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Asset managers need to work to restore investors’ trust.

Restoring trust in the asset management industry

Over the last 50 years, the trust that people have in institutions has gradually eroded. According to the Pew Research Center, over 70% of people in 1960s America trusted their president; today it is less than 25%. The trend is similar, if not as precipitous, for trust in the media, business and even non-governmental organizations. More recently, the decline in trust has occurred alongside the growth of social media, particularly Twitter. Today, angry voices – verified, trustworthy or otherwise – can be heard around the world in an instant.

There is an economic cost to this decline in trust. Social scientists like Dr. Richard Halpern have long shown societies with a higher level of trust are richer and more productive than others.

Societies with a higher level of trust are richer and more productive than others.

This overall decline in trust is very clear in asset management too. The financial crisis caused a huge schism between society and financial institutions, which has had major implications throughout the industry. Fund managers must now set aside greater amounts of capital to meet the requirements of the regulators, implement stricter disclosure and transparency standards and, more recently, bear the burden of third-party research costs. All to help ensure the industry is doing the right thing.

The “reallocation” of trust

But perhaps the picture is more nuanced. Instead of a simple decline in trust overall – people are conditioned and predisposed to trust because it’s a good survival instinct – it’s possible there has been a reallocation of trust. Within the asset management industry, active managers have fallen out of favor in some parts of the market, leading to investors placing their trust in passive funds and  away from active funds. But if you believe that active management is required to price risk, set the cost of capital and allocate that capital, the unchecked rise of passive funds ultimately means markets cease to function as an efficient allocator of capital.

Active management is required to price risk, set the cost of capital and allocate that capital.

Meanwhile, Bloomberg finds that there are currently more indices in the U.S. than there are listed stocks. Yet a benchmark needs to be chosen, an active decision needs to be taken. The move to passive does not necessarily lead to a reduction in risk, just a different form of risk.

The rise of cryptocurrencies is another example of the reallocation of trust, this time from the governments that traditionally issue currencies, to technology. There is no statutory authority standing behind cryptocurrencies; they are based on algorithms distributed via shared networks and have open source data. The dramatic rise of alternative currencies like Bitcoin similarly represents the dramatic rise in trust in the technology that supports it. There remains a lack of understanding of cryptocurrencies among investors and outstanding issues of regulation, governance and efficiency. And there is simply no way of knowing what could happen to them when things go wrong.

Let the buyer beware

Does the rise of passive funds and cryptocurrencies mean that investors are too trusting? Perhaps. The Latin phrase “caveat emptor,” or “let the buyer beware,” is very relevant.

Asset management has its own trust issues, and the industry must try to restore that by doing a better job for clients. But in a world of echo chambers where people very often seek out others with the same opinion, there is less of an ability to identify risks or indeed opportunities.

Investors must therefore continually question what they see, probe further and avoid the echo chamber. In my opinion, that is the best way to support clients in a complex and changing world.

ID: US-051217-53603-1