The Transparency Task Force Ideas to help improve the Future of Asset Management
October 07, 2022 |
Penny Lamont


Ideas to help Improve The Future of Asset Management.

A White Paper inspired by


held in London on 24th April 2018

JUNE 2018


The Purpose of this Document

This document has been compiled to share ideas on how the future of the Asset Management industry can be improved. It has been compiled for key stakeholders within the regulatory and policymaking environment with the intention that it helps to initiate a meeting where the content can be discussed and explored further.

The document is a cluster of stand-alone ideas; written by participants at the Transparency Task Force’s Transparency Symposium entitled “Time for Transparency – the Future of Asset Management” held at Orbis Investments’ London office on 24th April 2018.

By compiling this White Paper, we hope to have captured some of the thought leadership, creativity and desire for change that was expressed at the symposium. We are extremely grateful to all the attendees at our event for their participation on the day and in particular to those that have taken the time and effort to make a very valuable and highly worthwhile contribution to this co-created piece of work.

We hope you find the White Paper useful and worthwhile; and would welcome the opportunity for the contributors to discuss their ideas further at a suitable round-table discussion that we can organise.

Please note: If you are already familiar with the Transparency Task Force please skip straight to Contribution #1 on page 7.

About the Transparency Task Force

The Transparency Task Force (TTF) is the collaborative, campaigning community, dedicated to driving up levels of transparency in financial services, right around the world. We believe that higher levels of transparency are a pre-requisite for fairer, safer and more efficient markets that will deliver better value for money and better outcomes to consumers.

Furthermore, because of the correlation between transparency, truthfulness and trustworthiness, the TTF hopes and expects that its work will help to improve the reputation of the financial services sector.

The TTF seeks to operate in a collaborative, collegiate and consensus-building way; focusing on solutions, not blame. We have over 300 volunteers organised and mobilized into 13 teams. Each team is working on at least one campaign initiative.

For further information about our teams, their campaign objectives and the individuals involved see here:

The Transparency Task Force’s Mission

We believe the financial ecosystem is profoundly important to the wellbeing of society, the global economy and political stability. However, we also believe there’s a great deal wrong with it that needs fixing.

Our mission is “To help Fix Financial Services by harnessing the transformational power of transparency.”

The issues that are of concern to us include:

  • Hidden costs and risks
  • Opportunistic opacity
  • Opportunistic obfuscation
  • Opportunistic complexity
  • The Engagement Deficit
  • The Understanding Deficit
  • The Trust Deficit
  • Short-termism
  • Insufficient client-centricity
  • Damaging incentive structures
  • Asymmetries of information
  • Regulatory capture (USA?)
  • Scams and scandals
  • The prevalence of a ‘profit before principle’ mindset
  • Routine reputational damage
  • Conflicts of interest
  • Financial instability
  • Malpractice
  • The lack of market integrity
  • Miss-selling
  • The sector’s forgotten purpose

The Transparency Task Force Approach

Our approach is to raise awareness of what needs fixing; by shining a light into the darkness. The transformational power of transparency has been known for many years: The term “Sunlight is said to be the best of disinfectants; electric light the most efficient policeman” was first used by Louis D. Brandeis in his book “Other People’s Money and How the Bankers Use It” in 1914.

Transparency can be transformational because of the correlation between

  • Transparency
  • Truthfulness
  • Trustworthiness

Put simply, we believe that the financial services sector needs to be trusted for it to function properly, but it is clear that it is not. If we want our sector to be trusted, we need it to operate in a consistently trustworthy manner; and that means being transparent.

TTF’s Strategy for Driving Change

Our Strategy for Driving Change is all about bringing together the thoughts of two groups of people:

#1, those with a sense of passion & purpose about what needs to be changed – this group includes the many academics, subject-matter experts, consultants, campaigners, civil society and advocacy groups, thought leaders and practitioners in our community.

#2, those with the power & position to make change happen – this group includes Parliamentarians plus members of the policymaking and regulatory community.

We bring the thoughts of these two groups together in many ways, such as:

  • Through our Transparency Symposia
  • Through our Special Events (we have held 3 at the House of Commons)
  • Through our magazine, The Transparency Times
  • Through formal consultation responses
  • Through issuing White papers; such as this one.

About the topics covered in the White Paper

As mentioned, this White Paper is a compilation of stand-alone contributions. The contributors are sharing their own thoughts and there should be no assumption made that contributors agree with the contributions made by others; the TTF is an eclectic mix but the one thing that unites us all is the desire to see improvements in the way the world’s financial ecosystem works; and the belief that transparency can help drive the change that is needed.

Contribution #1:

By Leon Kamhi – Head of Responsibility, Hermes Investment Management

“Investors need to act as responsible owners to deliver investment’s true purpose”

Purpose of the Investment Industry

If you asked a typical fund manager what the purpose of investment management is, they are likely to answer that it is the delivery of investment returns. At Hermes, we believe the investment industry needs to provide much, much more.

As described in our CEO Saker Nusseibeh’s paper “The Why Question”, the purpose of investment is to create wealth sustainably over the long-term. This ensures the endinvestors – who are very often individuals through their company pension arrangements – enjoy the return on investments they need to meet their objectives, but also that those returns are holistic. This means that investors get both investment performance to fund a desired standard of living as they get older and that their investments contribute to an affordable cost of living and a stable, secure environment. In other words, enough money to live on, in a world that’s worth living in.

There is no benefit to an investor if they achieve a higher return relative to competitors or to an index benchmark if at the same time the absolute value of investments has fallen. An individual saving for a pension doesn’t benefit from a higher return on an investment in an Oil & Gas company achieved through a carbon intensive investment if the resulting carbon emissions lead to higher energy and food prices: both staples in the average pensioner’s goods basket. The holistic return that in our view should be the investment industry’s target, aims to optimise both the absolute investment return and the social and environmental impact of the investments made.

At the heart of the purpose of delivering holistic returns are the development and growth of sustainable companies (and other assets) which meet the needs of their customers, take care of, develop and pay their employees fairly, build effective relationships with suppliers and focus on the impact that their activities have on wider society. It is our view that sustainable companies deliver better-long term financial, social and environmental returns. Examples abound that show the dangers of failing to focus on holistic returns. One of the most recent examples is that of Facebook, which belatedly recognised that data privacy is important to its users and wider society. Other examples include Sports Direct’s treatmentof its employees at its Shirebrook warehouse and the conduct of banks in the LIBOR and PPI scandals which has cost them and their investors hundreds of billions of pounds. Each case shows that holistic consideration of all relevant stakeholders is critical to developing a sustainable and valuable business.

The investment industry needs to fundamentally change its mind-set and re-focus onsupporting the wider economy and the creation of wealth for everyone. That means looking after the end-investors who are the capital providers – and who may also be employees, pensioners, customers, carers, parents and members of society.

How is the industry performing on holistic returns for beneficiaries?

Industry participants, who are supposed to be the agents of the investors, are doing very well. According to the FCA’s UK Asset Management Market Study’s Final Report, investment management companies are earning on average 35% margins from 2010-2015 (page 4 Section 1.10; pages 22-23 Section 4.13; page 34 Section 6.4; Annex 1). Further, average pay per employee at asset management firms has risen since the financial crisis to $263,000 in 2014 (Source: New Financial, Taking Stock on Pay, February 2016). Investment managers are well rewarded. Other intermediaries in the investment chain also benefit significantly from investment activity. These include investment banks, lawyers, accountants, consultants and so on, each of whom take a slice of the pie as they go.

How well does the end beneficiary investor do? Sadly, not well at all. According to the FCA study, neither passive nor active managers in aggregate add value (page 4 Section 1.11; pages 33-34 Section 6.3). The reason is simple. Take equities. For every buyer there is a seller and then there is the management fee which each takes. Therefore, returns in aggregate have to be a negative-sum game. Compounding this, a significant proportion of fund managers target returns relative to an index and are not focused on generating the absolute returns that investors actually need. Furthermore the time horizon of the investment industry is normally much shorter than the long-time needs of the average investor, which may come at a cost to long-term potential.

