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Giant funds and market mispricing

The short-termism of corporate managers has been a recurring concern of policymakers for decades due to the close tie with mispricing in capital markets. This article shows that a root cause of mispricing is the tight tracking of asset managers to market cap benchmarks. This seemingly prudent practice is commonly adopted by giant pensions, sovereign-wealth funds and endowment funds. However, it gives rise to momentum trading, excessive focus on short-term price movements, high volatility for overvalued assets, and overvaluation for the aggregate market.

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Giant funds must curb short-termism

Many of the problems of present-day finance have their origins in the horizons set along the investment chain. The key players in this chain are the giant pension, sovereign wealth and endowment funds who appoint external asset managers, who in turn invest in companies. If these funds invest with their eyes set partially or largely on the short term, it sends a clear message down the line and embeds similar standards throughout the capitalist system.

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Markets as amplifiers of crises

The finance sector is widely recognised as an originator of periodic crises. What is less widely discussed is the unhelpful role that the finance sector can play in amplifying crises that emerge from entirely non-financial origins.

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