Friday, September 28, 2012

The particular problem of money management

The particular problem of money management

A former colleague of mine pointed out that every business has a significant problem living up to its stated values, especially when times grow difficult.  I think money management is a special case and is particularly challenged when it comes to adhering to values and maintaining appropriate standards of business conduct.

As a business, money management has three peculiar characteristics that are particularly toxic to the preservation of values.  First, it doesn’t produce anything other than money (from an investors perspective, hopefully more of it).  There’s no tangible product or service, just a statement with a bunch of balances and percentages.  Your money manager probably sends along a market commentary, but most commentaries are mere entertainment (if you’re into investment letters) and largely irrelevant to the task of managing money. 

Self Interest (2000)

Second, there’s no endpoint until you fire us or ask for your money back.  Everyone once in awhile a money manager admits that he can’t find appropriate investments and sends the capital back to his clients.  Think about the products and services created in any other industry.  There’s a beginning and an end. Parts are shipped into a plant, and a car rolls off an assembly line.   You provide your accountant with a shoebox full of statements and receipts, and she sends you a completed tax return.   In money management, the product is never finished.  Each day the interaction of the financial markets and the money manager’s trading reshapes the portfolio and changes the investment returns.  At the end of a quarter or a year, there’s a momentary pause as the results are tabulated for clients, and then the chase begins all over again the next day.

Third, the core function of money management, investing in financial markets, is an amoral pursuit.  It is not about right or wrong.  Rather it is a game of building collections of securities based on one’s predictions of corporate profits (stocks) or whether those profits will be sufficient to service interest and pay down debt (fixed income).  It’s about deciding when to buy and sell those securities.  Democrats, Republicans, liberals, conservatives, believers, and atheists can be equally good or bad at the game as their personal views are irrelevant when it comes time to invest. 

Isn’t social investing a moral pursuit?  We’ll leave that question for another time, but the short answer is that it makes the investor feel far better than they should feel.

A business that is about nothing except money, in which there is no end, and the playing field is decidedly amoral, is an industry where values have a great deal of difficulty governing behavior.  True, there are armies of compliance professionals hovering around the money managers, but their job is to monitor processes, not make value judgments.   If compliance tries to inject value judgments into the investment process, they’ll soon be looking for another job.

Undoubtedly, there are exceptional individuals and institutions who are able to maintain their hold on values.   However, the industry as a whole shows few signs of maintaining its values, except when it’s easy to do so or it’s time to issue the annual report.  The industry’s behavior in the run up to the financial crisis, its conduct during the crisis, and its quick return to “business as usual” is strong evidence that nothing has changed.

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