Turning to the other part of the holistic return, there remain significant economy-wide issues affecting cost of living and quality of life. There are major external risks that must be addressed for pensioners to have a decent future to retire in. These include climate change, pollution and the need for greater resource efficiency to deliver the so called “circular economy”, which needs to become standard practice and part of what a company or other asset is measured on.

Other examples include banks that continue to focus on transactions that generate fees but not necessarily value through supporting growth in the wider economy. Or pharmaceutical companies that do not get credit for the positive impact the drugs they produce can have on the cost of public healthcare systems and users’ overall wellbeing. The huge opportunity from the development of diverse talent in the workforce remains untapped. There has been progress in stronger corporate governance in most regions of the world with better skilled and independent boards but executive pay structures are fundamentally broken with pay and performance outcomes more often than not misaligned.

How should the investment industry step up?

There are a number of potential remedies. Perhaps the most high-impact would be a shift to active ownership focused on delivering holistic returns. It is imperative that asset owners and asset managers focus on the end-investor and, as their agents, act as informed and responsible owners of the investments they make on behalf of clients.

Significant resources in investment houses are currently focused on making investment decisions. While there has been some improvement, relatively few resources are expended on the stewardship that we feel is critical to the delivery of the holistic returns that are essential to the future all-round wellbeing of the pensioners who we serve. Hermes has 25% of its public markets Front Office staff engaged in stewardship activities, which is likely to be a significant multiple of any other investor’s investment in stewardship resources.

But stewardship resources are not enough on their own. They need to be focused on actively and effectively promoting better governance, better environmental and social performance and effective long-term capital allocation by companies. Well informed analysis and effective challenge to company boards are essential ingredients to successful engagement.

To achieve this, investment firms will need to explicitly reorient their business purposes to deliver long-term holistic returns for the beneficiaries they ultimately serve. They must be transparent about what they are trying to achieve and demonstrate how their investment and stewardship activities deliver this renewed corporate purpose. Governance, remuneration and fee structures will need to all work together to be aligned to delivering
holistic returns. Investment mandates should focus on long-term absolute, not short term benchmark-relative returns. This would encourage the integration of ESG factors alongside financial factors in investment decision-making and crucially a role for active ownership and stewardship of assets. Client performance reports would then need to reflect everything that the investor is delivering for the beneficiary not simply describe investment return as if it happens in a vacuum.

A greater focus on active ownership will not be easy and represents a significant structural change in the way the industry operates. It has started the journey. There is a long way to go.

The views and opinions contained herein are those of the author and may not necessarily represent views expressed or reflected in other Hermes communications, strategies or products. The above information does not constitute a solicitation or offer to any person to buy or sell any related securities or financial instruments.

Contribution #2:

By Daniel Godfrey, Independent Director and Consultant; TTF Ambassador

What are the risks that really matter?”

To define the risks that really matter, we need to agree on the purpose of the activity. Threats to fulfilment of that purpose are then the risks that really matter.

Let us suppose that we can define the purpose of asset management as being to deploy investors’ capital with the objective of creating wealth sustainably. This purpose statement is proposed because success would both secure the long-term, cumulative, absolute returns that the providers of capital need, but it would also help to ensure that they can spend those returns in a world that’s worth living in.

The key risk therefore would be a failure to create wealth sustainably. Success implies that business creates wealth in a way that is consistent with:

  • a planet that averts climate change above 2
  • a world where business and innovation reduce inequality and increase opportunity
  • businesses having a clear purpose and long-term, strategic objectives
  • businesses serving the interests of all stakeholders including employees, suppliers and communities.

The risks can broken down into one or both of two elements:

  • a failure to deliver returns that meet reasonable client expectations and/or
  • a failure to ensure that capital is deployed and stewarded in ways that enhance sustainability

Unfortunately, the primary driver of success in asset management is driven either by relatively short-term, relative returns or being able to match an index at the lowest cost.

This is a flaw in the investment chain, rather than being the fault of asset managers alone.

And a focus on short-term relative comes at a cost to long-term absolute, reducing the potential of the capital being invested to work harder for customers and to make the world a better place.

That’s why the risk that really matters in asset management is a failure to refocus on longterm, sustainable wealth creation and stewardship. Get this right and the rest will follow.

Contribution #3:

By Dr. Anna Tilba, Associate Professor in Strategy and Governance, Durham University Business School; TTF Ambassador

“The Future of UK Asset Management: Purpose, Prudence and Priorities”

Asset management is a key part of the financial system. Asset managers manage the savings and pensions of millions of UK people, making decisions for them that will affect their financial well-being. Through their investments, asset managers also support businesses that provide jobs and drive economic growth1. Therefore, trust, transparency and accountability within these services are profoundly important to the wellbeing of our society.

Notwithstanding the significance of this sector, there are some very worrying problems in many areas. The FCA’s recent review of the Asset Management industry has revealed weak price competition and that investors are not always clear what the objectives of funds are; that the fund performance is not always reported against an appropriate benchmark2 . The FCA was also concerned about the way the investment consultant market operates referring to the Competition and Markets Authority (CMA) to conduct an investigation into this sector3.

Following closely the FCA and the CMA reviews the Transparency Taskforce (TTF)4 has undertaken a broad range of activities to raise awareness and help tackle the key issues raised within these reports. One of the important questions that the TTF has been asking its members at the latest Transparency Symposium5 relates to the existential true purpose of asset management itself and how can asset management embrace a more prudent governance and better stewardship of capital.

1FCA (2016) Asset Management Market Study [available at: ]

2 FCA (2017) Asset Management Market Study, Final Report [available at: ]

3CMA (2018) The Market for Investment Consultancy Services and Fiduciary Management Services:
Experiences and Views of Pension Fund Trustees [available at: ]

4The Transparency Task Force is the collaborative, campaigning community, dedicated to driving up the levels of transparency in financial services, right around the world [ ]

5Transparency Symposium, The Future of Asset Management, 24th April 2018, London
[ ]

Before these questions can be answered, we need to consider several important points in relation to the purpose and asset manager stewardship priorities, namely, the concept of ‘Prudence’, which is often being used in blanket and vague terms; and particularly the role of investment consultants and the nature of their relationships with trustees (i.e. their pension fund clients) in this context.

The UK Law Commission’s report on Fiduciary Duties of Investment Intermediaries in 2014 has stated to focus on the nature of relationship between trustees and their investment consultant by disambiguating the legal concept of ‘fiduciary duty’ also in relation to investor Stewardship and engagement. The Report defined stewardship activities as including the monitoring of and engaging with companies on matters such as strategy, performance, risk, capital structure and corporate governance, including culture and remuneration.6 It aimed to establish whether the legal notion of Fiduciary duty precludes stewardship activities in asset management would and whether it is compatible with the fiduciary duties of pension fund trustees who buy their services. This is where the concept of Prudence appears to gain its significance.

Pension fund trustees are legally bound by common law fiduciary duty, which requires trustees to proceed with prudence and to act in the best interests of the beneficiaries when they decide pension fund investment strategies7. The concept of ‘prudence’ arises from the Duty of Care, which assumes that trustees exercise the care, diligence and skill that aprudent person of business would exercise in managing his or her own affairs8 . This is sometimes referred to as the ‘prudent man rule’. This typically implies that trustees should
seek advice when they make investment decisions if they are not investment experts9.

Significantly, this legal requirement has led to the arrangements within the UK financial system where nine out of ten big and medium sized pension funds rely on the big three investment consultancy service providers to advise them on the key strategic aspects of pension fund investment strategy (asset allocation and fund manager selection)10. Furthermore, the CMA report into the investment consultancy market highlighted that most pension fund trustees buy these services out of caution, i.e. being more concerned with

6 UK Law Commission (2014) Fiduciary Duties of Investment Intermediaries [available at

7Tilba and Reisberg (2018) ‘The UK Stewardship Code under the Microscope: Pension Fund Trustee

8The Law Commission (2014) above n 5.

9 9 TIlba and Reisberg (2018) above n 6.

1010 CMA (2018) above n 3.

ticking a box of bringing the external expertise rather than enhancing investment returns (including stewardship activities).

