Investment Management Association

It is suddenly fashionable for policymakers and opinion formers to talk about “short-termism”.  It has popped up in recent papers from Vince Cable’s Department of Business, in the European Commission’s Green Paper on corporate governance, and in papers from the Bank of England. 

It is less clear what is meant by the term, and in particular what profitable investments are being overlooked as a result of short-termism.  It gets mixed up in many people’s minds with socially responsible investment, with the need to combat climate change, and, if you are the Commission, with investing in “social enterprises”.

The narrative goes like this: because of investors’ restless pursuit of short term profit, all these good things are being starved of capital.  So something must be done.  And that something is usually some combination of curtailing shareholder rights and regulation of the commercial relationships between asset managers and asset owners.

These are pretty drastic solutions to a problem which nobody has properly defined.  So where has it all come from?  The source appears to be various academic papers that have been picked up in the search for policy responses in the wake of the financial crisis.  Once in circulation they seem to acquire a status which means their conclusions are recycled without any scrutiny of the actual arguments.

One example is a paper by Paul Woolley (the eponymous head of the Paul Woolley Centre for the Study of Capital Market Dysfunctionality at the London School of Economics).  This paper argues that agents in the investment chain bring about mispricing and customer detriment because of their ability to front-run and otherwise use their balance sheets to profit at the expense of clients.  But he makes the cardinal error of failing to distinguish between those (like investment banks) who operate as principals and can profit at the expense of clients and those (like investment managers) who act as agents, where interests are aligned with investors.  This simple point blows his whole argument out of the water when it comes to investment managers.  Yet the European Commission cites the paper as part of the case for potential new regulation of them.

Another is a recent paper by Bank of England economists who, starting from an academic debate about the source of the equity risk premium, conclude that the market systematically under-prices equities.  They then leap, with no evidence of what causes may underlie this, to the conclusion that this is a market failure which requires remedial regulatory action.  In an article in the FT, former CBI Director-General Richard Lambert gave a particularly uncritical reception to this paper when he joined the calls for action.

There are serious issues here – dealing with climate change and investing in energy security are vital for all our futures, for example.  But the policy response needs to be much more considered than it has been so far.  Introducing onerous and half-baked new regulation on investment managers would not only do nothing to tackle the perceived problem.  It would also be a distraction from addressing those wider long-term issues we need to confront.

Richard Saunders
Chief Executive, IMA

6 June 2011

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