'A game of mass psychology'
Professor of economics and finance at the School of Oriental and African Studies, Jan Toporowski, talks to Corporate Watch about the madness of the money markets, the rise of sovereign wealth funds and what scares investors.
1. Who are the biggest and most influential investors now compared to the last fifty years?
Fifty years ago, most stocks and shares were owned by individuals. Today they are largely owned by institutions, insurance companies, pension funds and investment funds (mutual funds). Banks too own a lot of assets but do not normally hold shares in companies. Hedge funds and private equity firms are now the last financial sector still dominated by private individuals, mostly very wealthy investment bankers and brokers. But even hedge funds and private equity funds, organised as partnerships to avoid too much disclosure of their operations, often have pension funds and insurance companies as partners and investors.
2. What does a portfolio manager working in one of those organisations do? And how does it differ when it is undertaken by different sorts of investors (bank, pension funds, hedge funds, other).
Portfolio management is the art of managing portfolios of financial assets, whose returns may be from interest or dividends, or from increases in the value of those assets, or capital gains. Investing for capital gains is commonly known as speculation. The finance textbooks tell all sorts of stories about how this is supposed to be done by taking into account the risk and returns from an asset. However, Keynes pointed out that it is essentially a game of mass psychology, in which a portfolio manager tries to anticipate what other portfolio managers will want to buy or sell in the future and then profit from it. The manager will even seek to form other portfolio managers' expectations of what to buy through making forecasts designed to form opinion in markets in a way that is profitable for the opinion-forming manager. This is why the financial markets and their hangers-on are so obsessed with 'information' and the financial press is so full of opinionated comments that mostly have no foundation in any reality other than the commentator's portfolio, whose value he is trying to talk up.
Portfolio managers may be classified according to how soon they need to return the money that they are managing. Pension fund managers typically invest for the very long-term, since their 'liabilities' to pay pensions are usually fairly predicable, determined by the respective retirement dates of the members of the fund, and the length of their service and the relationship of their pensions to their earnings. Insurance companies have somewhat less predictable liabilities, but they are nevertheless fairly long-term. Mutual funds (investment or unit trusts) or hedge funds have much shorter time horizons, and therefore typically have to show significant returns on their portfolios from year to year.
A number of other institutions manage their assets in rather more complex ways. Private equity firms make money by restructuring the balance sheets of the companies they buy, and by manipulating the markets in the capital liabilities (shares or bonds) of those companies. Investment banks specialise in restructuring the balance sheets of companies that they do not own in return for fees. Banks make loans and try to charge interest above the rate that they are paying, as well as offering financial services for which they charge fees. Among those financial services are derivatives contracts, which have been hugely lucrative for banks.
3. What happens to people's money when they deposit it in the bank?
The bank will normally lend out the money at interest, charging a higher interest than it pays its depositors, so that it can cover its costs. If you have a current account, which most people in financially developed countries have, and which businesses use, the deposit may be used to make payments. So your deposit may never leave the banking system but may simply circulate around different accounts in it. More importantly, it means that the deposit that you put into the bank, and even the income that you receive, originated in a loan which a bank gave to a customer, rather than loans being consequences of deposits that banks' customers have.
4. Sovereign wealth funds have attracted increasing attention in recent years. Can you tell us a bit about what they are, what they do and why this is significant for the world of finance today?
Sovereign wealth funds are portfolios of financial assets which are owned by a government that has no immediate need or use for the financial assets in the portfolio. Typically they are built up from the fiscal surpluses of governments that obtain more revenue from some scarce natural resource than they can usefully use because of small populations or limited development possibilities. This is the case with oil exporting countries such as Brunei, Libya and Norway. Alternatively they may be built up through trade, as in the case of China or, more controversially, Ireland.
Because sovereign wealth funds have no immediate need for the financial resources in their portfolios, they can afford to invest without necessarily having to worry too much about immediate returns from their investments. Nevertheless, sovereign wealth funds are run very conservatively, preferring to hold mostly bonds issued by other governments, or corporate bonds or the top companies, or gold, favoured by governments of Middle Eastern oil-exporting countries because of its traditional mystique (out of all proportion to its actual use-value). With the notable exception of China (see below) and Norway, the largest sovereign wealth funds are in rather traditional societies whose political attitudes tend to reflect the values of their societies.
Sovereign wealth funds are therefore very cautious investors, usually because the governments that own them do not want to be responsible for managing companies in other countries. This would bring governments into activities that go beyond traditional diplomacy. The activities of Chinese companies in Africa illustrate the perils well. In Africa, Chinese companies have become inevitably involved in industrial relations disputes that have not reflected well on Chinese management.
If sovereign wealth funds do invest in commercial businesses it is usually in trade or finance, where the fund managers may have some experience. At the time of the international financial crisis of 2007-11, sovereign wealth funds briefly supported some banks. In 2008, for example, a subsidiary of the Qatari sovereign wealth fund, the Qatari Investment Authority, invested some $2 billion in Barclays Bank. The investment was later the subject of an investigation by the UK Serious Fraud Office.
5. What do you think investors or fund managers would be most worried about from divestment campaigns?
The most successful disinvestment campaigns were conducted during the 1970s and the 1980s as part of the anti-apartheid struggles. In large part their success depended upon the widespread revulsion against apartheid felt in the United States, the world's largest financial investor, in the wake of the civil rights movement in that country. Few other campaigns could be as successful because there are few other examples of political issues that are so unambiguous and obvious as to win the support of the institutional investors who now constitute the bulk of shareholders. Nevertheless, informing institutional investors and their fund managers of the activities of their companies is an important way of making this section of the public more aware of the dark side of what business does. In the end, change will happen when social values guide economic activity and businesses are not obliged by the impersonal forces of market survival to exploit the misery of the poor and oppressed, and the diminishing resources of our environment. Meanwhile, companies and investors should also know about that poverty, oppression, and the environmental threats, and embarrassing questions should always be asked.