So what does this all tell us about Purpose, Prudence and Priorities for Asset Managers? In fulfilling their fiduciary duty to act prudently and in the best interests of members, pension fund trustees rely on investment consultants to supply them with strategic asset allocation advice and asset manager selection advice (91% and 88% of those using Investment Consultancy services respectively)11. The CMA (2018) report confirms the power and influence of investment consultants in the market while the FCA Asset Management Market Study (2016) highlights that Investment consultants do not appear to drive asset managers to compete on fees and that they can and do act as a barrier to entry when it comes to innovation. Significantly, the FCA finds that investment consultants may be incentivised to recommend overly complex and expensive investment strategies to clients and it is hard for clients to assess whether this is necessary because there is no clear and standardised market
methodology to assess and monitor their advice and performance. In other words, investment consultants are responsible for the way billions of pounds worth of assets are being invested and managed without considering their purpose, prudence and priorities in a way that they perhaps should be considering. As one respondent in the FCA study summarised:

‘They [investment consultants] don’t behave as if it’s their money. If they
were behaving as if it was their money they were managing, would they be more prudent? Would they be more challenging?’ (FCA, 2017, p.75)

If we are to ask existential questions about the true purpose of the asset managers and role that they can/should play in Stewardship, we should no doubt have a more critical look at the Purpose, Prudence and Priorities of investment consultants who have such a profound impact on the UK financial services. The CMA investigation into the Investment Consultancy market is a very important positive step forward.

However, more needs to be done in terms of improving accountability of these very powerful actors who remained in the shadows for far too long. The next regulatory challenge to overcome could be to regulate the advice and recommendations made by consultants to clients on strategic asset allocation and fund manager selection12 and create a clear and standardised market methodology for assessing and measuring investment
consultants advice and performance (including metrics on how they seek better fund manager mandates on their investment costs and charges and ESG).

11 CMA (2018) above n 3.
12 As indicated by the FCA in their interim Asset Management Market Study Report (2016)

Contribution #4:

By Valborg Lie, Founder and Director, Borg Consulting

“Busting the myth that Responsible Investment leads to underperformance”

While Responsible Investment (RI) is continuously under pressure to validate its existence in the mainstream investment world, has the time come to put the onus on those sceptical of
the RI investment case to prove their case?

What is more important in retirement; the Ferrari or the planet? This was a question posed at a Transparency Task Force symposium dedicated to debate The Future of Asset Management.

While I don’t accept the premise of the question – I disagree with the inherent proposition that there is a trade-off – I was thankful to be reminded of the divide between the “RI choir” and the mainstream investment community. Why is this divide still so sharp? I think one important reason is the fact that those who have practiced RI over time have not been able to sufficiently convey to the market the radical development that RI has undergone over the last 10-15 years. Equally important is the fact that conventional investors are not cognisant of the reality that a person of the Millennial generation would counter with; “Why would I want a Ferrari if there is no habitable planet to live on?”.

RI revolution

In the early days of RI, the emphasis was on negative screening and avoiding certain types of investments, such as weapons and tobacco, for ethical reasons. If this was still the only or main activity that constitutes RI, one could say that it lies in the domain that is not material to investment. As an example, the Norwegian Sovereign Wealth Fund (the GPFG) has had guidelines in place over the last 14 years that establish “no-go zones” for investments relative to specific sectors and activities that are considered grossly unethical. Financial
consequences, whether on the upside or downside, are irrelevant to this ethical screening.

RI has however quickly evolved into a much broader set of activities geared around the core goal of securing long-term financial returns. If you ask the manager of GPFG why they spend time talking to investee companies and standard setters about good governance, environmental and social issues; why they put money into research of economic trends like climate change; why they systematically map risks that stem from for instance greenhouse gas emissions, deforestation, bad corporate governance, corruption, health and safety, human capital, gender diversity – they will explain that this is all done in order to ensure sustainable long-term growth of the Fund and to contribute to the long-term health and stability of the market as a whole. Somehow this radical transition has been lost on the mainstream investment community and thus the myth that RI leads to underperformance continues.

We undoubtedly need to tidy up the language and be prepared to explain and educate on what current, best practice RI is about. I prefer to use the term non-traditional factors when talking about issues that are material to a given investment or to the overall health and wellfunctioning of markets, even though traditional financial analysis would not automatically cover it. Among non-traditional factors are those that will likely affect long-term economic growth, including for instance climate change, resource scarcity, social migration and

Long-term investors such as pension funds are increasingly interested in getting data and disclosure on these factors from companies in order make sound investment decisions. How companies are positioned to adapt to and manage these trends, will have direct impact on their value drive and risk management capabilities. Investors who understand this are asking for more quantifiable disclosure which can meaningfully be taken into account for investment strategy and decision-making. On the flip-side, I don’t see the term non-financial
as helpful in describing RI. If one means to refer to ethical screening, then the appropriate wording is precisely that; Ethical screening. A recent study commissioned by the Norwegian Ministry of Finance into global RI best practices13, finds that negative screens are used by investors in order to align with the purpose and values of the organisation and its ultimate beneficiaries. The same study concludes that RI is seen by several prominent institutions simply as best practice asset management and the best way of ensuring that assets are safeguarded and continue to grow over the long term.

The “new” investor

I remain firm in my conviction that RI represents a new way of thinking and doing investment which is likely to become tomorrow’s best practice asset management. RI carries in it innovation, change and transparency. Those three elements can be daunting for an industry that has a natural inclination to follow tradition rather than innovate and would prefer to keep things opaque and complex rather than transparent.


The reality is that time has come for change for the investment industry. I would argue that we will be seeing the beginnings of a “new investor” entering the stage, with new norms and a new mindset. For those who are open to that, they have a host of aligning trends on their side including, regulatory changes14, academic research15, peer performance and pressure16and stakeholder expectations17. For those who are not open to this proposition, I would ask them to bring forward the evidence of why RI in its current form should be ignored by the asset management industry.

14 The concept of fiduciary duty is being revised to reflect a new outlook on the job of looking after other people’s money. In the words of The Law Commission, in its 2014 report on the ‘Fiduciary Duties of Investment Intermediaries’: “There is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material.”

15 A growing volume of academic studies and meta-studies strongly suggests that companies exhibiting strong ESG credentials have historically generated superior risk-adjusted returns over the medium and long term. See, for example: Harvard Business School, Moza ar Khan, George Serafeim and Aaron Yoon (2016) Corporate Sustainability: First Evidence on Materiality; University of Oxford/Arabesque (2015) From the Stockholder to the Stakeholder; Friede, G. et al. (2015) Aggregated Evidence From More Than 2,000 Empirical Studies, Journal of Sustainable Finance and Investment 5:4, pp 210-233; DB Climate Change Advisors/Deutsche Bank (2012) Sustainable Investing: Establishing Long-Term Value and Performance; MSCI (November 2017) Foundations of ESG Investing; Harvard Business Review, George Serafeim (December 2017) Can Index Funds Be a Force for Sustainable Capitalism.

16 See footnote 1.

17 Recent research on millennials’ investment preferences shows a clear generational drive in favour of Responsible Investment. See for instance “Millenials Drive Growth in Sustainable Investing” (August 2017), and Opinium Research on behalf of Triodos Bank (October2016).

Contribution #5:

By Valborg Lie, Founder and Director, Borg Consulting; and Mais Callan, Founder and Managing Director, Impactive Associates

“Well-informed trustees are fundamental to sustainable and prosperous pensions”

The investment industry has seen some rapid shifts in embracing responsible investment (RI) as a new standard for investing. So much so that many funds now are embedding environmental, social and corporate governance (ESG) factors as part of their ‘mainstream’ investment activities. While this is good news, the uptake at the trustee level seems much slower, despite numerous best practice initiatives. Is lack of knowledge the key problem?

We believe that for pension funds to act in the long-term interests of their beneficiaries, they must ensure that sustainability risks and opportunities are systematically identified and addressed. The push for this should come from the very top of the organisation – at the trustee level – through learning and knowledge sharing.

