“Financial Innovation Boosts Economic Growth,” an Oxford-style debate — featuring Jeremy Grantham, a doyenne of investment management, and author Richard Bookstaber, author of A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation, opposing the proposition, and Myron Scholes, Noble Prize winner, and Robert Reynolds, CEO of Putnam Investments, in favor of the proposition — is summarized in an Appendix to Grantham’s January 2010 Quarterly Newsletter entitled, “What a Decade!”
In offering stinging criticism about the investment management industry, from which he admits he has profited handsomely, Grantham provides:
Clients can’t easily distinguish talent from luck or risk taking. It’s an unfair contest [between clients and the investment management industry], nothing like the fair fight assumed by standard Economists. As we add new products, options, futures, CDO’s, hedge funds, and private equity, aggregate fees per dollar rise. As the layers of fees and layers of agents increase, so too products become more complicated and opaque, causing clients to need us more.
The ultimate industry insider acknowledges that the game is stacked against the clients in favor of the service providers. Ironically, however, he includes that the high fees, complexity and opacity, create greater reliance upon the industry itself.
Au Contraire!! The trifecta of high fees, complexity and opacity cries out for the role of professional fiduciaries to cut through the jargon, smokescreens and hype surrounding the investment of plan assets.
To focus momentarily just on fees, as fiduciaries, with respect to administrative expenses, we clearly have an obligation to “defray reasonable expenses.” The explosion of fee litigation clearly bears this out. However, with respect to investment management fees the directive is not as explicit, but nonetheless the obligation to monitor fees is critical. Certainly there is an obligation to make sure that fees are reasonable, but the exclusive benefit language in ERISA also suggests that where possible, fiduciaries should work to reduce fees wherever possible. Simply put, any reduction in fees is an increase in the assets available for plan participants and beneficiaries.
The current shock to the financial system, as well as to client portfolios across the board, provides a unique opportunity for fiduciaries to review all of their investment relationships not only with respect to investment performance, but also with respect to fees. Fiduciaries must ask themselves a hard question; are the fees being charged by private equity, real estate, venture and hedge funds justified by the investment returns being generated and the risks assumed?
The current financial environment levels the playing field between the investment management industry on the one hand, and plan fiduciaries on the other. Plan fiduciaries must jump at this opportunity to exercise responsibility to strike deals in the best interest of their plans. Negotiate, negotiate, negotiate!