Today’s investment management system is a bit like a black box – it’s complex and a mystery to most people who are simply looking to invest for retirement or some other opportunity.
A new book co-authored by Assistant Professor Diane-Laure Arjaliès, Chains of Finance: How Investment Management is Shaped (Oxford University Press), uncovers the intricacies of investment management practices. It also calls for some reforms to investment management similar to those implemented in the banking industry after the 2008-09 financial crisis. After all, the authors point out investment management firms control assets totalling $100 trillion, equivalent to about one year of total global economic output, and that power has a massive impact on the economy and society.
Simply put, the authors say investing today is no longer about individuals directly buying shares or bonds to build a nest egg. Instead their money flows through a long chain of people in different roles, or intermediaries, who influence how it is spent and take a share of the profits. In addition, the authors say traditional investment management models are now challenged, not only due to some structural issues in the industry, but also because of questions raised by citizens about what the purpose of financial markets should be.
Chart courtesy of Chains of Finance. Click on image to view full size.
An insider perspective
The arguments and case studies in the book are based on 451 in-depth interviews with investment management industry employees in France, Switzerland, Germany, England, Scotland, the U.S., and Canada. The authors also bring knowledge from diverse disciplines such as anthropology, sociology, accounting and finance, and international relations. Arjaliès herself has a cross-disciplinary appointment at Ivey in Managerial Accounting and Control, Sustainability, and General Management, and brings that broad expertise to the book. Her co-authors include Philip Grant, a social anthropologist and sociologist; Iain Hardie, a Senior Lecturer in International Relations at the University of Edinburgh; Donald MacKenzie, a Professor of Sociology at the University of Edinburgh; and Ekaterina Svetlova, Associate Professor in Accounting and Finance at the University of Leicester.
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Here are a few key takeaways from the book:
The problem with today’s investment system
When you invest your money, it will go through many intermediaries, such as financial advisers, investment managers, wealth management firms, insurance companies, pension funds, brokers, and investment consultancy firms, who influence each other on how it will be spent. Arjaliès said most people don’t even know where their money goes and that disconnect needs to be corrected. Additionally, she said there are so many players in the chain that it is difficult to make some changes, even if all actors want to do it.
“We have built a system where nobody is the pilot,” she said. “Even if you put everyone in the room to make a decision about one aspect, they can’t move forward because the structure is so complex. There are always new rules, regulations, and risks and, to solve a problem, we often add another intermediary, which makes the chain even more complicated.”
The fees and costs of investing
Each player in the investment chain takes a piece of the pie, which raises questions regarding the overall benefits of the chain’s structure. The book cites one example where an employee’s pension fund is reduced by one-third as a result of a small increase of fees paid to an intermediary.
“Sometimes, the beneficiaries don’t get the returns on investment they want and it’s not because the companies they invest in aren’t doing well. It’s because there are so many intermediaries on the way – intermediaries who are here to build trust and connect actors, but who eventually add to each other,” she said. “We have to think about where the value is going and how we share the value along the chain.”
Finance and society
In the aftermath of the 2008-09 financial crisis, there has been a greater emphasis on reforming financial markets so they contribute to the development of a sustainable economy. The authors wonder whether the investment management industry should be looked at in the same light. Larry Fink, the chief executive of BlackRock Inc., the world’s largest asset manager, recently sent a letter to the companies with which it does business demanding they both contribute to society and perform financially.
Arjaliès said there’s a greater need today for a financial industry that cares about the long-term success of its investment decisions, which means investment practices that bring in returns for the beneficiaries of investment plans through channeling money toward the development of a sustainable real economy, rather than from betting on price differences between markets.
“Increasingly, there are investors like BlackRock that realize there are a lot of opportunities in investing in businesses that help both the economy and society thrive, and want to shape the markets toward this goal. There is a lot of potential for change, but it means we have to rethink the way we are investing our money and the legal rules we have put into place, such as fiduciary duty,” she said. “Many of our financial models come from the '60s. They were meant for a world that is not the world of today.”
Reshaping the investment industry
Arjaliès said she hopes the book will prompt a larger discussion about the future of the investment management industry and the challenges ahead to generate regular returns for pension funds over a 20-year period while investing in today and tomorrow’s growth. She’s already discussing the issues with students in her HBA and MBA course, Sustainable Finance, and the HBA course, Assessing the Broader Impact of Business.
“What I really want my students to get out of my class is the mechanics of value creation. There's a big difference between creating value from mispricing mechanisms, and creating value from the production of services and products,” she said. “I want them to have a holistic view of the investment chain – if you do not understand the workings of the financial system in which you invest, it is as if you were making decisions half-blind, and I don’t want this to happen for my students.”
Arjaliès is also working on two new research projects:
- Conservation finance – Looking at how investors can channel private money toward the protection of ecosystems and the new financial products and structures that have resulted; and,
- Impact investing – Looking at the conditions under which Canada can become a global leader on the topic of impact investing.
Her research investigates how new devices or collective actions can transform markets toward responsibility and she has won several academic awards and professional prizes for her work in this area.