There are growing regulatory and best practice provisions in the UK and beyond encouraging pension funds to articulate and formalise their RI policies and practices. There are also more pronounced societal expectations for companies and the financial system to behave responsibly and create a positive impact. In combination, this undoubtedly puts increased pressure on pension funds to take RI seriously. The question is; are trustees equipped to tackle this new development? And if not, what are the main obstacles and how can those
obstacles be overcome?

While there are pockets of excellence within the pension fund industry, the majority still have a long way to go and need to act fast to address the gaps. We see three main obstacles to a wider uptake and understanding of RI at trustee level:

One: The myth that fiduciary duty is a legal impediment to trustees considering environmental, social and governance (ESG) factors in the investment strategy, asset allocation and investment decision making of a pension scheme still prevails.

Two: There is not enough knowledge among pension fund trustees of why RI, including ESG integration, is relevant to investments, and how to integrate that thinking into investment operations.

Three: There is a lot of jargon and confusing terminology, for instance the term “nonfinancial factors” as synonymous to ESG factors, that prevent the immediate recognition and uptake of best practice RI at trustee level.

How can these obstacles be tackled?

Clarity is emerging

We see clear evidence that the myth around fiduciary duty constraints is being busted and a more modern interpretation is taking hold. The Law Commission, in its 2014 report on the ‘Fiduciary Duties of Investment Intermediaries’, stated that “There is no impediment to trustees taking account of environmental, social or governance factors where they are, or may be, financially material.” Already in 2005, the landmark Freshfields report, legitimised the role of trustees to consider ESG issues in investment decision making. 10 years later, the Fiduciary Duty in the 21st Century publication concludes that “Failing to consider all longterm investment value drivers, including ESG issues, is a failure of fiduciary duty”.

At its core, RI encompasses all efforts to carry out the investment mandate in a way that aligns with the interests and values of the ultimate owners. As was evident in a recent study commissioned by the Norwegian Ministry of Finance into RI best practices among 18 pension funds across 13 markets, RI is seen by several prominent institutions simply as best practice asset management. As the definition of fiduciary duty broadens to allow trustees to consider ESG factors as materially relevant to beneficiaries’ interests, the next step must be to get clear and comfortable with what ESG issues are and how they work.

Knowledge is key

We believe that all pension fund trustees should have a minimum standard of knowledge on RI policy and ESG issues. A lack thereof could limit debate, hinder appropriate decisionmaking and potentially expose the fund to reputational or financial risks. It can also limit trustees’ ability to hold their immediate investment chain and intermediaries to account. As with any organisation, leaving key decisions on such long-term material issues to an individual or a siloed department is unlikely to be a lasting solution.

Language matters

Through targeted education, confusion caused by terminology can be diminished and clear distinctions can be made regarding different investment styles so that not all are associated with, for instance, exclusions and thus the fear of underperformance. We would caution against using a term such as “non-financial factors” in describing ESG issues, because it risks implying that they are not material or relevant to the bottom line. What trustees need to be able to understand and address are complex and systemic economic issues such as the impact of climate change, food and water security, demographic changes, and how those trends will affect long-term investment performance. With that knowledge, trustees will be able to develop their policies and practices so that they are prepared, pro-active and continuously improving in their role of fiduciaries.

Training in RI needs to be continuous and up-to-date

We believe that pension fund boards should dedicate a sufficient portion of time every year towards professional training in responsible investment – not as a one-off, but as an integralm,part of ongoing development, ensuring that current and emerging topics are covered.

Contribution #6:

By Guy Spier, Chief Executive Officer, Aquamarine Fund

“It’s time for managers to move to Zero Management Fees”

Now is the time for asset managers to shake off the criticism often levelled at our industry by setting our standards at the very highest level of competence and integrity in everything that we do.

One very significant step in that direction would be a for more industry participants to step up and stop charging a management fee – at least on incremental funds.

The fact of the matter is that when it comes to investment management operations, there are enormous economies of scale. Once an investment operation goes beyond a certain size, the incremental cost of managing extra assets is de minimis. By contrast, with increasing size, the opportunities to outperform become vastly diminished.

An investment firm that simply charges a fixed fee, no matter what the level of assets, at some point, is simply creaming money off the top – and not working to deliver value add to its clients. By contrast, those firms that seek to align with their clients’ interests by only charging a performance fee, are far less likely to simply gather assets, and seek to skim money off the top – no matter what the performance. Moreover, there can be no better signal to the market of the intention to deliver superior returns, as well as the capacity to do so – than having the manager only make money if he delivers superior returns.

Many funds don’t call those that invest with them investors but refer to them as partnersand this is a perfect way to qualify the alignment and the value proposition, which we should be striving for.

But while not charging a fee is clearly and emphatically the right thing to do, it’s remarkably difficult for investment managers to give up the predictable income stream and the security that comes from an annual fee of 1% or 2% of assets. In that, it’s really a matter of an investment manager’s behaviour, acknowledging that to keep driving down the direct costs of investing in a fund will result in more and more investors in the fund taking advantage of share classes, which may have longer lockups, but which enhance the fund’s ability to build
wealth for everyone involved for the long term.

But thinking in this way has the added benefit of forcing all the participants to think longterm. This is crucial in this model because of the peaks and troughs that affect the markets, and which time and again have been shown to flatten out when one compounds over many years. Add in zero fees and that is a thing of beauty.

Although this is counter intuitive idea, sophisticated investors are starting to realise that the only investment managers who are willing to go to all the trouble and expense of setting up a fund in which they only get paid if they outperform a hurdle, are the ones who are capable of outperforming the market. If one believes that, then simply choosing to invest in funds with no management fees may be the best way to identify and invest with superior investment managers.

Even if only some investors think this way, that may be enough reason to entice better investment managers, or at least those with a high opinion of themselves, to step up and go the extra mile with a frugal fee structure. Thus, offering a zero-management fee structure may serve as a kind of signal for prospective investors.

If this is indeed the case, there is a lot more for investment managers to do in order to signal that they can beat the market. In many cases the annual hurdle rate is 6%, which makes a lot of sense. Most investors should be content with a 6% annual return. But in the case of most funds with a 6% hurdle, it also has the feature that the hurdle is non-cumulative. That means if the outcome in year 1 is 3% the next year’s hurdle is still just 6%; rather than the 9% that would have applied in a cumulative model.

An investment manager that truly wanted to signal their confidence in delivering superior annualized returns would be able to demonstrate that by making their hurdle a cumulative one. So far, very few have done that. If more investment managers can start to think in this way, we can really start to elevate our industry from the other investment opportunities that exist.

Contribution #7:

By Malcolm Delahaye, SuperTrust UK Mastrtrust

“The Pensions Charging Cap in current form is ineffective”

Level of investment fees

Fees for institutional fund management range from as low as 0.02% to 0.65% according to level of risk management and diversification. They are also the level of fees included within the overall costs borne by a pension provider, whether an occupational pension, a personal pension or a master trust.

The only difference between schemes is how much of the costs over and above investment costs are passed on as a charge.

Prior to regulatory control, retail charges on personal pensions were typically in the range of 1% to 2.5% p.a, plus loadings to cover commission typically an initial 5% charge on contributions and renewal commission. Underlying investment fees (0.02% to 0.65%) could therefore possibly represent only 1/125th of total charges.
Simply because the total charges are deducted by the investment manager the perception has wrongly been allowed to survive that they represent investment fees. This has led to the flawed belief that reducing underlying investment charges will improve value for money.

Flaw in an AMC charge cap

The charge cap is a legitimate and necessary imposition to curb exploitation of a distorted market where the end consumer, the employee, is a forced buyer of a pension provider product chosen on his behalf.

However, a charge cap based on an AMC percentage, in isolation, is not achieving the object of protecting employees from excessive charges, nor is it allowing employees to be provided with appropriate investment strategies.

Excessive charges are not a function of the size of the rate of the AMC, they are a function of the AMC model itself, which lacks symmetry with underlying costs and service levels.

It leads to charges on small pots, which do not cover the costs to serve, and charges on larger pots, which produce excessive profit margins.

The point is illustrated by examining the cost profiles of pension accounts of both immature and mature pension schemes and identifying when and how economy of scale bites.

