Just back from St James’s Palace and the opening session of a conference of the Prince of Wales' Accounting for Sustainability Forum. The day started with a powerful speech from HRH in which he argued that the factors that had led to the credit crunch – debt fuelled over consumption, complacency about risk and regulation and rampant short-termism – were precisely those which had to be overcome if a new model of capitalism is to confront the ‘climate crunch’. Sadly, the Prince’s challenge was not fully met by the rather bland and complacent offering from some of the big business bigwigs who followed HRH to the podium. It’s not that they said anything one could disagree with, more that they failed to confront the question of how the hard wiring of modern capitalism has to be reengineered.
Perhaps, I should send Prince Charles the RSA Tomorrow’s Investor report: published today, and reported in the Times. As the report makes clear, the incentives placed on fund managers to make quick wins drives short-termism and increases volatility in the market. In other words, it places relative performance ahead of absolute performance. Companies go up and down, increasing the risk of a crash, but no real value is added to the economy.
The way the fund management industry operates reduces returns for investors in another way. Every time fund mangers buy and sell on our behalf, or the funds in which they invest buy and sell on their behalf, fees are generated. These fees eat into our funds and are one of the reasons someone who saves for a pension throughout their working life ends up paying about 40% of their savings in fees. The fees are good news for the financial sector. They are the basis for the bonuses and lavish lifestyles the sector had come to see as its birth right. But there is no evidence over the long run that any of this leads to better returns, as Warren Buffett has pointed out repeatedly. The cost of trading wipes out the benefit of the exchange, as Paul Lee points out in his Tomorrow’s Investor paper.
Investing over the long term not only reduces fees but also provides incentives for fund managers to be more active in scrutinising company performance: exercising what Albert Hirschman calls “voice”. It can thus be a more effective driver of sustainable efficiency and real accountability.
We need many solutions to avoid a recurrence of the credit crunch. The kind of pension funds advocated in the Tomorrows’ Investor report is one of them.