21 September 2017
Money is not Wealth
Do asset managers pursue profit above social responsibility?
by Frank O’Nomics
Asset managers have decided to give us something for nothing. Incoming regulatory changes, known as MIFID II, will mean that banks will have to charge asset managers for the research that they receive. For some this could entail a significant increase in costs – Barclays for example will charge as much as £350,000 for full access to their research service. Over the last few weeks a number of firms, including Blackrock, Jupiter and Aberdeen have said that they will absorb the increase in costs. However, when one realises that profit margins in the asset management industry are in the region of 40%, as opposed to around 16% for the FTSE All Share Index this is not as generous as it sounds. In recent years the asset management industry has made a great deal of noise about the incorporation of social responsibility into their investment processes – but aren’t such margins evidence to suggest that the only real driver has been that of profit?
Here’s the problem. The business model of asset managers is based on asset gathering – not on performance, and this potentially works against the consumer. It is often said that “a rising tide floats all ships” and the process of quantitative easing has been to transfer money from central banks to investors, and the asset management industry has been a willing conduit. This has made the buyers of most assets look very clever, but has produced little more than a wealth transfer, rather than any wealth creation. The incentives have all been to follow the money, rather than to engage in any proper asset allocation, looking for the next growth area. If money is going from cash into equities and other assets classes in a huge wave, the benefits of careful selection become hard to discern, making most active managers just closet index-trackers – earning high fees for very little effort.
There are further problems in the way in which asset managers intervene by putting pressure on the companies that they invest in. Because the asset manager is assessed on short-term returns, they encourage companies to do the same, rather than invest for the long-term and for the good of society as a whole. Further, they exacerbate problems by encouraging risky practices, as did the lending processes of banks 10 years ago, creating healthy margins at the expense of an overly onerous risk dynamic.
One of the biggest issues that we face as a society is that we do not save enough, and a lack of innovation and creativity by fund managers is doing nothing to correct this. The products created to assist auto enrolment and the shift from defined benefit to defined contribution pension schemes have so far not helped those most in need, and the lack of take-up of the Lifetime ISAs (despite my enthusiasm) points to a reluctance to develop areas where the profit margins are not instantly attractive.
Many will argue that these criticisms miss the broader importance of asset managers. Their function is to act as the transmission mechanism for the economy, turning peoples savings into investments in our society. In doing so they allow savers to have broader life choices (savings being just deferred consumption) and relieve the state of the burden of supporting people in their old age. If savers were to try to invest their money without using an asset manager the costs of doing so would be seven times greater and the asset management industry in the UK, which is a major global investment centre, has been a major contributor to our economy (anyone making that kind of profit must be paying a healthy amount of tax). It may be reasonable to argue that it is the responsibility of the government to police social responsibility and that asset managers cannot behave badly if regulations prohibit it. Indeed, why should asset managers force their views of social responsibility on their customers? Most asset managers would argue that Environmental, Social and Governance factors are fully incorporated into their investment process and they cite meta-analysis that demonstrates a long-term strong correlation between corporate profits and good ESG.
The next few years should add a lot of clarity to these arguments. We are already seeing the first signs of tapering in terms of QE, and this will necessitate a move back to more active management and notably a refocus on asset allocation. Asset managers will have to look at wealth creation and, given that investing in companies that destroy our environment makes no sense in the long-term, this should mean that profit and social responsibility are not mutually exclusive. The recent FCA review stopped short of advocating price caps, although the major investment consultancies (there are 3) will be the subject of a monopoly inquiry. For now then, we are in danger of having a group of people (who earn on average around £200,000 each) under pressure to accumulate assets by generating short-term profits and nothing more. When someone suggested to a former boss of mine that money can’t buy you happiness, he responded “it can if you know where to shop”. Let’s hope that, once the QE prop has been removed, UK asset managers know where to put our money.
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