What is economy of scale

Convention says that the larger the fund the better is the economy of scale to cover costs.The costs of running a workplace pension scheme can be broken down as follows, not all apply to every type of scheme, but the list demonstrates that investment costs are a but a small element of overall costs to be met:

1.Trustee fees and expenses

2.Professional benefit consultancy fees

3. Professional investment adviser fees

4. Administration costs:

a.Either staff and IT systems of in-house administration

b. Outsourced third party administration costs

5. Member servicing, including communication and web site costs

6.Accounting and book keeping

7. Audit costs

8. Master Trust Assurance Audit costs

9. Regulatory fees

10 Head office costs

11 Investment management charges

12 Investment administration charges

The largest percentage of overall costs is administration and these increase directly in line with the increase in member numbers rather than size of assets.

Both NEST and the British Rail pension fund would be accepted as exhibiting economy of scale. NEST has assets of £1.7bn and British Rail assets of £28bn. If economy of scale is a function of size of aggregate funds then British Rail should be 16 times cheaper to run than NEST. In fact, from the latest accounts, NEST shows costs of £27 per member p.a. and British Rail costs of £59 per member p.a.

With NEST’s average declared charge of 0.50% on assets of £1.7bn its revenue is shown as £3.40 per member p.a, but with costs of £27 p.a it leads to a loss of over £100m p.a. If British Rail were a commercial provider with charges of 0.50% its revenue would be £411 p.a per member, a profit of £352 per member, or £120m p.a.

However, at an average cost per member of £59 p.a, British Rail would be making a loss on any member with a pension pot less than £11,800. British Rail’s average pot per member is in excess of £80k. NEST is making a loss because it requires an average pension pot of £5,400 to break even whilst its average pot per member is only £344.

Once break-even point is achieved, the crucial factor in harnessing economy of scale is clearly the pot size per member, not total assets. Note that the above figures are exclusive of investment charges, which will, as stated above, range from 0.02% to 0.065% making up perhaps only 4% of total costs to be met.


The AMC model is used by the financial services to maximise profits, it bears no correlation to underlying costs, which are largely fixed. It costs the same to run a fund of £1,000 as a fund of £1m.

The effect of the cap is to:


    • Ensure that no scheme is able to cover its costs for auto enrolment until the average pot per member is sufficient to generate between £20 – £60 per annum, depending on quality of services and support.

2. Ensure that any reduction in the cap increases losses on small accounts and only
marginally impacts the excessive profit on large accounts

3. Ensure that providers offer the cheapest investment products in order to minimise
the losses on small accounts.

4. Ensure that the low cost investments apply as a default for larger accounts which
could support more sophisticated, but expensive, investments.

5. Ensure that access to active management to provide better risk/reward profiles are

6. Ensure that innovative investment products to meet new pension freedoms are
inaccessible as a default.

Members interests will continue to be harmed unless the charge cap recognises that:

  • Investment fees are the least significant element in contributing to costs.
  • Administration and governance are the greatest elements contributing to costs.
  • An ad valorum charge on assets without scale to reduce the nominal charge on large
    accounts will not reduce costs over a career.
  • Providing a service to administer small accounts generating less than the costs to
    serve does not need to be tested against a value for money benchmark.
  • Value for money is related to the relationship between the charge, the profit margin,
    and service and support levels.
  • Investment charges are related to the degree of control to manage the risk/reward
    profile, not performance.

Contribution #8:

By David Butcher, Director & Founder, Communications and Content

“The anti-social network: engaging consumers and gaining advocates”

We live in times of diminished trust.

A 2014 PwC study placed fund managers last on a list of financial and public sectors trusted by consumers, with just 12% (versus, say, the 15% amassed by investment banks).18

The industry has dug its own hole. For years some of the smartest people in any economic sector consistently designed complex products with opaque fee structures. At the same time the sector became increasingly intermediated and the distance between it and its underlying clients widened.

This is partly a problem of poor communications. Fund management groups are expert in explaining how they see the world and what they think is important. They rarely listen to what their clients need, still less act on those needs.

At the same time, downward pressure on fees (spurred by cheap passive products) has drawn focus towards the cost of investing and away from the reason for investing: good consumer outcomes.

There are two things that could address this.

1. Repair the link between the industry and consumers.

Fund management groups can strengthen this connection by identifying and working with consumer and investor groups to achieve a mutually desirable level of disclosure.

Actions – disclosure

  • Work with consumer and investor groups to agree
    • An appropriate disclosure of costs that is meaningful to consumers and that reflects the full value chain.
    • An appropriate disclosure of holdings in a portfolio that balances the necessity of long-term horizons with tangible data and interesting examples of holdings.
  • Encourage greater contact between investor and consumer groups


They can also create a compelling narrative to capture the interest and imagination of

Actions – narrative

  • Start using terms and language with greater resonance to consumers
  • For example:
  • Less “fund management”
  • More “investing in Britain”, “investing in my future” and “family savings”.
  • Create industry-wide stories that show consumers how their money funds the real economy: housing, companies, the high street, jobs, hospitals and other things with meaning to people’s everyday lives.
  • For example:
  • “Don’t just wear Nike, own it”
  • “Support your community, invest in it”
  • “I’m funding the next generation of British businesses”
  • “This hospital wing was funded by 171,524 British savers, invested through Company X” [plus pictures of individual savers and their quotes]
  • Compile proper and exhaustive data to demonstrate the real-life impact of the sector.
  • For example: jobs created, companies financed, houses built and carbon emissions reduced.
  • Use technology more effectively to help excite an audience that expects instant and responsive digital customer service.
  • For example:
  • More effective engagement through the social and other digital channels consumers expect brands to use.
  • A generic investment app on a smartphone, linked to underlying providers.
  • Bring in expertise from outside the fund management sector to help build this narrative into a brand, with a clear identity

2. Win friends and get them to influence people.

It is hard to think of industry cheerleaders. When policymakers or regulators put the boot in, who can explain why fund management is valuable? Who might call for restraint?

But the field of candidates is large. They fall into three groups.

2.1 Consumers

The UK asset management sector provides services to millions of consumers, delivering positive outcomes to many of them.

Actions – consumer advocacy

  • Conduct quantitative analysis to detail these outcomes in aggregate and in the range of
    worst to best.
  • Conduct qualitative analysis to understand how these outcomes compared to expectations or targets.
  • Use a representative sample of findings / experiences to create a bank of case studies of individuals willing to speak about the industry as a whole.
  • Engage more wholeheartedly with investor and consumer groups. Provide them with the necessary support and information to help them talk about the industry accurately.
  • Encourage the creation of new, independent consumer group(s) who can provide underlying clients with a louder voice. Support that voice with information and appropriate platforms. Investigate the best aspects of rail commuter groups.

2.2 Institutions

The fund management sector brings substantial benefits to both UK and internationalinstitutions. It enables governments to fund transport and hospitals, and it helps insurance companies and pension schemes make promised payments to policyholders and members.

Actions – institutional advocacy

  • Build a bank of case studies explaining the role fund management played in meeting liabilities for different segments of institutional clients.
  • Encourage individual institutions to talk publicly about their experience of the fund management sector.
  • Encourage trade associations of institutional investors to talk publicly about their experiences.
  • Work with regulators to investigate the creation of a simple, consumer friendly metric that quantifies the value add of fund management in a pension scheme report and accounts – something that an institution could air publicly that would resonate with members and consumers more broadly.

2.3 Corporates

Fund managers provide valuable support to the plans of chief executives and finance directors of listed and private enterprises around the world.

Actions – corporate advocacy

  • Build a bank of case studies explaining the role fund management played in supporting a
    company, housing association or other enterprise’s achievements.
  • Work with friendly individuals to create conditions in which they would be willing to talk
    publicly about their experiences

More broadly, it is unfortunate that there is a diminished media voice for fund managers. A
once-vibrant (and supportive) trade media sector has been allowed to wither, as fund management groups directed marketing spend away from third-party endorsement and into self-generated digital communications.

It would be helpful if the industry could support and encourage more informed, independent critique by directing a proportion of marketing spend towards industry critics, bloggers and other publishing enterprises.

