Generations of scribes have benefited from George Orwell’s famous rules for writing, guidelines that are still cited in the style manuals used at The Economist and Bloomberg. The author of 1984 and Animal Farm teaches us: never use a long word when a short word will do; if it is possible to cut a word out, always cut it out; and never use a foreign phrase, a scientific word, or a jargon word if you can think of an everyday English equivalent. In other words, keep it simple.
Orwell, like all masters of their craft, knew that simplicity is the ultimate goal of any endeavour. Simplicity aids understanding. Simplicity promotes efficiency. Simplicity means fewer things can go wrong. And yet, simplicity, ironically, is hard to achieve. Mathematicians seek ‘elegant’ solutions to problems – solutions that are simple yet effective. Stephen Hawking, arguably the most famous scientist alive, spent many years searching for the single, as yet elusive, ‘theory of everything’.
Sadly, simplicity has eluded the financial industry, opines the Asian Equity Team at Aberdeen Asset Management. More than 50 years ago Benjamin Graham, Warren Buffett’s investing mentor, warned that the more elaborate the mathematics used to support an investment strategy the greater the likelihood experience was being replaced by theory, investment with speculation.
And yet complex mathematical models that nobody understood underpinned the most egregious products to blow up ahead of the financial crisis. ‘Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex,’ said Andy Haldane, chief economist at the Bank of England, as recently as 2012. ‘That configuration spells trouble.’
“Asset management, in line with the broader financial industry, faces reform as regulators seek to prevent the repeat of abuses. They are subjecting fund managers to unprecedented scrutiny and censure even as new evidence of wrongdoing is being uncovered at the banks. Investors are also questioning whether so- called ‘actively managed’ funds offer value for money, while opting for low-cost index-tracking alternatives. Years of central bank stimulus policies have neutered the volatility in stock markets on which active fund managers depend”, writes the Aberdeen´s Asian Equity Team.
One of the biggest challenges the industry faces, continue the team, lies in winning back the trust of sceptical investors and market watchdogs. The challenge is both ethical and organisational. A simpler compensation structure helps remove some of the conflicts of interest that were inherent. For example, the U.K. has banned the payment of commissions by fund managers to financial advisers, a system which disadvantaged investors. This is something other jurisdictions are now looking to adopt.
Meanwhile, regulators need reassurance that financial institutions are behaving.
Whether they like it or not, fund managers are being treated more like banks, amid proposals in the U.S. to categorise them as being ‘systemically important’ to the financial industry and therefore subject to much of the restrictive legislation created after the financial crisis.
Asset managers would argue their industry does not pose the same risks, since it does not commit its own capital.
Creating and selling products that everyone understands is a priority, points out Aberdeen Asset Management. Regulators are trying to introduce more investor safeguards, but this can spawn more complexity not less. For example, excessive small print designed to highlight investment risks may serve the opposite purpose because the longer the disclaimers the less likely they are to be read. In an attempt to address this problem easier-to-understand ‘mini prospectuses’ are now mandatory in some jurisdictions.
“Disgust over the way some companies behaved before the financial crisis has paved the way for the return of simplicity as business proposition and regulatory imperative. However we believe that financial institutions, especially asset managers, should embrace the principle not because they have to, but because they want to. There should be nothing to fear if you have confidence in your investment process. Scrutiny should be something to be welcomed rather than avoided. We welcome the move towards simplicity, which is just as well, because simplicity is here to stay”, conclude.