Gloom, doom and dysfunctional markets: academics have their say

Last week’s inaugural Australian conference of the Paul Woolley Centre for Capital Market Dysfunctionality was told that the world was on the verge of a depression, active management was of questionable value and the whole funds management industry may well subtract value from society.

The conference was held last Wednesday and Thursday at the University of Technology Sydney, one of three centres which are part of the Paul Woolley research program. Paul Woolley is a former director of global quant manager GMO, who has returned to academia in retirement, focusing on researching capital markets. Speakers at the event included both academics and practitioners. Steve Keen, associate professor at the University of Western Sydney, presented a paper on ‘Developing a Monetary Model of Financial Instability’. He said that Australia’s debt-to-GDP ratio of 164 per cent was now more than twice as high as it was just before the Great Depression. “This is the biggest financial bubble in Australian history, probably the history of capitalism given that it’s in the US too,” he said. When coupled with high nominal interest rates and low inflation, the debt-to-GDP ratio increased the real debt burden. The only way out of a looming depression was through Chinese growth or through oil prices, he said. In a discussion about the value of active management Don Hamson, chief executive of boutique quant shop Plato Investment Management, admitted that an index fund might, on average, be a better alternative for investors. “But most people don’t want to be average,” he said. “Active managers offer hope in a falling market compared with index managers.” David Lee, an alternatives specialist consultant with Mercer Investment Consulting, said the industry was “playing a game of deception and self deception”. Mercer research showed that the median active equity manager, in the 10 years to June 2007, had an excess return of 1.6 per cent a year, for an information ratio of 0.5. The upper quartile manager had an average excess return of 2.7 per cent. Australian active managers performed better, relatively, than those in Canada, Hong Kong, Japan, the UK or US. Paul Woolley delivered a public lecture during the conference, posing the question: ‘Is society well served by its financial institutions?’ He canvassed the impact of momentum investing on the formation of stock market bubbles and the burden of fees. The rough cost of managing and trading $US40 trillion in global equities was about $US500 billion a year, he said. “Active management … with its accustomed turnover of 100 per cent per annum will involve pension funds exchanging holdings with other pension funds for no net gain in value but at a cost in terms of management fees and brokerage that reduces the end value of the fund by a quarter compared with the alternative of a passive index-tracking strategy.” He said there was no sign that competition was eroding the profits of the funds management industry. “Rather, the scale of the industry is growing by leaps and bounds.”