should not look only at the short- or even the medium-term financial return but should incorporate within it an attempt at designing an optimal societal outcome for savers from their investment holdings holistically which may well incorporate forfeiture of short-term nominal return.”
What he is suggesting is that, faced with a choice, people might be willing to take a lower return on their electricity company shares if that meant they would be less exposed to power cuts in the future.
They might accept a lower return from railway companies if the trade-off was that the trains were cleaner faster and more frequent. They might prefer a smaller bank dividend if it meant more branches stayed open. And in a world where climate change is a serious threat, they might well accept lower returns if it meant a company could cut its carbon footprint.
The core thesis is that investing in order to pay a pension is not simply about delivering a cer t ain sum of money in 20 or 30 years, it is about delivering a certain standard of living to the pensioner, and thi s will be affected by all sorts of non-monetary items in addition to the amount of cash the person has in their pocket.
Pensioners’ qualit y of life in the future will be influenced by the infrastructure around them.
The environment and the pension promise will only have been properly met if that environment is as good as it should be. It is up to asset managers today to use their influence to ensure that it is — that the return to society is maximised even if this means the purely financial return on an investment is less than it might otherwise have been.
O NE has to say it all sounds a bit unlikely. There are issues about who should decide how society should look in 50 years. Do intermediaries really have a mandate to choose on behalf of their clients? Would boards be able to engage on those terms and run the company with such constraints, and is it really what all investors want? But there is also the kernel of a crucial idea here about the sust ainabilit y of business and the planet and the responsibility of the investment world to promote it.
Many will feel that even if Nusseibeh has failed to provide a detailed road map for the asset management industry, he has certainly indicated the general direction of travel.
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