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Stabilising and destabilising strategies

The social utility of an ever-expanding asset management industry is rarely discussed. In this note we distinguish between different strategy types on the basis of their impact on market stability. We argue that destabilising strategies impose a largely unrecognised negative externality on society.

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Defensive diversification

By treating diversification as an unmitigated good, investors by and large ignore the damage that it does to returns. We would do well to channel Buffett who once remarked that “diversification is protection against ignorance; it makes little sense if you know what you’re doing.” The outcome of an obsession with benchmark-relative performance together with principal-agent problems is “defensive diversification”.

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Asset mispricing: the ignored externality

The externalities of greatest interest in contemporary discussion typically fall under the E, S and G headings. However, this leaves a critically important externality – that of asset mispricing – largely ignored. Asset owners should broaden their awareness of the externalities that arise from their investment approach.

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