Transparency makes investors confident they understand what they have bought and builds trust. The global financial crisis witnessed a failure of transparency around mortgage-backed securities. Openness helps to counter market ills such as moral hazard, asymmetric information and principal-agent problems. But transparency is not a silver bullet as risks come from different directions and data overload can lead to complexity.
The impact of the global financial crisis, shorter time horizons for investment results and poor returns over the last decade have all led to increased interest in transparency.
Nowadays transparency must reach across all aspects of fund management – from the governance culture of fund management companies to transparency of sales processes by which asset managers deliver products to customers. Transparency is of course a principle to which everyone would seemingly agree, but is more difficult to optimise in practice than might first meet the eye.
Among the chief regulatory concerns is transparency of financial products, particularly with the effect on end investors and consumers. The mortgage-backed securities that triggered so much of the global financial crisis revealed that investors and credit agencies were ultimately ignorant of what was being sold. Nobody wanted to look stupid by asking: “do we really understand what we’re selling?”. There are periods in financial market history where transparency has failed, or that understanding and openness have been in the wrong place.
Research by EFAMA, the European trade association of asset management groups, has revealed the fall in savings in financial assets of Europe’s population is not just driven by market risk, but by lack of trust in the sector. Many investors are therefore choosing not to engage. There is also a loss of faith in the models that were meant to ensure diversification, many of which clearly failed in the downturn. Separate analysis has shown similar uncertainties surrounding the academic assumptions on which the capital asset pricing model (CAPM) and modern portfolio theory (MPT) are based.
Issues of understanding, trust and investor confidence have implications for the future evolution of fund management. Behavioural finance is becoming a key academic study, to understand the motivation of investors and promote understanding and transparency when the performance of markets and products disappoint clients.
In 2013 the Investment Management Association (IMA) Annual reviewed the pressures affecting changing client needs and the necessity of building customers’ trust for the future. The IMA believes an emphasis on better client communication should be a priority for asset management firms. Improved customer communication should not only explain charges and costs, but move beyond product information into education on personal investing, market behaviour and related areas of investor interest.
Similarly, a survey by public relations firm Lansons of investors across the UK, US and Germany showed that investors want complexity reduced across the whole fund management system. Investors would also like to have a comprehensible conversation with their asset managers about how their money is being handled. Transparency therefore is not solely about the product and its components, but how it is explained and communicated.
Asset managers can build trust by being frank about risks such as the probability of a shortfall in a market downturn. Transparency about fees will also reassure investors. In asset selection too transparency is important to the customer, boosting demand for passive products such as ETFs and index funds. But even as predominantly active managers at Aberdeen, we recognise our opportunities do not lie in complex instruments, whose value or risk may be nearly impossible to discern, but in identifying long-term trends, by investing in solid, well managed companies.
At Aberdeen we take a common-sense approach to transparency in our active equity portfolios: in investment terms, if there is something about a company that does not make sense, we walk away and avoid it as an investment. We are wary of processes and businesses that are opaque. We are committed to adopting best practice for our own corporate governance. Internally, the ethos of transparency is intrinsic to our values. We have always valued a culture of openness, mutual dependence and collective purpose. Our fund managers are organised in teams, giving everyone a voice. We believe all this, combined with clear investment processes, leads to better outcomes than having a star fund manager, charting his own course, in charge.
We do recognise that transparency has its limits and is not a universal panacea. In the words of Tom Dolembo from Harvard Business School, “to trust transparency alone to engender trust in management and co-operation is a pipe dream”. Openness however helps to restore confidence and counter problems such as moral hazard and asymmetric information; but it is not a magic bullet. Data overload can be counterproductive, creating complexity instead of reducing it. A balanced approach would recognise that transparency is essential to support a productive economy and stable financial environment as it promotes trust. And yet, it must be presented in a way that is easy to process and contextualise – simply possessing all the relevant information does not automatically solve the problem.
Overall, our shared aim must be to reduce clutter and seek optimal transparency, recognising that in times of crisis required disclosure levels will be higher – and the next challenge is just around the corner.
