by Rowland Manthorpe
As the financial system goes into meltdown, few people are reaching to acclaim Margaret Thatcher. Robert Peston has already decided that recent events mark “the death of Thatcherism”.[1] The pendulum is swinging back towards the interventionist state.
Yet some of Thatcher’s principles merit retention. Her headlong pursuit of deregulation deserves its infamy. But her attachment to shareholder democracy should live on.
In 1992, Thatcher heralded the impact of successive privatisations on share ownership in Britain, declaring that “private property should be spread as widely as possible, as a bulwark for the liberty and independence of the people and to enhance a sense of responsibility to future generations”.[2]
Of course, things did not work out like that. No more than a quarter of Britons ever owned shares directly. Those that did were not able to use them as a bulwark for liberty. That does not mean the principle does not hold.
The current financial crisis is a crisis of ownership and control. Its proximate cause – the inappropriate sale of subprime mortgages – was made possible by the division of these essential elements. Put simply, there was no bank manager who ‘owned’ your mortgage, and hence was concerned for its security. The long term cause – the risks taken by banks – lies in the same separation. Shareholders did not know what their representatives were up to. The financial system allowed fund managers, and bank directors, to take excessive risks.
There is a bitter irony here. For a democratisation of shareownership had taken place in the second half of the twentieth century. The creation of mass-market pensions and insurance schemes had given millions of ordinary people a stake in the stock market.
The scale of this shift is startling. In the 1960s, private individuals owned most of the UK stock market. Forty years later, their share has been reduced to thirteen per cent. The most significant players today are the institutional investors – public vehicles which invest third parties’ money. In 2006, they owned over forty per cent of the stock market, with over £700 billion in assets.[3]
This might have realised Thatcher’s vision. But instead of giving beneficial owners a stake in wealth creation, indirect investment has disempowered them, multiplying ten-fold the distance between the ultimate shareholders and the ranks of salaried executives they hire to do their bidding. As the FSA reported recently, many people are not even aware that their pension is invested in shares.
It is being made painfully obvious now, but this disconnect has vitiated the financial system for a while now. Its most flagrant example is remuneration – but this only reflects excessive charges.
Costs in collective schemes are much higher than they should be. In a forthcoming paper for the RSA, Alistair Blair shows how unit trust costs have multiplied beyond any rational basis. In the 1930s, when the schemes were first set up, they charged half a per cent annually. Since then, they have increased the amount of money they manage. But instead of declining, costs have tripled.
It should not be this way. “If the investment world shared its economies of scale meaningfully with its customers”, Blair writes, “the benefits for customers would be dramatic”. If you invest for 25 years, a manager offering fees of 0.5 per cent per annum will, all else equal, produce a return 40 per cent higher than the fund charging 1.5 per cent.
The RSA’s Tomorrow’s Investor project is working to draw people closer to their investments. [4] For some, this is a hopeless task. The financial journalist Chris Dillow has advocated the abandonment of joint-stock ownership, saying we should turn instead to the one common in hedge funds.[5] Hedge fund managers tend to be more active in looking after their investments. This, he suggests, is the future of ownership.
Dillow wants to revert to an older form of capitalism. Instead of public companies, he wants private ones. This goes against the trend of the times – which has been for more accountability, not less. It also underestimates the ability of the joint stock company – proved over 150 years – to marshal people and capital. If it has failed recently, that does not mean it is doomed.
For others, regulation is the answer. In part, it is – contra-cylical capital requirements, for example, will help prevent reckless lending. But regulation is never enough – this is the myth of central control that Thatcherism destroyed. Without the scrutiny of engaged investors, regulation only provides the contours of the next crisis.
Promoting investor engagement is no easy task. The Tomorrow’s Investor research event asked a small group of ordinary investors what they wanted from the financial system. They didn’t really know. They knew they wanted a comfortable retirement, and to provide for their children, but they were not able to calculate the financial implications of these aspirations.
Education will not suffice here. Recent research from the Financial Services Authority backed up the findings of behavioural psychologists: more information does not make for better decisions.[6] We need a market solution. The market has failed to provide investors with a way to register their preferences. Despite a huge range of choice, there is no single fund that offers what our research shows investors truly want: low costs combined with responsible management.
Over the next six months, the RSA will be working to create a plan for what this ideal fund would look like. But here is just one idea which has emerged from our research: stopping the practice of expressing investment charges as an annual percentage of the funds being managed. If investment charges were expressed as a total cost over the lifetime of the investment, or even as percentage of the average annual return over the last five years, people would be much clearer about what they were getting for their money.
This may go against the grain for financial professionals. But if funds are really to work on behalf of investors, surely this is information they should give. And it is one way of ensuring the integrity of the chain of accountability, from the citizen investor to the board room. It is only when that chain of accountability works that the idea of shareholder democracy – and liberty, independence and stability – can be preserved and maintained.