Practical analysis for investment professionals
06 June 2017

The Financial Industry: A New Discipline of Ownership

The finance industry, long plagued by public distrust, has reached a tipping point, says Stephen Davis of Harvard Law School and co-author of What They Do With Your Money: How the Financial System Fails Us and How to Fix It.

The public’s anger, fueled by a belief that investors have been unjustly “separated from their money,” has helped to usher in a new “discipline of ownership,” Davis explained at the 70th CFA Institute Annual Conference. His assessment of the state of the financial industry struck a tone of cautious optimism.

Most investors are not “playing the market,” Davis said. Rather, they are what Leo E. Strine, Jr., chief justice of the Delaware Supreme Court, has called “forced capitalists.” That is, they’re invested in the capital markets because it’s the only way they can sufficiently grow their money, particularly in a low-interest-rate environment.

But the financial industry has served them poorly. The proliferation of intermediaries and their associated agency conflicts has created complexity and doubt that these agents are acting in the best interests of investors.

Davis contrasted the fortunes of retirees in the Netherlands with those in the United States. Dutch workers will retire with a nest egg approximately 50% larger than their US counterparts. In 1950, the United States had 16 workers for every retiree, a ratio that is expected to drop to two to one within the next decade. This trend is putting greater pressure on returns, and Davis asserted that the industry should address this looming crisis by simplifying its structure.

The financial industry in the United States, relative to GDP, has quadrupled in size over the past 130 years. Over that same period, Davis noted that in almost every human endeavor, from health care to transportation, productivity has increased — except in finance. It still costs about 2% to perform one of finance’s essential functions: moving money. That’s not to say that other efficiencies haven’t been realized. Electronic money transfers and more efficient trading markets are important innovations, but the gains that accompanied these changes have largely accrued to the intermediaries.

The glut of investment products is perhaps best represented by the nearly 77,000 mutual funds available to the public, and the drag of intermediation by an estimated 16 agents standing between an investor and a targeted investment. Institutional investors, including Railpen in the United Kingdom, and CalSTRS in the United States, are finally responding to the public outcry and examining the fees they pay more closely. They are also becoming more responsible stewards and asset owners.

Rather than shirking their responsibilities on important issues like executive compensation, diversity, and supply chain risks, asset owners are exerting their influence over their portfolios of companies. A group of institutional investors, including State Street Global Advisors (SSGA), Vanguard Group, and BlackRock, created the Investor Stewardship Group in November 2016 to demonstrate their commitment to sound corporate governance practices. And SSGA’s recent installation of the “Fearless Girl” statue near Wall Street was a strong signal to corporate boards about their intent to vote for greater diversity on corporate boards. Davis said that we may look back on it as a pivotal moment for the industry, when institutional investors went from being passive owners to embracing their roles as responsible stewards for the industry, their customers, and society.

Davis wants asset owners to walk the walk as well. As fiduciaries, he’s called on them to increase their own disclosures, suggesting “the financial equivalent of a nutrition label.” And he celebrated the ability of social media to hold both asset owners and the companies they own accountable for their actions. Davis is hopeful that these forces of change will help to bring the transparency and simplicity that has been lacking for too long.

This article originally appeared on the 70th CFA Institute Annual Conference blog. Experience the conference online through the Virtual Link. It’s an insider’s perspective with archived videos of select sessions, exclusive speaker interviews, discussions of current topics, and updates on CFA Institute initiatives.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo courtesy of W. Scott Mitchell

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

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