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Fiduciary duty in dysfunctional markets

Financial markets play a central role in the capitalist economy, allocating new savings to productive investment, acting as a signalling device to corporate management, and providing liquidity to investors. The efficient markets paradigm claims that competition among investors keeps asset prices close to fair value. A new interpretation contends that stock markets have morphed into a contest between two sets of investors: those seeking short-term gain matched against those targeting long-term value. This unending battle corrupts prices, creates macroeconomic instability and costs vast sums in asset management fees.

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Innovation and shirking in financial markets

Innovation is usually viewed by economists as a productivity-enhancing force, powering economic growth in modern capitalist societies. This is just as true in the investment industry, where new products are assumed to help consumers meet their individual financial needs. This optimistic view ignores the damage that can be done by innovations, especially in the financial sector, where agency issues create the potential for negligence and rent extraction.

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A precondition for sustainability

The asset management industry is horribly conflicted. On the one hand it is supporting the grassroots drive to encourage big business to adopt sustainable policies. On the other, the majority of investors and asset managers are adopting strategies that destabilise asset prices and promote short-termism. Unfortunately, the latter effect not only undermines the former, but does untold damage to the macroeconomy.

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Paul Woolley Centre for the Study of Capital Market Dysfunctionality

The PW Centre produces and disseminates high-quality research focused on the workings of capital markets and the social efficiency of allocations achieved in these markets.

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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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