Changing Power Dynamics between Investors, Fund Managers and Investees, 2014

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Changes in the balance of power along the investment chain, and changes in investment fashions, have shifted investment away from long term investment, and away from investors and investees (those who are invested in) towards those in the middle of the chain. The balance may switch back, partly as a result of developments such as peer-to-peer investment and possibly the growing use of cryptocurrencies. But there also may be be a revival of more direct investor and investee influence via their assertion of fiduciary obligations, as well as the creation of new customer-owned financial bodies, and a re-assertion of customer-governance within those that already exist.

Any investment has an investor and an investee. At its simplest, they are one and the same (re-investment) and sometime there are only two parties, such as a venture capitalist or a share holder making a direct investment in a company. More typically there are at least three in the chain — the investor or saver; the ‘agent’ in the middle, such as the fund manager at a bank or investment institution; and the borrower or investee. The investor’s agent has a legal fiduciary duty to act in the investor’s interest. There is a constant tension between investors and financial bodies owned by other investors over fiduciary duty. Customer-owned bodies address this problem directly, but their history shows a continuing conflicts of interest that occur, because the employees’ interest, who is still in effect an agent, is not the same as the investor. Top executives or traders extracting excessive remuneration, unsupported by performance gain for investors, is a reoccurring issue in investor- and customer-owned institutions alike, although it is tamed in customer-owned bodies. Continuing along the chain, the investee, such as a company, also has a fiduciary duty to act in the interest of those who are investing in them, and also stand accused of awarding excessive management rewards unsupported by increased investor returns.

In recent decades, according to The Triumph of the Optimists, and supported by the Deutsche Bank’s From the Golden to the Grey Age, there has been a switch from long term investment in intrinsic value with reinvestment of dividends to rapid turn-over of share holdings trying to capture stock market fluctuations. This may generate higher management fees, but failed to capture higher value for the investor, as well as reducing the importance of investing in companies with long term intrinsic value. In other words, whatever the intent, the end result has been a structure where the agent has been benefiting at the expense of the investor, and trend bending potential became immaterial.

Peer to Peer lending is growing. In theory this increases returns to investor and investee by cutting out the agent. Cryptocurrencies (the name comes from the cryptographic techniques that make their forgery impractical, rather than they are hidden from tax authorities!) such as bitcoin, that eliminate the need and costs of a third party holding funds and extracting value, would further increase returns, and might accelerate the trend towards peer-to-peer, assuming that a cryptocurrency can be established that is a reliable store of value. If Triumph of the Optimists is correct, peer-to-peer investment should support a shift to the long term as this coincides with the interests of both investor and investee. But whether everyday pension savers have the skill to make the best peer-to-peer investment judgements is dubious. A better option for them would be be a customer-owned pension funds, with fund management, which should increase long term investment if done in the interest of the customers. The problem has been a disappearance of governance by and for the customers as documented in From the Sober to the Profound. The good news is that the problem is well understood, as are the customer governance solutions. The customer-owners’ watch words are clear: doveryai, no proveryai, “trust, but verify”.

From Future Business, Long Finance, updated 2014, MMG