In this blog Dr Ekaterina Svetlova discusses her recently published book – an insider perspective on the investment industry – arguing that the industry should be seen more as a chain of multiple intermediaries who influence how savers’ money is spent and take shares of the profits.
We may be entering ‘the age of asset management’, suggested the Bank of England’s Director of Financial Stability (now Chief Economist), Andrew Haldane, in an April 2014 speech. Investment management firms control assets equivalent in value to around a year of total global economic output—ca. $100 trillion. Yet today’s investment management system is a bit like a black box – despite its large impact on the economy and society.
Chains of Finance – How Investment Management is Shaped, published at the Oxford University Press (2017), aims to uncover the intricacies of investment management practices and explores the inner workings of the industry. The key message of the book is simple: The investment industry today has little to do with individual savers choosing which shares or bonds to buy directly; it is also not just about professional groups tied to a specific set of expertise, such as fund managers, securities analysts, and investment consultants. The investment industry today is better understood as a chain of multiple intermediaries linking savers to the companies and governments that issue financial instruments. Those intermediaries – such as financial advisers, investment managers, wealth management firms, insurance companies, pension funds, brokers, and investment consultancy firms – influence how savers’ money is spent and take a share of the profits.
An insider perspective
The arguments and case studies in the book are built on ethnographic and auto-ethnographic work in the investment industry spanning several years in four cities (Paris, Zurich, Frankfurt, London) and 451 in-depth interviews with investment management industry employees in France, Switzerland, Germany, the UK, the US and Canada. The authors also bring knowledge from diverse disciplines such as anthropology, sociology, accounting and finance, and international relations. In addition, the book draws occasionally on the personal experiences of two co-authors (Grant and Svetlova) in their previous working lives – of five years and six years, respectively – in investment management.
The investment chain that both constrains and enables
The book pictures the investment chain as a series of relations that facilitate decisions. For example, investment managers’ decisions cannot properly be understood by focusing simply on a fund manager’s beliefs about particular securities or markets, but are co-shaped by clients, brokers, investment consultants, securities analysts, and even unions and politicians.
At the same time, the chain may constrain and impede decisions. One case study in the book focuses on attempts by a number of links in the chain to pressure the US subsidiary of a French automotive manufacturer to recognize unions at its plants and improve working conditions there. In unprecedented meetings, fund managers, pension fund trustees, representatives of different French unions, French politicians, and US workers came together to try to work out a way to use a shareholding in the car company to bring about meaningful change in line with responsible investment objectives. What ensued, however, was a demonstration of the difficulty of moving the chain due to the constraints intermediaries impose on each other through their relationships. The fund managers would only act on instructions from the clients; the clients, as represented by the pension fund trustees, did not want to do anything that might contradict their legal duties; the politicians were unsure whether they could bring about pressure on an American subsidiary; the unions were focused on getting the best deal for French workers.
In another chapter, the book shows how the investment management division of a Frankfurt bank formed a new ‘quant’ team. Reacting to the external expectations set by clients, investment consultants and competitors, the division’s managers decided they need a new, quantitative, ‘rigorous’, ‘scientific’ approach alongside their existing ‘fundamental’ method. In other words, the establishment of the quantitative department was driven by marketing and not by a business necessity. The department was set up to present the fund managers’ work as more rigorous and scientific. Clients such as pension funds, and the investment consultants who advise them, want to hear about rigour and ‘process’, a theme the authors came across time and time again in their book.
The death of the principal-agent concept?
The principal-agent theory claims that if fund managers fail to deliver performance, investors will exit. The whole story is one of control and punishment (nearly always in the form of money withdrawal). The book shows, however, that the relationship between asset managers and asset owners is more nuanced than a straightforward principal-agent approach suggests. Rather, this relationship is multi-faceted, contextually dependent and malleable. Fund managers, for example, are not simply given clear instructions by their clients but can also reshape what their clients imagine their interests to be, influencing them to align their goals with those of the managers. Moreover, relationships between clients and fund managers are often characterized by reciprocity, loyalty and even amity, not just by control and punishment.
Following the chain in a different direction, fund managers (and traders in their firms acting on their behalf) need to choose where to execute their orders to buy or sell shares or bonds, and these decisions are strongly affected by fund managers’ relationships with brokers or dealers. One of the book chapters show that the first generation „dark pools“ did not succeed because of the „soft dollars“ arrangements that often went beyond providing free research but also concert tickets, wines, books and expensive trips. Also, long-term friendships were built between brokers and fund managers and highly influenced which broker was chosen to execute the orders. Those personal relationships allow to explain why new, anonymous, computerized market devices did not sweep away traditional human intermediaries, even though the latter were not only far more expensive but also distrusted as possible conduits of information leakage.
Finance and society
The concept of the investment chain allows a complementary approach to the question of where influence resides within finance. So far, the focus of research has tended to be on those who make the final investment or lending decision, fund managers or banks, with, if they are acknowledged at all, other market actors being seen as below these decision makers in a hierarchy. The book shows that power lies rather in the chain and its multiple influences on investment decisions.
The chain matters to outcomes in financial markets that might have broad societal consequences. The book focuses on investors’ investment time horizons, responsible investment broadly and, as already mentioned, attempts by trade unionists to use the pension fund investments of their members to influence a company’s treatment of its workers. In each case, the investment chain had a major influence. In particular, the fund manager ‘link’ increases the likelihood of short-term investment and thwarts trade union efforts. The discussion of sustainable investing in one of the chapters shows in addition how the relationships within an investment management company can act as a hindrance to responsible investment.
Further research needed
Despite the investment chain’s importance, and its ubiquity in official reports across a variety of concerns with financial market operations, the chain is rarely the subject of explicit academic enquiry. It is even less often the subject of public debate. But if a poorly functioning investment chain contributes to lower growth, inequality, poor workers’ rights, and a hotter planet, its functioning should be a matter of urgent academic and political enquiry. This book is a first step towards this direction, one we hope more researchers and practitioners will follow.