This is one of a series of columns that were produced for Moneyweb Investor in which Stuart Theobald explores the intersection of philosophy of science and finance. This followed an earlier series for Business Day Investors Monthly on the same theme. This column was first published in July 2014.
Since the Second World War there have been two major phases of economic development in the western world. At first, economies were focused on building conglomerates as part of the reconstruction effort. This was the managerial era, when the industrial giants of Europe and America were created, often on the back of import substitution and government-backed development efforts. Business schools and universities spewed out managers, ready to move into fine tuning supply chains and factory lines.
The managerial era came to an end in the 1980s, when a wave of deregulation transformed the financial sector, opening opportunities for significant growth and profits. This sparked the era of financial capitalism, when banks and other financial companies began driving economic activity. The shift mirrored the behaviour of business school students. As the sociologist Donald MacKenzie has noted, in 1950, just 3% of graduates from Harvard Business School ended up working on Wall Street, which was considered a low prestige career. By 2007, 38% of Harvard’s graduates ended up on Wall Street, mostly in investment banks.
While it is at times hard to discern, the financial crisis has dealt a severe blow to financial capitalism. As varied as the causes of the crisis were, the moral accountability has been pinned on the financial sector. Bright students are once again shunning Wall Street. Regulators, while at times appearing slow and counter-productive, are inexorably turning the screws on financial firms, forcing them out of riskier behaviour and pouring cold water on excessive remuneration. For those prone to gazing into crystal balls, what might the next era of economic growth look like?
John Rogers, who was until recently the president of the CFA Institute, a global body of financial markets professionals, has heralded a third phase he calls “fiduciary capitalism”. The locus of economic power will shift from investment banks and other intermediaries to the holders of capital including foundations, pension funds, sovereign wealth funds and endowments. While in the past they were content to let investment banks intermediate these savings, that is increasingly less the case. One clear example is the rise of “dark pools” which allow large holders of assets to trade directly with one another, excluding investment banks. Asset managers in South Africa and the rest of the world are investing more in their own research and becoming less reliant on the opinions of the “sell side”.
This is, to be sure, an optimistic vision. Fiduciary capitalism has a positive ring to it. Many funds are multigenerational with long-term interests at heart, eschewing the short-term alpha seeking behaviour found in most existing capital markets. During the financial era, asset management became entrenched, accounting for an ever larger proportion of the pool of financial assets available. The Bank of England has estimated that total assets now under control of fund managers is around $87-trillion, equivalent to the world’s GDP, and set to grow to $400-trillion by 2050. With time horizons of centuries, such funds must concern themselves not just with investment returns, but ensuring that investment supports sustainable economic development in general.
The era of fiduciary capitalism will have pros and cons. The pros will be improvements in the efficiency of fiduciaries, cutting transaction costs and the over-packaging of financial instruments which is one way investment banks have extracted value. They should also play a benevolent paternalist role in overseeing economic growth that is sustainable and ensuring companies are well managed. On the other hand, institutions can be prone to secrecy with limited accountability to their own clients. Crises could well be sparked by asset managers’ strategies if they lead to herding behaviour. Many asset-owners, such as rapidly growing pension funds in China, have limited financial experience and are understaffed. A part of the fiduciary era will need to be consolidation of the many fragmented pools of assets that are currently managed badly and expensively. Also, alongside the growth of fiduciaries will be growth in passive strategies like exchange-traded funds which will bring their own risks.
Mostly optimistically, the fiduciary era could herald a new capitalism that efficiently and cleanly connects the best ideas to capital, with investing done long term and for the good of society. Governments can promote long-term orientation by reducing taxes on long term investment returns relative to short term. Indeed, the South African government’s plan to introduce tax-free savings accounts next year is a bold step in this direction. While the past few decades have seen the emergence of investment banks as global household names, the next few decades will see the rise of asset managers.