When a company puts the customer front and center in everything it does, the outcome often results in a great American success story. Take Amazon.com Inc., for example. Well known for its exceptional customer service, Amazon champions a value chain where every process is geared toward fulfilling customers’ needs. From inbound logistics to site design to fulfillment to delivery, the people behind these processes have customer focus embedded in their DNA. It’s no surprise that Amazon has been one of the great investments of the last decade.
Imagine an asset management industry with a similar client-centric mantra, where the entire value chain — from asset owners to third-party consultants to traders to asset managers — focuses on what’s best for the client, a value chain that delivers transparency of fees, incentives that align with client expectations and long-horizon investment advice, and where asset managers are good stewards of their beneficiaries’ capital and actively avoid buying momentum or chasing performance. Hard to imagine? Let’s be honest: This doesn’t resemble what exists in the industry today.
Today’s asset management value chain is engineered around short-term performance and a prevalent beauty contest culture. It is entrenched in relics of the past — such as quarter-over-quarter fund rankings, market-cap-weighted benchmarks, principal-agent disconnects, poor governance, and misguided incentives and compensation structures. If the industry continues to be viewed as a self-feeding machination rather than a true profession that serves the greater good, the public will look elsewhere to attempt to fulfill its future financial needs and savings gaps.
Something needs to give.
The stakeholder disconnects that permeate the value chain create a vicious cycle of hot potato with client wealth, and realignment is needed to work on behalf of customers. Asset owners possess immense power to influence this type of change, and their decisions on which managers invest their capital can be a very public declaration of their values and beliefs. In that vein, asset owners should wield this power in two important ways: 1) demand better from managers; and 2) re-engineer their own governance practices.
Asset owners need to hire good stewards of their capital that are able to exploit the natural advantage a long-term horizon offers. These managers have the courage to align their asset allocation with meeting the unique liability needs of the beneficiaries and consider the underlying investor, rather than their peer group, the primary benchmark. They reward investment professionals for making countercyclical moves without looking over their shoulder, and they are poised in the face of short-term volatility and media pundit fear-mongering as they remain laser-focused on meeting a long-term return objective. But that’s easier said than done. Clients have been conditioned by the system to purely seek out relative performance, and consultants propel this merry-go-round by tending to buy managers high, and sell them low.
Asset owners must also look inward by practicing better governance.
In the International Monetary Fund working paper “Institutionalizing Countercyclical Investment: A Framework for Long-Term Asset Owners,” by Bradley A. Jones asserts good governance is a critical enabler and offers the first line of defense against investment short-termism and procyclicality.
Asset owners must empower their managers to exhibit their skill (or not) over much longer performance assessment windows than the typical one to three years of scrutiny. Further, requiring minimum accreditation standards for governing fiduciaries would liberate managers from misguided inquiry and distraction. Finally, an unwavering anchor to the values espoused on the investment policy statement vs. the emotional whims of market forces will ensure beneficiary needs remain paramount.
Mr. Jones sums up the disconnect between society and the industry well: “Long-horizon investing is a valuable activity for both society and the investor; however, there is a significant gap between aspiration and reality to be bridged.”
Patient, long-horizon investing can confer both a private and public good, but the industry has come unmoored from its purpose. And with the public remaining skeptical and distrustful, we must step up to avoid being regulated into irrelevance.
In May, executives at eight influential pension plan sponsors — including the California State Teachers’ Retirement System, California Public Employees’ Retirement System and the Massachusetts Pension Reserves Investment Management Board — took a step in this direction when they wrote an open letter to the asset management industry calling for adoption of the Asset Manager Code of Professional Conduct, a voluntary code of conduct from the CFA Institute that prescribes ethical principles to ensure managers put client interests first.
The significance of this can’t be understated. In an era of rampant short-termism among asset managers and conflicts of interest throughout the value chain, these influential plan sponsors are calling asset managers to embrace a voluntary code that is entirely self-enforced.
And while the firms that signed the open letter would indeed like to encourage the right ethical culture, these thought leaders have a more enduring end in mind: fostering a true profession. A profession is signified by an impassioned commitment to set aside self-interest for the sole purpose of meeting client outcomes. So, while the regulators are consumed with assessing whether asset managers are systematically important and pose liquidity risks to the system, this transformation of the industry must begin by first returning it to its origin of high ethical standards and a fiduciary culture.
More than 1,340 firms have claimed compliance with the Asset Manager Code of Professional Conduct, and each signature inches the industry closer to becoming a profession and creating a value chain that compares to that of Amazon.
