We have organic food. Why not organic finance?

Posted by Robin Powell on March 16, 2016

Organic finance.

Like any parent of teenagers, I often find myself preaching the benefits of sensible eating. But I’m sure my children’s generation are far savvier about food than we ever were. Of course nutrition has become part of the school curriculum, but something else that has changed over the last 30 years is that there is now much greater transparency about the food we eat.

I’ve often thought how good it would be if providers of financial products were forced to be as open and honest in their “packaging” as food producers now have to be. Of course, there would be nothing stopping you buying the same old rubbish as you did before, but at least you would be able to make an informed choice.

How pleasantly surprised I was, then, to read a report by two Stanford University academics recommending just that. The paper, Organic Finance: the Incentives in Our Investment Products by Ashby Monk and Rajiv Sharma, explains how “increasing complexity has allowed for an obfuscation of fees and costs that asset managers, implicitly or explicitly, charge to asset owners”.

This distortion, Monk and Sharma argue, “is driving an increasingly short-term and disconnected financial world”. The solution they suggest is investor action — a consumer revolt similar to the one that forced the food industry to change its ways:

As people began to understand the ingredients in their food, and the consequences for their own health, they began to consume food products differently – often preferring organic foods. As investors begin to understand the fees and costs in their investment products, and the consequences for their and the world’s health, they are beginning to invest differently – preferring efficient and transparent products rooted in real assets in the real economy.

There’s no shortage of very clever people suggesting ways to mend the broken financial sector and restore public trust. But for me, the Stanford report and the reforms it recommends are particularly worthy of attention, for three main reasons.

First, Monk and Sharma rightly stress the need to make public investment organisations much more professional in their approach. The temptation for pension funds and endowment boards is to take the easy option and outsource investment strategy to outside bodies, despite research which shows that it typically costs ten times as much to do so as bringing it in-house.

In the UK, we’ve seen the scandalous waste of public money on external fund managers and consultants by the Local Government Pension Scheme, while in the US, state pension funds are finally seeing the need to rein in the amount of fees they pay to Wall Street firms. By making themselves more professional, these large funds can help to force the investing industry to raise its game and set a good example to retail investors, who also need to wise up about how much they’re paying and the performance (or the lack of it) that intermediaries are delivering.

Secondly, the Stanford researchers are right to suggest that, ultimately, the power to change investing for the better lies with investors themselves, both institutional and individual. Regulators such as the FCA in the UK, ESMA in Europe and the SEC in the United States have for many years put the onus on the industry to get its own house in order on transparency. Because it suits the industry to be opaque, we shouldn’t be surprised at the lack of progress. Only when investors demand change, and withhold their custom from firms that resist it, will meaningful reforms materialise.

Finally, in emphasising the international dimension to this issue, Monk and Sharma are once again spot on. Lack of transparency is a problem investors are facing all over the world. It was a concerted effort by campaigners in different countries that led to higher standards in the food industry. It will take a similar, global effort to bring about the same sort of change in investing.

 

Related posts:

Transparency — the time for talking is over

Is Pension-gate the next big scandal to rock the financial services industry?

Investment industry reform is not a party political issue

 

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.

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