If the fund management sector makes no effort to engage with underlying economic owners, there is every possibility they will take their business elsewhere – probably to future disruptors.

But if it does engage, it could regain lost trust, generate new business and acquire a large number of advocates.

Contribution #9:

By David Masters, Director, Lansons

“Facing up to the intergenerational challenge facing the asset management industry”

If the asset management industry was to ignore the intergenerational challenge that it faces it would not result in its immediate demise. Such is the accumulated invested wealth of the baby boomer generation that the fund industry could probably survive for some time without changing its course.

The problem with that is twofold. First, it would clearly have a major impact on the longerterm sustainability of the fund sector, and, second, it would incrementally diminish asset managers’ claims to provide societal value.

The fund management industry has, by nearly every financial measure, been hugely successful in serving the boomer generation – profitability, growth of assets under management, shareholder returns, for example.

But this success has to some degree bred inertia. Furthermore, the sheer weight of assets owned by or on behalf of baby boomers has had a considerable impact upon the financial markets themselves. In the US alone, the Investment Company Institute estimates that 50% of all mutual fund assets are owned by baby boomers. Put another way, some 15% of US corporate equity and 10% of all corporate bonds are owned by US mutual funds on baby boomers’ behalf (1). It is, therefore, not difficult to extrapolate how that has impacted upon
corporate behaviour.

At its heart, the intergenerational challenge is simple. How can the asset management industry better service the successor generations to the baby boomers (Gen X, Millennials etc.) to offset imbalances in wealth and the transfer of financial risk from governments and corporations to the individual to help those ensuing demographic groups secure their longterm financial futures?

Asset managers need to overcome evolutionary inertia and reinvent themselves to be more relevant to the younger generations whilst still delivering on behalf of older generations. To some degree these principles may conflict.

The fund sector is not seen as attractive to the younger generations, either as service provider or as employer. It lacks the technological presence to make it relevant to theireveryday lives, it’s too opaque, masculine, esoteric, self-serving and too enmeshed in the corporate world to be effective stewards. In short, ‘pale, male and stale’.

Technology, culture and brand are all critical components of the solution framework, as these ultimately shape how the sector both interfaces with its audiences and delivers costeffective solutions. None is more important than the other, they are largely interwoven and mutually enabling.

The emergence of new digital players such as “Amazon Asset Management” or “Google
Funds” remains a pipedream (or nightmare, depending on your viewpoint). These businesses
have publicly expressed a preference to be the enablers of a digital revolution in fund
management rather than the pioneers. Asset management is, after all, complex, heavily
regulated and has rising barriers to entry.

This offer of partnership seems genuine and beneficial. The reasons why traditional asset managers fear the digital behemoths is because these are brands that both seem to love and be loved by the millennials.

In China, Ant Financial, the fintech offshoot of internet megafirm Alibaba, now manages the largest money market fund in the world, the Yu’e Bao Fund. This four-year old vehicle has assets above $250 billion, often garnered by tapping into how its investors go about their daily lives (e.g., rounding up the ‘change’ from an electronic payment for a cup of coffee). The challenge is how to migrate such an approach for a fund that makes investments beyond cash instruments.

The rapid evolution of Exchange Traded Funds (ETFs) would superficially at least seem to play to this market, but there are caveats. First, ETFs only [currently] offer a subset of the investment universe and are primarily passively managed or factor-based. Second, by allowing much more idiosyncratic, small-scale investing, you are starting to reassemble the infrastructure around which our investment industry is built. That will be time-consuming, far-reaching and expensive.

Environmental, Social and Governance, or ESG, investing is expected to benefit from the growth of millennial investing. So how would Google or Amazon go about setting up an ESG investment solution? One can imagine that the answer would be a combination of two things: analysing client data to reveal their ESG choices and asking them. From that, it can derive a suite of investment products that seek to fulfil its clients ESG needs. Effectively, it would set up a small number of groups who’s ESG needs are aligned under certain affinities.
Matching this would bring the asset management industry into a more client-focused, cocreative approach, and away from a “one size fits all” mentality.

These shifts in mindset will be difficult to establish without further cultural shifts at asset managers. ‘Pale, male and stale’ may seem harsh, but the recent round of Gender Pay Gap reporting shows the evidence is there. In the industry’s defence, it does largely mirror its investor base. Initiatives such as Investment2020 and Diversity are vital, but long-term.
Change is needed now.

You cannot simply parachute in the solution. There is little value bringing in employees with more cultural diversity and different skillsets if they do not stay or their skills get socialised away.

The industry needs to make more of the resources it already has, realigning culture and working practices to better harness the well-educated, innovative thinkers that it currently employs. In an industry that proudly flaunts its roots in the Victorian and Edwardian eras, is it really that surprising that its two largest and most progressive global players were founded in the 1970s and 1980s? Modernity is not just about technology, it is about attitude.

The necessary evolution of asset management to ensure that it keeps on delivering its promised societal value through the generations can be achieved partly through internal cultural realignment, technological advancement and, where the solutions cannot be delivered quickly enough internally, by finding the right external partners to pull the industry through to its next stage.

(1) Source. Investment Company Institute Year Book 2018

Contribution #10:

By Con Keating, Head of Research, BrightonRock Group; TTF Ambassador

“CDC Fund Management”

One of the less discussed aspects of CDC is the management of the investment fund. This differs from traditional DC where the asset management objective is to maximise asset values at all times. It is intrinsically short-term. Incidentally this conflicts with the desires of individual members, who should prefer low asset prices while they are saving and contributing, and maximal asset prices when they are decumulating their fund in retirement.

The CDC fund has an explicit target to achieve or surpass on average. The target arises from the terms on which trustees made awards to members and the contributions they had received. The averaging arises from the risk-sharing and risk pooling rules of the scheme. These rules substitute for the risk buffers and capital adequacy requirements so familiar in insurance and banking. The open question here, as well as in commercial finance elsewhere, is how large these buffers should be and how might they operate. CDC schemes have explicit
target benefits which may be cut if investment performance is inadequate.

When the objective is to avoid cuts, the answer to the size question depends on the volatility of the investment portfolio. The question becomes: how long does it take to exhaust the risk-sharing capacity? A quantitative illustration is appropriate. Suppose we allow, for support to pensions in payment, an amount of up to ten percent of the value of members’ claims, and that the fund is composed of 60% active and deferreds with just 40% pensioners in payment. Then the ten percent support represents 25% of the pensioners claims. At first
sight the adequacy of this is questionable. A 25% drop in the value of the portfolio in any year has a likelihood of occurring of around 5% when its portfolio volatility is 15% and over 10% when that volatility is 20%. This is a frequency of cuts that is not likely to prove attractive to members generally or pensioners in particular. It is the frequency which arises in DB scheme solvency based management, which includes Dutch CDC.

Much of the DB de-risking and LDI agenda has been driven by a desire on the part of the sponsor to avoid the calls on their guarantee associated and low volatility investment strategies have been pursued. With fund volatility at 10% calls have a frequency of 0.6% and at 5% are unlikely in many lifetimes.

However, the immediate exposure of the CDC scheme is merely to the current year’s pension payments. This is usually of the order of 3%-5% of the members’ claims. If the funding level is 75% then the support among members to ensure full payment is simply 1.25%, a minor fraction of the total available support, 10%. Obviously, the largest claim in any year is the full amount of the pension payment, and that is far less than to total support. Other articles have discussed an important element of a sustainable risk-sharing scheme, the
need to maintain an equitable balance among members and proposed mechanisms whereby
this may be achieved.

Of course, the greatest threat of cuts comes from sequences of poor returns, rather than from extreme, catastrophic events. Let us consider sequences of losses at the conditional expected loss amounts for portfolios of different volatilities. The conditional expected losses are:

The asset portfolio values resulting from repetitions of these losses are rather extreme.
These are shown below for the range of portfolio volatilities.

The total of 10% support is exhausted after five years for the 20% volatility portfolio, after six years for the 15%, after eight years for the 10% and after ten years for the 5% volatility portfolio. No cut is likely within these periods. Put another way, even in these extreme and highly unlikely circumstances, the likelihood of any cut is 1.5% for the twenty percent volatility portfolio, 0.8% for the fifteen percent, 0.2% for the ten percent and 0.04% for the five percent volatility portfolio.

