Earlier this year the Financial Times ran a series of editorials under the title “Capitalism in Crisis.” Contributors ranged from Bill Clinton and Alan Greenspan to FT editors Martin Wolf and John Kay. There was also a submission with the byline, “Occupy London.” While I am admittedly unable to add much to their collective wisdom, I think a sound analysis of capitalism requires an understanding of the role of the investment management industry within the financial services “ecosystem."
Investment managers perform two vital functions. We serve as capital intermediaries and advisors, and as capital allocators. In our first role, we provide savers and investors with access to, and insights about, the capital markets and investment opportunities that they would not otherwise have. This emanates largely from the scale derived by pooling resources. Among the most obvious examples are open-end mutual funds and exchange-traded funds. These investment "technologies” essentially provide opportunities to individual and institutional investors to access an array of investments across asset classes.
The second role performed by investment managers is capital allocation. There are several approaches that investment managers take to accomplish this, and while we can certainly debate the merits of investing in indexed strategies versus an actively managed approach, that’s a topic better saved for another day. Yet, whether an investor chooses the de facto capital allocation prescribed by an index or selects an active approach in the belief that markets are inefficient, each dollar, euro and yen invested is an allocation of capital that is consequential to the functioning of a capitalistic economy. In fact this activity is an essential fuel that helps fire the global economy. If we have learned anything from the financial crisis, it is that how and to whom capital is allocated has significant and far-reaching effects.
And this presents a conundrum. As investment managers are fiduciaries and return generators on behalf of our clients, to what extent should we incorporate social responsibility into our decisions? Do we not have a primary duty to maximize returns to the investors we serve? Alternatively, should the investment management industry acknowledge and reflect the society in which it exists, and respond to rising demands to address principles of social justice? Given the fact that the dynamics that underlie capital markets do not per se completely align with broader societal goals, how should the investment management industry reconcile the tension that sometimes arises between maximizing returns and achieving social goals?
Economists from Adam Smith through Milton Friedman to Alan Greenspan have argued that the objective of capitalism is to provide returns for the shareholders or the owner. Any diversion from this purpose imposes a tax of sub-optimality on the investor, and on society. This is the foundational principle that underpins fiduciary responsibility, and as such it is to be pursued with singular focus, in strict adherence to the laws and regulations that govern our activities. At PIMCO, we understand our fiduciary responsibility, a priori. It is the core duty to which we abide with the utmost seriousness.
As a global investment manager we have fiduciary relationships with thousands of institutional clients and millions of individuals who invest in our commingled funds and separate accounts. At PIMCO, we have worked hard to honor these obligations. In turn, we have delivered over $400 billion in returns to our clients over the last decade.* This “value” has been used to help working and retired people prepare for their old age; to support foundations and endowments as they pursue their missions of charity, investment and education; to help governments serve their constituents; and to enable myriad others to reach for their financial goals.
At the same time, PIMCO recognizes that we are members of a community − actually many communities. We are members of the financial community. We are also members of the global community of clients we serve. Locally, we are members of the communities in which each of our 12 offices is located. As members of these and other communities, we agree to abide by the rules that govern these communities; equally we share in the benefits (and obligations) of these associations.
While communities are governed by laws, arguably an even stronger form of governance is culture – the shared set of beliefs and principles that establish a set of behavioral norms. In a democracy, the laws are a reflection of the culture. Through these laws societies delegate the responsibility for providing public goods. As Martin Wolf wrote in a recent column, public goods are “non-excludable” and “non-rivalrous,” meaning they are provided to every community member equally, whether they choose to utilize that particular good or not. As users of these public goods, and beyond our fiduciary responsibilities, we believe that investment managers have an additional and separate set of significant, non-fiduciary obligations. These responsibilities are owed to those whose freedoms and wellbeing are affected by our economic behavior. Equally, these responsibilities are not rooted in the basic fiduciary relationship. Instead we believe these obligations derive from an investment manager’s role as a steward of the capital markets.
