It is rare to see a group of Chief Investment Officers (CIOs) take the limelight to talk about market structure problems. Rarer still for that stance to allude rather dramatically to heroic Spartan warriors. So last week’s announcement by a group of influential European fund management investment heads of the creation of a think-tank to highlight irrational and dangerous market behaviour under the name of The 300 Club was not your usual market war cry. Then again, Saker Nusseibeh, Head of Investments at Hermes Fund Managers, and Chairman of The 300 Club, is hardly your retiring, number crunching investment manager. With his background – he has a PhD in history – the origin of the 300 moniker becomes less mysterious. It refers to the legendary 300 Spartans who in 480 BC held off the vastly numerically superior invading Persian army at the Battle of Thermopylae to give time for the remaining Greek forces to regroup. The 300 group, a more manageable 10 investment analysis heads, includes William De Vijlder, CIO at BNP Paribas Investment Partners and Alan Brown, CIO at Schroders. In its launch statement, it said its aim was to raise “uncomfortable and fundamental” questions about the foundations of the investment industry. The history of the 300, it added, had become a symbol of what can be achieved by a small band of high conviction individuals against overwhelming odds. In slightly more mundane financial markets terms, they said, this meant a “perfect storm” for institutional investors of economic uncertainty, regulatory disruption and a finance industry fixated on costly and complex financial structures.Speaking to Responsible-investor.com, Nusseibeh said the inspiration for the 300 Club followed the publication of an article last year in which he argued that over the last 20 years asset managers had steadily moved away from looking after pensions money to becoming sellers of investment product. It’s a theme he’s returned to increasingly vocally since: “I went out and discussed with other CIOs what they thought about the article to see if they thought the thrust of what I was saying was wrong? They all said no, although there were disagreements on some of the points. The other main issue that was concerning me was that when I asked them whether things looked ‘rational’ in financial markets back in the heyday of 2007 before the crisis, most said no. William De Vijlder at BNP Paribas said something very interesting in response. He thought each individual actor in the investment chain had probably been acting rationally based on their own ‘role’, but that if you added up the sum of actions they became quite irrational.”
Nusseibeh says he believes there are three main behavioural issues that mitigate against going against the grain: “The first, I think, is the personal risk of countering the herd. The second is the inherent career risk in saying that a certain kind of financial environment is ‘wrong’. The third is the sense of consequence: does what you think as an individual make a difference?” He says an issue that demonstrates the point is that of value-at-risk (VAR). “No-one questions regulators asking investors to use VAR as their risk model, but the bigger question should be whether VAR is a wise model to use, which I’m not sure it is.”
Similarly, he says there is much received wisdom in the foundations of investment theory that needs openly challenging: “People that studied Markowitz and Sharpe never bothered to read the fine print. At least two of the Capital Asset Pricing Model (CAPM) theories are highly questionable: firstly that all market participants are rational, which completely discounts behaviour, and secondly that all market participants have access to equal pricing information, which frankly belongs in a parallel universe. These are theories built on assumptions that don’t tally with the real world.” With his historian’s hat on, Nusseibeh says he tends towards the simplicity of medieval scholar William of Ockham in the principle known as Ockham’s razor – entia non sunt multiplicanda praeter necessitatem – that we should tend towards simplicity unless we can trade it for increased explanatory power. Markets, however, he says have tended to go the other way, craving complexity, due to what Nusseibeh says are two false premises. The first is that complexity leads to better control of risk. The second is that rising markets are a free lunch and will always “skew to the upside” in the parlance.
“That used to be called alchemy,” he says. “As an industry, we haven’t thought through what some of these misapplied theories could mean for the way finance is structured. Indeed, there are many issues such as de-risking, Solvency II, or the idea of uncorrelated alpha, that we haven’t really thought through at all!”While these issues are market technicalities, Nussebeih says their impact is societal: “This is not just about the very important issue of pension provision, but also about the structure of equity markets and their role in the world today. As a group we believe these issues are hugely important and that is why we are standing up together outside of our corporate backing to ask these questions.” Over the next 12 months, The 300 Club will convene regular meetings and publish thought papers. Its first – on transparency – will be written by Dylan Grice, Global Strategist at Société Générale and is expected in Q4. It will be hotly anticipated, not least because Grice is reputed for his trenchant thinking. Last month, in an analysis paper on the potential effects of quantitative easing, he criticised the “perpetual Ponzi machine that is the global financial system”, adding: “The ‘free lunch’ providers will be the late entrants into whatever asset-bubble or investment fad the money printing inflates.”
Nusseibeh says the 300 Club does not have a set of pre-baked answers to its own questions: “I think that if over the next year we can make enough noise and keep the debate open we can buy enough time for something to change. If not we are likely to see more of what we are seeing already: a ratcheting up the numbers of financial crises and ever increasing market volatility.”