This suggests that the unutilised risk-sharing capacity and the period for which full benefits are assured by this scheme feature are useful metrics of the robustness of a CDC scheme. Certainly, they should inspire member confidence in the scheme.
There is nothing comparable to these simulations in the historic empirical record. The most extreme set of circumstances centred on the 1999 – 2002 Dotcom crisis

Diagram 1 shows the call upon risk-sharing resources which might have occurred over that period had the scheme assets been fully invested in UK equity using index returns for fund performance. Annual pensions payments were a little under 5% (on average) of scheme liabilities over this period. The cumulative exposure rose over a five-year period and totalled, at its maximum, a little under 5%, but had fully recovered all of that support within two years.

The interpretation of these support periods that is relevant for the fund management objective is that these are the periods over which performance is not pressured by pension payment requirements, that full payment is essentially assured, and the scheme may be managed on the basis of its average return.

Contribution #11:

By Clive Menzies, Coordinator, Macro Risk Connect Programme

“Time to reconsider unlimited liability”

The 1986 Financial Services Act heralded “big bang” which swept away personalaccountability; regulation has been playing catch-up ever since.

Human ingenuity will overcome the highest hurdles and traverse the deepest chasms toachieve its ambitions. Nowhere is this more true than in the world of finance where product innovation has accelerated in an unprecedented fashion over the last 30 years.

It is no wonder that regulators struggle to contain the “monster” that was unleashed by deregulation of banking and finance. Que? The 1986 Act introduced mandatory regulation, didn’t it? Well, for many financial services practitioners, it did but, simultaneously, it created vast behemoths of financial power (global banks) which effectively took over the regulatory playing field while releasing themselves from constraints which previously limited their power over investment banking and markets, i.e. their ability to make even more money at other people’s expense.

First, a recap. Pre-big bang, we had single capacity actors in the London stockmarket, brokers (only brokers could act on behalf of investors in the market) and jobbers (market makers who tended to specialise in particular stocks or bonds). Both were governed by a self-regulatory body of their peers, the London Stock Exchange. More importantly, their personal wealth (and the well-being of their families) was at risk in all their activities. Unlimited liability was effective in keeping people relatively honest although there were instances of front running (buying or selling before recommending transactions to clients) and insider trading; however, there was a code of honour of sorts which ensured the really bad apples were blackballed and excluded from the markets. Yes, it was something of a cosy club in which members would “scratch each others’ backs” but it was sufficiently diverse and decentralised to exclude systemic risk.

Similarly, merchant or investment banking was separate from retail (deposit taking and lending) banking and also operated on the basis of unlimited liability; banks did go bust but the threat of bringing down the system was remote.

There was a pyramid of power (as there is across all hierarchical structures and institutions) but it was flatter and money power was much more decentralised than today.

Big-bang swept all that away under the pretext of driving down dealing costs while making the stockmarket more transparent and open to outsiders. Big banks were the major beneficiaries of this process as they swallowed up most of the formerly independent partnerships of brokers and jobbers to create complex, multi functional businesses in which conflicts of interest blossomed and personal accountability evaporated. We traded the resilience of the old system for “efficiency”.

This is the “monster” that regulators have been seeking to monitor and control ever since but, as was indicated in the opening paragraph, human ingenuity ensures that the regulators are always playing catch-up. In effect, they are always looking in the rear-view mirror because it is impossible to anticipate how markets will evolve (and from whence the next crisis will emerge) as human ingenuity innovates to solve problems, satisfy needs or
overcome regulatory hurdles.

Each successive crisis provokes a howl of anguish from politicians and the public for more regulation. Inevitably, there follows a radical reorganisation of the regulatory framework but to no avail. Regulators are blamed for crises they weren’t in a position to anticipate – market collapses are seldom anticipated by most professionals let alone regulators.

In the case of the sub-prime crisis, global bank board members failed to understand the risks within their businesses; how could anyone have expected regulators to anticipate the credit crunch? Some tried to warn the SEC but, for reasons beyond the remit of this paper, the warnings went unheeded. There were some who could see the crisis coming and shorted sub-prime securities but they were subjected to an unprecedented “bear squeeze”, by the very banks which created the crisis and sought to off-load their toxic assets to clients before knowledge of how little value existed in these securities became widespread. (see Michael Lewis’s The Big Short).

Incentives and penalties, throughout the transaction chain of the sub-prime market, ensured that no-one flagged up that this particular “emperor had no clothes”. And that’s the point, other than the people who took out the low-start mortgages (at the bottom of the food chain), none of the professionals (realtors, lenders, rating agents, securitisers or vendors of the toxic securities) were “on the hook” for the liabilities. None of them were going to lose their homes or have to explain to their wives, husbands, partners and children that their
privileged lifestyle was about to be whipped away from under them. Before “big bang”, occasionally stockbrokers or jobbers would overreach themselves, taking on excessive risk only to lose everything.

During the recent Transparency Task Force symposium, there was discussion of codes of conduct to foster a culture of integrity and prudential stewardship but the scale and complexity of financial services, combined with the asymmetry of financial power and information, militate against those who aspire to the highest ideals.
Financial regulation is no substitute for the self-regulating power of personal liability. We have to recognise that scale, complexity, compartmentalisation which fragments accountability and concentration of power will always undermine the integrity of the market. Unlimited liability for investment banking and financial services professionals would transform the financial industry at a stroke; it would result in a diverse market of smaller
actors, personally accountable for their actions.

The market would become self-organising and self-regulating once more, evolving to serve the needs of the economy rather than the bottom line of the global banks as at present. Yes, there would be a need to regulate to prevent abuses and provide transparency but today we’ve technology which can do this.

Frederic Laloux’s research19 demonstrates the superior power of self-organisation; it is ideally suited to tackle complex tasks. Command and control structures are obsolete.

Unlimited liability will transform financial services by aligning professionals’ long term interests with those of their clients and remove costly layers of unnecessary and ineffective regulation.


Contribution #12:

By Clive Menzies, Coordinator, Macro Risk Connect Programme

“Financial services – wealth transfer or creation?”

Financial services facilitates wealth creation. True or false?

Once upon a time, regional stockbrokers would help local firms, which made things, raisecapital for development and wealth creation. This was at a time when Britain had thriving engineering and manufacturing industries. One can argue that the disappearance of Britain’s industrial base was a political choice in the context of globalisation but this paper is looking specifically at the financialisation of the economy and the consequent decline in wealth creation.

First, we need to dispense with some economic myths. Land is not capital, although it is treated as such. Those who own land do not create wealth but benefit from the location value created by public investment in infrastructure and the community which participates in economic activity on and around a particular location.20 The value, created by the buildings or activities on the land, legitimately belongs to those who create or undertake them but the rise in land value does not. Rising land values aren’t necessarily a result of wealth creation; property values are more a function of the volume of money committed to property investment than increasing productivity on the land.

Second, interest on money doesn’t treat everyone equally: inequality is a function of interest. Margrit Kennedy’s study of West Germany from 198221 empirically demonstrates how interest migrates wealth from the poorest to the richest. She found the bottom 80% of the population (by income) paid twice as much interest as they received but the top 10% received twice as much interest as they paid i.e. the lowest four fifths of the population paid all their interest to the top 10%. And the top 0.01% received 2,000 times what the top 10%
received on average. The interest system drives exponential inequality; it is a wealth transfer mechanism. This is why, according to a recent Oxfam research, the richest 66 people own as much as the poorest three and a half billion.


The world is dividing, as confirmed by a series of reports from Citigroup around 2005/6, between the Plutonomy22 and the rest. “…the plutonomies, where economic growth is powered by and largely consumed by the wealthy few, and the rest. Plutonomies have occurred before in sixteenth century Spain, in seventeenth century Holland, the Gilded Age and the Roaring Twenties in the U.S.”

