The Financial Industry Is Ushering in a New Discipline of Ownership


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The finance industry, long plagued by distrust among the public, has reached a tipping point, according to Stephen Davis, associate director and senior fellow of the Harvard Law School program on corporate governance and co-author of What They Do With Your Money: How the Financial System Fails Us and How to Fix It. At the 70th CFA Institute Annual Conference, Davis said that the public’s anger, fueled by a belief that they’ve been unjustly “separated from their money,” has helped to usher in a new “discipline of ownership.” His assessment of state of the financial industry struck a tone of cautious optimism.

Most investors are not “playing the market,” Davis said. Rather, they are what Leo E. Strine, Jr., Chief Justice of the Delaware Supreme Court, has called “forced capitalists.” That is, they’re invested in the capital markets because it’s the only way they can sufficiently grow their money, particularly in a low-interest-rate environment. However, the financial industry has served them poorly. The proliferation of intermediaries and their associated agency conflicts has created complexity and doubt that these agents are acting in the best interests of investors.

Davis contrasted the fortunes of retirees in the Netherlands with those in the US. Workers in the Netherlands will find themselves retiring with a nest egg approximately 50% larger than their counterparts in the US. In 1950, the US had 16 workers for every retiree, a ratio that is expected to drop to 2-to-1 within the next decade. This trend is putting greater pressure on returns, and Davis asserted that the industry should address this looming crisis by simplifying its structure.

The financial industry in the US, relative to GDP, has quadrupled in size over the past 130 years. Over that same period, Davis noted that in almost every human endeavor, from healthcare to transportation, we’ve seen great productivity gains — except in finance. It still costs about 2% to perform one of finance’s essential functions: moving money. That’s not to say that there haven’t been efficiencies realized. Advances like electronic transfers of money and more efficient trading markets have been important innovations, but the gains that accompanied these changes have largely accrued to the intermediaries.

The glut of investment products is perhaps best represented by the nearly 77,000 mutual funds available to the public, and the drag of intermediation by an estimated 16 agents standing between an investor and a targeted investment. Institutional investors, including Railpen in the UK, and CalSTRS in the US, are finally responding to the public outcry and examining the fees they pay more closely. They are also becoming more responsible stewards and asset owners.

Rather than shirking their responsibilities on important issues like executive compensation, diversity, and supply chain risks, asset owners are taking notice and exerting their influence over their portfolios of companies. In November 2016, a group of institutional investors, including State Street Global Advisors (SSGA), Vanguard Group, and BlackRock, created the Investor Stewardship Group to demonstrate their commitment to sound corporate governance practices. And SSGA’s recent installation of the statue of the “Fearless Girl” near Wall Street was a strong signal to corporate boards about their intent to vote for greater diversity on corporate boards. Davis said that we may look back on it as a pivotal moment for the industry, when institutional investors went from being passive owners to embracing their roles as responsible stewards for the industry, their customers, and society.

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Davis wants asset owners to walk the walk as well. As fiduciaries, he’s called on them to increase their own disclosures, suggesting “the financial equivalent of a nutrition label.” And he celebrated the ability of social media to hold both asset owners and the companies they own accountable for their actions. Davis is hopeful that these forces of change will help to bring the transparency and simplicity that has been lacking for too long.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo courtesy of W. Scott Mitchell

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