Articles - Moving into a 3D investment world


In May of this year the Financial Times reported that Department for Communities and Local Government (DCLG) issued a consultation paper that suggested that local authorities use passive management techniques to save the estimated £660m per annum wasted on active managers who rarely beat the markets. For decades we have known that highly-paid fund managers, on average, consistently underperform the index, yet costly active fund management has predominated - to the substantial detriment of pensioners and their savings.

 By Rodney Schwartz, CEO, ClearlySo
  
 The persistence of such practices shows a wanton disregard for the interests of those whose savings we have a fiduciary responsibility to protect.
  
 There is another way in which beneficiaries’ interests are being systematically disregarded and one suspects that the causes are similar. Historically, most investors sought to maximise risk-adjusted rates of returns. Prior to the 1980s, adjustments for risk were less of a norm, yet the volatility of the 1970s brought about a distinct preference from most investors for stable returns - beta became one of the more widely accepted yardsticks for measuring this. The investment world operated on this two-dimensional plane for decades.
 
 In the aftermath of the socially and fiscally tumultuous period since the financial crisis of 2008, there are growing signs that wealth-holders are seeking to generate socially beneficial impacts alongside their financial returns. Conversations we are having with both institutional and individual investors suggest that non-financial factors are rocketing upwards in terms of importance in decision making. Nevertheless private banks, IFAs, professional fund managers, pension fund advisers and a host of other gatekeepers have been loath to offer access to such products or even to accept their entry into the lexicon. We are moving into a 3D investment world but the investment community is stuck in a 2D model of operating. Yet again, beneficiary interests are being ignored.
 
 It may be argued that such non-pecuniary factors are difficult to assess. It is also regularly pointed out that social impacts are hard to measure, and can be highly subjective. There is some truth with regard to the former, although progress in this regard is continuing. Understanding the carbon footprint of large companies is now a regular part of the assessment by analysts and fund managers. This is done in order to measure their negative impact on society, in terms of negative externalities generated, and to estimate vulnerability to changes in legislation - witness the divergent impacts on US energy shares in the aftermath of the Obama Government’s recent pronouncements.
 
 That the analysis is subjective misses the point. Some investors place a very high value on negative externalities, whilst others could not care less - varied preferences such as this make markets. Similarly, widely divergent preferences for the avoidance of volatility are also subjective. This is no excuse for a failure to take these preferences into account in looking after beneficiary interests. For investors who care about carbon footprint, the ethical quality of the supply chain, the harmful impacts of certain consumer products (such as tobacco or food products that encourage obesity) and other social, ethical and environmental factors, to have these preferences ignored by mainstream fund managers is offensive - it is also bad business practice not to give clients what they want. Moreover, these factors do eventually have an impact on share prices, as the example above about US energy shares illustrates.
 
 It fails to occur because of incentives - incentives that were also a factor in the built-in bias for value-destroying active fund management. Managing others people’s money is a cosy and well-paid field. Changing its nature threatens this and fund managers, like many of us, are averse to change. One also suspects that rewards, which can be incentivised to encourage financial performance, will be threatened by a shift towards non-financial factors.
 
 The boards of charitable foundations have historically hidden behind Charity Commission guidelines to avoid this question—but hiding is becoming more difficult in light of recent directives. Local authority pension funds have been in the lead in taking impact into account, as in the “Investing for Growth” initiative announced in 2013. Private Banks, IFAs and others have moved at a glacial pace in this direction, despite the notable efforts of one or two leaders. There is a competitive advantage to be gained by moving in this direction and two-fold moral imperative - clients get what they increasingly want and society may be better off. At the very least, it should be incumbent upon those offering products to survey their clients and ask what trade-offs they would make.
  

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