Investment funds should limit their annual turnover to 30 per cent and avoid any dealings with hedge funds or other forms of alternative investment, argues a radical new manifesto aimed at saving 'dysfunctional' markets from future crises.
The proposals are part of a 10-point manifesto which will be outlined by Dr Paul Woolley in a lecture at the London School of Economics and Political Science on Tuesday (25 May).
Dr Woolley, a former banker, IMF economist and founder of the Paul Woolley Centres for the study of Capital Market Dysfunctionality at the London School of Economics and the University of Toulouse , says if his policies are adopted by Giant Funds – his term for the world's biggest public, pension and charitable funds – they would boost annual returns for a fund (after inflation) by 25 per cent. Once widely adopted they would restore stability to the markets – giving funds another similarly-sized rise for an overall gain in long-term returns of 50 per cent or more.
He argues that policy-makers who see improved regulation as the means to prevent future crises are adopting a negative approach based on restrictions that can be side-stepped by bankers. Instead, he argues for a positive approach that harnesses self-interest in avoiding the causes of financial dysfunction.
Dr Woolley, who said: 'Wide-scale adoption of these measures would secure private gains by increasing the profits of funds from an annual return of four or five percent to six or seven per cent. But these measures would also deliver social gains by reducing the likelihood of bubbles and crashes, bringing faster growth and making finance less bloated and exploitative.
'Economic theory and received wisdom have brainwashed everyone into believing that capital markets are efficient, that prices are always right, capital markets are self-stabilizing and competition keeps banks and financial firms from earning abnormal profits The reality is very different. The finance industry is performing its utilitarian task of channelling savings into real investment badly and at punitive cost. And as soon as profits disappear, bail-outs are needed.'
His lecture, to be delivered at LSE's Old Theatre in Houghton Street, London, will set out the 10-point manifesto for the first time. It says that investment funds should:
1 Adopt long-term investment approach (future dividend flows), rather than momentum (short-run price change)
2 Cap annual turnover of portfolios at 30%
3 Understand that all tools now used to manage risk and return are based on the discredited theory of efficient markets
4 Adopt a stable benchmark such as growth of GDP plus a risk premium
5 Not pay performance fees
6 Not engage in alternative investments – Hedge funds, Private equity, Commodities
7 Insist on total transparency of agents' strategies
8 Ensure everything in the portfolio is traded on a public exchange
9 Secure full transparency of banking service costs incurred by companies you invest in
10 Provide full disclosure of compliance with these policies
Finance's failures, Dr Woolley argues, have their origin in 'principal/agent problems' which arise because agents (banks, investment managers, brokers and other financial middlemen) have better information than principals (the Giant Funds) and because the interests of the two groups are misaligned.
The consequences are first that delegation to agents is the source of momentum investing and short-termism which are the root cause of mispricing, bubbles and crashes and second, that agents are able to capture excess profits through constant innovation of complex products, lack of transparency and fee structures that encourage gambling.
The best remedy, he suggests, is for principals to change the way they contract with, and instruct agents. And he sets out three actions for policy-makers and regulators:
1 Call for the adoption of the manifesto by all public funds.
2 Withdraw tax-exemption rights for all funds that fail to impose limits on turnover or that fail to provide adequate reporting to their end-investors.
3 Issue GDP bonds as ideal investments offering growth, inflation protection and relative price stability
Dr Woolley said: 'Unless action is taken quickly along these lines, the next crisis will spell the end of capitalism as we know it'.
For more information, or to request a media seat at the lecture, which is at 6.30pm on Tuesday 25 May, please contact email@example.com or call 020 7955 7060.
Or contact Dr Woolley at firstname.lastname@example.org
The Paul Woolley Centre for the Study of Capital Market Dysfunctionality