The investment industry faces a credibility problem. Investors suspect that owners’ commercial interests are being put before their own.
The Bible says you cannot serve two masters, yet asset managers face this exact challenge: how to satisfy both shareholders and the investors in their funds.
There are many situations in asset management, a business that owes a duty of fiduciary care to its investors, where the desire to maximise profits for shareholders can come into conflict with the best interests of investors.
This conflict is pervasive throughout our economic system and is the Achilles heel of the finance industry.
Asset management is becoming an attractive business to own as it is less capital intensive and has mostly escaped invasive regulatory attention. Industry, regulators, investors and shareholders therefore need to deal with some significant conflicts of interest at the heart of asset management companies.
The conflict can be addressed in many ways. A business model that is based on mutuality (it is owned by its clients), as in the case of Vanguard, the US fund house, removes the problem at source. However, it is unlikely that this will be universally adopted as much of our modern economy is built on the entrepreneurship of owners, to the obvious benefit of all.
Better aligning investment management fees with investor outcomes (short or long term) would help, too.
One way to improve matters would be for asset managers to adopt an ethical code that spells out that client interest is paramount. The UK’s industry body, the Investment Association, unveiled such a code last year.
As fiduciaries, that obligation is already implied but should be explicitly stated for internal and external consumption.
Part of the battle must also be to strengthen the internal culture in investment management businesses. Officers of investment management companies should instil a culture that honours the primacy of the client.
Privately owned wealth and investment managers have a competitive advantage here as it is far easier for them to demonstrate the successful management of the conflicts between owners and investors than their publicly owned competitors.
During the past few years, the bigger managers have become even bigger and assets ever more concentrated in the hands of fewer and fewer managers (mostly publicly owned). The next decade may well belong to those managers that can demonstrate they put their clients’ interests above their own.
Change must occur at an employee level if businesses are to thrive. Individual investment management practitioners should adhere to a professional code of conduct that puts investors first and prohibits conflicts of interest between owners and clients.
With the increasing complexity of financial markets and products, aided and abetted by globalisation and advances in technology, comes a rising supervisory burden. This burden needs to be shared better between regulator, employer and individual.
Fiduciary care must be brought to the forefront if conflicts of interest are to be mitigated with greater professionalism. Investment managers have a duty to act as stewards of investors’ assets, in an environment that nurtures a culture of more ethical behaviour and promotes market integrity.
The current system needs to adapt in order to manage conflicts. If our industry is to recapture the trust of our investor base, we need to work hard to prove that we truly mean it when we say that we put their interests first.
The investment management industry, its participants, and, most importantly, society at large will only prosper under these circumstances.
Paul Smith is president and chief executive of the CFA Institute
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