The world of high finance sounds rather like a zoo. It’s not only the bulls and bears of the stock market, or the hawks and doves that flock around the central banks.
Investment banks are “vampire squids”. Hedge funds are “locusts”, speculating against decent companies and entire countries until they collapse into bankruptcy.
Jordan Belfort, the drug-addled conman who pushed dodgy stocks of hopeless companies on poor Americans in the 1990s, styled himself as the “Wolf of Wall Street”.
And there is, sadly, a lot of truth in such stereotypes. Finance is often parasitic on the real economy and predatory in its behaviour towards clients and customers.
But critics and reformers should also recognise when some financiers do not conform to this negative characterisation; and to acknowledge when the industry performs a broad public service.
The first people who recognised that something was financially awry at the giant outsourcing firm Carillion were not regulators. They weren’t civil servants. They certainly weren’t the company’s auditors. Nor were they the firms’ bankers or passive asset managers, who invested in Carillion on behalf of pension funds and insurance companies.
It was hedge funds. Their research on the company revealed that Carillion was paying its suppliers very late – a classic sign of possible financial distress. They also noticed that Carillion was piling up large amounts of off-balance sheet debt. Hedge funds such as Marshall Wace and CapeView Capital started taking substantial short positions in Carillion (betting on the share price falling) as early as 2013. If only ministers, who continued bunging large public contracts to the firm right up until its demise, had been similarly on the ball.
The hedge funds didn’t kill Carillion – its incompetent management did that. The hedge funds were effectively sounding a warning, albeit one that wasn’t heeded by enough people.
The classic image of “sell-side” analysts working for stockbrokers and investment banks is that they are hopelessly compromised, tailoring their views on the prospects of firms to please their existing (or potential future) corporate clients, rather than to serve the interests of actual investors.
It’s often true – but not always. Two years ago another outsourcer, Capita, was riding high in the stock market, its share price at £ 11, and was widely approved of across the City. But one analyst at the stockbroker Panmure Gordon, Michael Donnelly, broke with the consensus and cautioned clients about the sustainability of the business based on his own reading of the company’s data. Last week Capita’s share price fell below £ 2 and the new chief executive admitted that the company had, in fact, been appallingly run for years. Donnelly’s warning was vindicated.
Purple Bricks is one of the new breed of online estate agents. Managers have claimed they successfully sell around 90 per cent of the properties they handle within 10 months – a comfortingly high proportion for homeowners thinking of paying the roughly £ 1,000 flat up-front fee for its services. But Anthony Codling, an analyst for the investment bank Jefferies, said in a note last week that his own research (ploughing through Land Registry data) suggested Purple Bricks is actually only selling around half of the properties on its books in that time, which is in line with the rest of the estate agent industry. The share price of the company, which is in the midst of an international expansion, sank in response.
Purple Bricks has rejected Jefferies’ data, although it hasn’t released their own to rebut it. But the point here is not the truth of any particular view on a company’s finances or growth prospects, but one pertaining to the kind of behaviour we want from asset managers and financial analysts. These are instances of financiers ignoring the rubber stamps of auditors, brushing aside the confident assertions of company executives, going against the herd, and performing their own, original, research.
This is also what the small band of hedge fund managers profiled in Michael Lewis’ The Big Short did with regard to US “sub-prime” mortgage loans that fuelled the disastrous international credit bubble before 2008.
The economist John Kay, who wrote an official review of equity markets for the Government in 2012, recommended that asset managers should have deep knowledge of and regular engagement with the managements of the companies in which they invest. This will involve digging out inconvenient facts.
“Obtaining better information about companies is essential to the efficiency of markets and society,” he says.
The many critics of finance are quite right. The sector unquestionably needs wholesale reform. The wolves and vampire squids must be defanged. But high finance is not going to disappear, at least not while ordinary people have savings and pensions that they want to be invested in decent companies with reasonable growth prospects.
As well as getting justly angry at finance’s many abuses, we need to have a vision of what we want the sector to be and the socially useful job we ultimately want financiers to perform. The past month has given us some signposts.
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