Call for radical reform of 'poor' quality funds industry

Investment professionals’ low opinion of their own industry in Asia has led to a call for sweeping changes in the funds sector.

Because asset owners are failing to meet their long-term investment objectives, a senior industry figure says changes to asset owners’ fiduciary framework are needed.

He said firmer finances and stronger investment processes were needed to restore faith in the system, create a better institutional culture and bolster the regulatory environment.

Institutional delegates at AsianInvestor’s recent Asian Investment Summit were asked to rate the current state of the investment industry, considering the alignment of interests, costs and efficiency.

On a scale of one to ten, from “very poor” to “very good”, the audience in Hong Kong marked the industry as “poor”.

Presenting on the subject 'Institutional portfolios of the future', Peter Ryan-Kane, head of Asia-Pacific portfolio advisory at consultancy Towers Watson, said this rating was consistent with similar polls Towers Watson had conducted in New York and London. “How does it feel working for an industry that is not delivering?” he asked the delegates.

By “recognising we have a problem,” which echoed some of the comments made at the same event by CFA Institute CEO Paul Smith, Ryan-Kane asked: “What are we doing about it?”

He presented an alternative future for the investment industry: one where profit motive and self-interest were tempered by elements of “inclusive capitalism”. This "desired" situation would allow externalities to be properly valued, for there to be a focus on sustainability and where social entrepreneurship could thrive and better balance the gains from economic development.

The failure of asset owners to meet their long-term investment objectives required a change to the fiduciary framework, said Ryan-Kane. Persistent low bond yields were putting pressure on balance sheets. Pension benefits, insurance contracts and sovereign wealth have been sub-optimally managed, resulting in mediocre outcomes. And in extreme cases, past rights and entitlements have been renegotiated. The result has been a complete breakdown of trust and faith in the financial system, he said.

“A pension or sovereign fund is not run for the benefit of its members or citizens, but for the grandees who sit in their big comfy chairs and run these things.”

Again, the "desired" outcome – secure pension delivery, sustainable wealth and a fair share of profits – has remained out of reach, but could be achieved with changes to the accountability of fiduciaries, increasing the professionalism of the industry and a redesign of investment processes to ensure the outcome matched the objective.

Ryan-Kane was equally critical of fiduciaries whom, he said, “behave like warlords; they behave like it’s their money.”

When the next financial crisis occurs - and Ryan-Kane assured delegates there would certainly be one - the likely outcome, if we continued in the same way, was the status quo would be maintained, with misaligned incentive structures and a mismatch between portfolios and investment capability.

The ability of companies to build capacity in the fiduciary process “to get the right calibre of people to implement, manage and monitor a portfolio” was vitally important, he said.

The desired outcome of a better institutional culture, effective regulation and a more stable financial system could be achieved through a more robust financial culture and stronger investment processes.

“Our industry is volatile, uncertain, complex and ambiguous,” said Ryan-Kane. A future without change promises only more of the same, he said - forecasts projected from past outcomes and an over-reliance on linear models that didn’t take into account dramatic changes in sentiment, market behaviour and structure.

Change will only come with “extreme clarity of mission allied to a strengthening of investment intelligence,” said Ryan-Kane. In the past, he explained, spending rules focused on income needs, where a fund’s income typically exceeded income needs. Under this arrangement capital growth was implicit, not planned for, resulting in poor outcomes in down markets and stress in times of low interest rates.

The future scenario will need to incorporate a stronger linkage between expected earnings and spending promises. It will include “a more explicit intergenerational deal – a path for capital,” and for some it will mean buffer funds, or other ways of locking in capital.

A lack of long-term perspective was evident even in the management of sovereign portfolios. Ryan-Kane said: “There is only one sovereign fund in this region that is planning for the wealth of the fund in three to four generations. None of the rest can do it. They are just not set up to do it.”

As Paul Smith also suggested, it is about “changing the investment industry for the benefit of the end-saver,” Ryan-Kane said.

To that end, Towers Watson is involved in developing the ‘Thinking Ahead Institute”, a think tank comprised of asset owners and asset managers, “who believe in the value and power of thought-leadership to create change.”

The Institute is tackling a lot of these issues surrounding investment focus, assessing whether finance sector bonuses are fit for purpose and creating sustainable structures for long-term funding.