Virtualisation and financialisation are driving this process but we’ll focus on the latter. Both property (land) and interest are primary components in today’s financial markets. The subprime mortgage market created a virtuous or vicious circle, depending on whether you were a beneficiary or victim of its eventual collapse. The combination of money creation from nothing in raising the initial mortgage combined with the leverage applied through financial engineering facilitated the illusion of wealth creation but it was a typical bubble market23 in which greed, ignorance and cheap money drove the illusory value of worthless assets to dizzy heights.

Buy-to-let landlords and overseas investors have driven UK property values and rents to unprecedented levels in relation to average earnings. The cost of putting a roof over one’s head is prohibitively expensive for a growing proportion of the population and this is driven by the financial services industry facilitating this process.

Debt and leverage play a key role in concentrating wealth and corporate power into fewer hands. A study published in the NewScientist in 201124 revealed how control of 40% of 43,060 transnational corporations and 60% of their turnover was in the hands of just 147 companies (mainly banks). The study only looked at shareholdings and common directorships; circumstantial evidence suggests control is even more concentrated with beneficial ownership hidden behind nominees, trusts, foundations and other opaque structures.

Share buy-backs and financial engineering are commonplace and much investment activity rides on the back of this illusory wealth creation. And then we have derivative products, the value of which is almost impossible to compute but probably runs into hundreds of $trillions.

Let us not forget that AIG’s Credit Default Swaps were a significant component of the subprime crisis triggering a $128Bn bailout of which Goldman Sachs received some $13Bn – the bailout was agreed at a secret meeting in September 2008 involving the then Goldman CEO,

22 art1.pdf

23 Memoirs of Extraordinary Popular Delusions and the Madness of Crowds by Mackay


Lloyd Blankfein, and former Goldman CEO and US Treasury Secretary, Hank Paulson. In the first quarter of 2009, Goldman Sachs executives paid themselves $4.5Bn in bonuses.

Who knows what will trigger the next crisis but the prime candidates are probably somewhere in the derivative markets.

Where we have centralised power, opacity and concentrated wealth, we have middlemen, consultants and advisers all looking to get a piece of the pie. Further down the food chain people are competing to rise up the ladder of wealth and power but at the top resides a cosy monopoly in which insiders enjoy rich, risk free rewards. Criminality is rife and goes unpunished. When HSBC and its executives should have been indicted for money laundering, the US Department of Justice was warned off by the Financial Stability Board25. HSBC agreed a “settlement” which, when you can conjure money out of nothing26, is no punishment at all.

If there is little or no real wealth creation, investment is a zero sum game in which not everyone can win; yet we talk as if it is possible to manage investments for a growing proportion of the population to provide an adequate pension pot to secure them a reasonable lifestyle in old age. In the context of today’s synthetic/financialised markets that seems like a pipe-dream.

25 All the Plenary’s Men

Contribution #13:

By Clive Menzies, Coordinator, Macro Risk Connect Programme

“Structural incentives and penalties trump
codes of conduct”

From October 2011: Examine the growth of debt and leverage in the global economy and it is difficult to conclude that the route to salvation is additional stimulus from governments, taking on yet more debt to accelerate growth. Public sector deficits and consumer indebtedness weigh heavily upon economic activity and more debt will add fuel to a potential meltdown. But how did the world arrive at this parlous state? The responsibility rests not with individuals, politicians or otherwise. It is the result of a system with skewed incentives exemplified by the banks’ profiting from ever expanding debt.27

The sub-prime mortgage crisis was created by perverse structural incentives to obscure the truth. The major culprits were the banks which issued and traded mortgage backed securities and derivatives. But others were by no means blameless.

The often fraudulent mortgage loans were made either to people on low incomes, allowing them to buy houses they couldn’t afford, or to speculators who hoped to make a profit through a quick sale in a rising market. The house buyers had every incentive to hide that fact they wouldn’t be able to keep up the payments. Real estate agents were earning higher commissions as prices were inflated by excessive liquidity. The originating lenders were able to offload dubious loans enabling them to write more mortgage business. Investors were earning high yields on AAA rated securities, relying on the credit rating agencies’ due diligence. Meanwhile, the ratings agencies quadrupled their turnover between 2000 and 2006 as demand for their services from the issuing banks increased. The issuing banks were making money from origination and sales of securities and, in some cases, by shorting their book at the expense of their clients. All of these players had a strong incentive to hide the toxic nature of sub-prime mortgage securities and their derivatives.

To this day, no organisation or individual of significance has been held to account for the crisis. The credit rating agencies continue to be rewarded by the issuers, a fundamental root cause of the crisis. Up until the 1970s, investors paid for credit ratings but thereafter the issuing banks paid the ratings agencies, sowing the seeds of the sub-prime crisis.


And this is the fundamental point of this paper: human behaviour is determined, in the main, by short term incentives and penalties. Perverse motivational forces within the financial services industry overwhelm attempts to regulate behaviour; codes of conduct or mandatory rules cannot accommodate the evolving complexity arising from human ingenuity seeking to optimise short-term advantage.

Structural incentives and penalties are embedded throughout the supply chain: from origination of securities, to the markets in which they are traded and on through the layers of financial advisors, managers, custodians, consultants and trustees.

For example, in corporate finance, the bigger the transactions, the greater the rewards; consequently, all the incentives drive scale, irrespective of the consequences. Indeed, there are penalties arising from “lack of critical mass”. Scale brings its own rewards in terms of asymmetric power. Richard Werner refers to the power of the short side.28 Smaller players in the market are always operating at a disadvantage, not merely from their inability to achieve economies of scale but because they are often beholden to counter-parties who exercise their power over the short-side.

We talk of markets as if they are comprised of many independent actors but today’s financial markets are dominated by a handful of players (global banks) often acting in collusion with each other and central banks29 controlled by the same narrow coterie of vested interests30.

Quantitative Easing was a very visible form of collusion between central and global banks which has driven asset prices to record levels while having minimal effect on wealth creation (See the section: Financial Services – wealth transfer or creation). Central bank influence driving “structural adjustment” and market cycles is well documented in Richard Werner’s Princes of the Yen.31

Then we come to the investment managers and advisers. They too are subject to incentives and penalties which often run counter to the interests of their clients. Whether it is throughad valorem fees which drive fund sizes beyond investment strategy capacity constraints or the disincentive to advise clients not to invest at a particular time, although market timing is fraught with difficulty. Where there is a vested interest in selling “product” there is always a risk of misselling. Fund managers often launch strategies that are popular because they are in demand but then investors lose money because they invested at the top of a market cycle. Investor behaviour is an issue but as professionals, we should be motivated to



30The Creature From Jekyll Island (by G. Edward Griffin)

31 Princes of the Yen: Central Bank Truth Documentary

promote strategies which will benefit clients rather than those that investors are inclined to buy because of the herd instinct to follow the crowd.

This is by no means an exhaustive list of incentives and penalties which run counter to clients’ interests but are illustrative of the problem. Scale is a major factor because, in small firms, the chain of accountability is short and senior executives (who are often also proprietors) are closer to where conflicts of interest arise; they can make judgements about the long term interests of their clients and consequently their firms. In large businesses, the chain of accountability is extended and fragmented; senior executives may espouse putting clients’ interests first but the effect of compartmentalisation of responsibility and competing priorities (driven by regulatory and commercial pressures) ultimately subvert the best of intentions. (See the section: Time to reconsider unlimited liability).

In summary, we need to address structures rather than behaviours which are symptoms of flawed structural incentives and penalties

You can access the White Paper here.

I’m a Zurich based investor. Since 1997, I’ve managed a privately offered investment fund known as the Aquamarine Fund.

I am also the author of a book titled The Education of a Value Investor, which was published in 2014.

As I wrote in my book, we are all a work in progress. This site documents my ongoing quest for “wealth, wisdom and enlightenment”.

I have created a /now page – inspired by Derek Sivers

I’m a Zurich based investor. Since 1997, I’ve managed a privately offered investment fund known as the Aquamarine Fund.

I am also the author of a book titled The Education of a Value Investor, which was published in 2014.

As I wrote in my book, we are all a work in progress. This site documents my ongoing quest for “wealth, wisdom and enlightenment”.

I have created a /now page – inspired by Derek Sivers

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