Investment management: investment managers should be covered by the rules of the game
Let’s look at another incident. On January 24, 2020, the US Senate Committee on Health and Foreign Relations held a meeting with Senators to brief them on the Covid-19 outbreak. After the meeting, Senator Kelly Loeffler and her husband Jeffrey Sprecher sold shares worth $ 3.1 million. Senator David Perdue sold shares valued at $ 825,000 and bought shares valued at $ 1.8 million, including DuPont, a company that manufactures personal protective equipment, on the same day as the Senate briefing (2).
The Chairman of the Senate Intelligence Committee, Senator Burr, and his wife sold shares valued at more than $ 2.3 million on February 13, 2020, a week after writing an op-ed stating, “Fortunately, we have a framework in place that has put us in a better position than any other country to respond to a public health threat like the coronavirus. An investigation followed and on January 19, 2021, the Justice Department closed its investigation into Burr.
This despite the existence of the STOCK law, the objective of which is to increase the transparency of the legislative profession. An insider trading investigation found that 49 members of Congress and 182 of Capitol Hill’s highest paid staff filed their late stock trades in 2020 and 2021. Yet there is no public record to indicate who broke STOCK law or paid a fine (3) exist.
Now compare that to the huge financial penalty (and sometimes incarceration) imposed on the general public for insider trading. The rules are strictly enforced, but not for those responsible for making the laws.
A similar nuance also exists in the investment management industry. It is currently structured so that the asset management company (AMC) receives either a fixed fee for managing the assets (regardless of investor returns) or a “carry” (large increase if returns cross the threshold). obstacle, and no inconvenience if the returns are negative). Investors essentially write a free option to their AMCs, which in turn encourages risk taking at the expense of investors.
It happened at the peak of the small-cap cycle in 2017, when investment managers, fueled by stellar two-year returns, continued to add illiquid small-company stocks to investor portfolios. Many of these companies went bankrupt and suffered a large-scale take-out in 2018. While investors lost half of their investments, investment managers recorded “zero” fees for this year, to give rise to a new style of investing in 2019 and 2020 (buying only stocks), and history repeats itself in 2021.
In my opinion, there is a way to fix this problem. Investment managers should be mandated to park all of their equity investments only in the funds they manage, i.e. have a fairly large in-game skin (SITG). The idea behind SITG is mostly about symmetry – if you have to gain from the upside, you should also be forced to pay for the downside. If people with fiduciary responsibilities had SITG, they would behave more rationally, rather than just “going with the flow”. SITG makes boring activities less boring, like checking the security door of a plane that’s about to fly with you as a passenger or reading the fine print in annual reports while managing your money.
SITG also promotes results over perception. Investing is simple, but not easy. But asset managers, to make it acceptable to everyone, often narrow the investment process down to small formulas that look cool. This makes them smart and helps their AMCs collect big assets to manage. However, when the market cycle changes and these formulas stop working, end investors pay the price, in the form of lower returns or loss of capital. If a large portion of asset managers’ personal wealth is invested in the fund they manage, they will be incentivized to deliver lasting results rather than come up with theories that only build their personal brands. Check if your portfolio manager chooses to invest his personal wealth in the fund where he has invested your money.
(The author, Jigar Mistry is co-founder of Buoyant Capital. His views are his own.)