The asset management industry is failing to fulfil its purpose because of an overreliance on modern portfolio theory, which has not evolved to meet current challenges, latest research claims.
The report - The Purpose of Asset Management - says the purpose of asset management is to generate returns for investors as well as mitigate risks for them, leading to the movement of capital to where it is needed in the real economy.
But it says the industry does not adequately fulfil its purpose - noting this problem is primarily caused by overreliance on a theory of investing, modern portfolio theory, which has, according to the authors, failed to evolve enough since the 1950s to meet current challenges.
It said this contributes to, and perpetuates, misalignments of interest with the industry's customers by focusing internally on capital markets and not enough on systemic issues - something that could have resulted in a sub-optimal provision of both risk adjusted returns to off-set liabilities and the efficient allocation of capital.
It added this could also have driven unnecessary complexity, a multiplicity of fees, and short-termism.
The report was co-authored Dr Jim Hawley, an academic who is currently head of applied research at TruValue Labs and professor emeritus at Saint Mary's College, and Jon Lukomnik, the managing partner of Sinclair Capital who formerly oversaw the New York City pension schemes.
Recommendations from the report included that:
- The asset management industry should address systemic risk by focusing on the real world's economic, environmental and social systems to improve its customers' risk/return profile, and use wider metrics to measure those links
- Incremental fixes including a simple fee statement, equivalent to the nutrition labels which appear on prepared foods, and a ‘do-no-harm' Hippocratic Oath
Commenting on the launch of the report, Hawley said: "The asset management industry is vitally important, helping to finance the real economy and create jobs, as well as help people save for retirement, for a house or other significant investment.
"While there is tremendous expertise available to savers, the interests of the industry and the individual and institutional investors who are its ultimate clients, and should be its ultimate beneficiaries, have become misaligned. This is caused in large part by the limitations of today's investing paradigm, which ignores systems-level risks to investing, such as government actions, diversity issues and climate change."
Lukomnik added: "Using a systems-based approach alongside modern portfolio theory has the power to evolve the asset management industry and realign its interests with its customers. Our clear recommendation is to unify this potential to affect real world risk under a common banner that could be called ‘systems-level investing'. This will benefit not only the performance of the industry and its customers, but society more generally."
The report, the second in a series of papers on the purpose of finance, was sponsored by Pension Insurance Corporation. Chief executive Tracy Blackwell explained: "Our aim in facilitating this paper is to change the nature of the debate about financial reform.
"We believe profoundly in the importance of the finance industry. But asset management, like other parts of the finance industry, must demonstrate that it fulfils a clear purpose. As Hawley and Lukomnik argue, for that to happen, we have work to do."
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