In January, 2008, before Bear Stearns, before Freddie and Fannie become wards of the state and a full nine months before the Lehman Brothers collapse and TARP, Bill Gross proposed a homeowner bailout of $300 billion to $500 billion.
The ultimate solution, it seems to me, must not emanate from the bowels of the Fed headquarters on Constitution Avenue, but from the West Wing of 1600 Pennsylvania Avenue. Fiscal, not monetary policy should be the preferred remedy, one scaling Rooseveltian proportions emblematic of the RFC, or perhaps to be more current, the RTC in the early 1990’s when the government absorbed the bad debts of the failing saving and loan industry. Why is it possible to rescue corrupt S&L buccaneers in the early 1990’s and provide guidance to the levered Wall Street investment bankers in 1998 LTCM crisis, yet throw 2,000,000 homeowners to the wolves in 2007.—Investment Outlook: Where’s Waldo? Where’s W?, August 2007
Needless to say, we will never know the counterfactual had Washington only listened. But, these and other PIMCO views expressing our preference at that time for mortgage principal modifications as a means to restore stability to the U.S. housing market were not intuitively the counsel that would come from an investor in mortgage-backed securities. Rather, it was a demonstration that as stewards of our clients’ assets we had an obligation to speak up because it was part of our duty to our clients, as well as in society’s interest for us to do so. In the recognition of the greater community we serve Bill and PIMCO realized that it was both good civics and good business to do the right thing.
More recently, PIMCO became a signatory to the United Nations-backed Principles for Responsible Investment (UN PRI). These principles were devised by the investment community and reflect the view that environmental, social and corporate governance (ESG) issues can affect the performance of investment portfolios, and therefore must be given appropriate consideration by investors as they fulfill their fiduciary duties. As a result, we committed to incorporating ESG factors when assessing the long-term sustainability of a company. While our credit process has incorporated ESG factors for some time, as a member of the community of signatories to the UN PRI, we will now formally include into our investment decision making process an analysis of a company’s impact on the environment, and on society, as well as how a company is governed. Yet we elected to sign the UN PRI because we think that by investing in companies that will succeed by acting responsibly, we believe PIMCO will provide enhanced benefit to our clients while operating at the efficient intersection of our fiduciary and social responsibilities.
Within PIMCO we are also making additional investments in people and time that we believe are inherent in our broad social responsibilities. We have embarked on an ambitious program to promote workforce diversity. As part of this important initiative, our firm has conducted numerous sessions to educate our people on unconscious bias and its insidious effects in the workplace. Separately, within our local communities around the world, we are striving to foster a culture of volunteerism. This past year 45% of our staff volunteered their time in firm-sponsored events through which we partnered with community based organizations to serve those in need. These programs serve dual interests. Both diversity and volunteerism strengthen our culture and make PIMCO a more desirable place to work, thereby enhancing our ability to recruit, hire and retain world-class talent. More importantly, as managers we realize that these investments are important contributions to the public good of social equality.
This is not to suggest that there are not tensions between important societal goals and PIMCO’s core business activities. These issues can and should be resolved at the industry level, the firm level, and ultimately by the individuals who comprise these organizations. We must bear in mind that the investment management industry plays a crucial role in a capitalist economy. As both capital intermediaries and allocators, it is important that we understand that our investment activities impact economic priorities and outcomes that may also have social consequences. In this regard, our collective fiduciary responsibility to allocate capital in the best interest of our clients takes priority. However, we must also acknowledge that we have a role to play in achieving a set of broader societal goals of the communities of which we are all members. How we reconcile these challenges will be a key determinant of the long-term secular shifts occurring across the entire financial services industry landscape.
*Past performance is not a guarantee or a reliable indicator of future results. The account growth study was conducted by PIMCO in February 2012. The reported sum is for the 2002 to 2011 period. Over the 10 year period PIMCO total account growth resulted in nine out of 10 positive growth years. Different periods will have different results. Individual account growth will vary. At any time an individual account may have account growth or loss that differ from another individual account. All investments contain risk and may lose value.