They have been acting like another tier of agent rather than the principals they should be. This is hardly surprising given that they are advised by agents, and their trustees and staff are drawn from the investment industry or aspire to win lucrative jobs in it. They have also failed to understand the damage done to performance from following benchmarks and using risk analysis based on a defunct theory. “Another problem has been that the early success of the Yale [endowment’s] model of investing won a large following, especially among charitable funds and endowments in recent years… But the flow of new money going into alternatives undermined their diversification attractions and the financial crisis revealed other vulnerabilities.” Policy-makers and regulators around the world can encourage pension funds, which are located nationally, to adopt these strategies. Woolley has a five-point plan for them, too:
1. Encourage adoption by all public funds – an ideal start would be for the International Monetary Fund to apply these principals to its new US$12 billion endowment fund created by the sale of its gold holdings. 2. Withdraw tax-exemption rights for all funds that fail to cap turnover – in the UK the statutes actually already empower this for any fund deemed to be ‘trading’ rather than ‘investing’. 3. National governments should issue GDP-linked bonds, which would encourage the adoption of GDP as a performance benchmark for funds as well as being an attractive proposition for both investors and issuers. 4. Recognise that mark-tomarket accounting is inappropriate when pricing is inefficient. 5. Regulators should not automatically approve financial products on the grounds that they enhance liquidity or ‘complete’ markets. The Paul Woolley Centre funds research into various aspects of capital markets, from broad topics to very specific analyses, at LSE, Toulouse and UTS.
Woolley, who started the GMO business in the UK, has financed much of this himself. In Australia, Professor Ron Bird, of UTS, runs the centre, with assistance from Jack Gray, who is an adjunct professor. Both also worked for GMO and are currently collaborating on research. With the centre-funded research to do with the interaction between managers, pension funds and the markets themselves, a common element is the impact of agency issues and the introduction of moral hazard into the mix. In A Manifesto for Giant Funds, Woolley says delegation creates an agency problem. Most pension funds have pursued the delegation model for many years by using a range of managers in various asset classes. Smaller funds even delegate asset allocation decisions to agents. “Agents have access to more and better information than the investors who appoint them, and the interests and objective of agents frequently differ from those of their principals,” Woolley says.
