I have cheekily (some may say unoriginally) adapted the title of a new book by Kenan Malik for the title of this post. Unlike Malik's book, this is by no means a treatise on an ethical approach to investing, but rather a collection of thoughts that will continue to be refined through experience and discourse. As Malik says in his introduction, "In the modern world, morality is inseparable from choice." Earlier this week, I finished Kurt Eichenwald's excellent Conspiracy of Fools, which narrates the rise and fall of Enron. Mercifully, scandals on the scale of Enron happen infrequently, but I was struck by how many people were complicit in its collapse through indifference to detail, fears for job security and subservience to presumed expertise (as opposed to those driven by outright greed & intent to defraud).
The world of investing, as we know from the likes of Bernie Madoff, is equally fraught with such moral decisions. More subtly, investors make implicit ethical choices by investing in companies or asset classes, or even by settling on different investing strategies. (If this sounds impossibly sanctimonious, I wish I had some folksy, homespun Buffet-isms to help, but they would probably sound pretty ridiculous coming from someone from Singapore). Bodies like the CFA Institute attempt to sketch out guidelines for financial professionals' "fiduciary duties", but these can never cover the complex interaction of real-world investors and clients. Fiduciary duty can only be described vaguely as "doing what's right for one's client". I list some examples below of possible areas of ethical conflict for those engaged in the purchase of securities or allocation to managers and strategies:
1) Is it ethical to invest a new dollar for a client if you believe a market is overvalued? Inflows from clients (particularly retail) are notoriously pro-cyclical, which suggests that you are very likely to be receiving new capital late in the game when valuations are stretched. Some PMs seem to take the view that investors have given them a mandate, and that they should then meet that mandate by investing in ideas that can outperform a benchmark, thereby achieving relative, if not absolute outperformance. Their clients, they argue, are not paying them to hold cash. I, on the other hand, think there are plenty of times when it's more appropriate to hold cash, and consider it another asset class. I understand well that the pressures of running a business often compel investors (particularly long-only funds) to be fully invested at all times, but this strategy seems doomed to the occasional (and possibly fatal) blow-up.
2) The recent decision by Stanford University's endowment to divest from coal-related investments has renewed (no pun intended) the debate on socially responsible investing. The investor's role is obviously to make the highest return possible for his client within a socially acceptable framework of risks and care for society and other stakeholders, but delineating that framework is tricky. Stanford has reportedly kept its stakes in oil & gas companies because of a lack of alternatives for those fuels. A cynic might plausibly suggest that given the growing prospects of natural gas and renewables, the likelihood of explicit or implicit carbon taxes in the future and the poor returns on coal-related equities, Stanford has simply decided to take its lumps on its coal holdings (ok, I meant that one). Arguably, a socially motivated owner could do more good by pushing his company to engage with regulators more keenly, rather than merely selling his stake.
3) This one might be the most controversial of the three. I've been listening to a lot of Michael Covel's podcasts lately on trend-following strategies (the longer interviews often feature interesting guests; the shorter ones seem less worthwhile). I recognize the potential for profitable trend-following/momentum strategies (right on cue, AQR has contributed its intellectual heft in defense of momentum investing), not to mention other technical strategies as laid out for popular consumption here by Andrew Lo and Jasmina Hasanhodzic. Mind you, an investor doesn't have to have an exclusively technical framework to be a momentum investor - as George Soros famously said, "When I see a bubble forming I rush in to buy, adding fuel to the fire." Yet one of the supposed benefits of a market is that it generates prices, which in turn provide information about the allocation of resources. I've seen it said that Soros used to say of his speculating, "I shouldn't be allowed to do what I do, but I'll do it as long as I'm allowed." That seems an amoral escape route, and one I suspect Soros himself has largely abjured in his later incarnation as global statesman. One can often make a good deal of money pushing up the price of an asset from fair value to overvalued levels before offloading to an unsuspecting patsy, but that hardly seems like a socially defensible form of investing, philosophically indistinct to me from other forms of legal but unethical business practices. But before I sound like I'm on my high horse and ready to break into canter, let me say that this somewhat ideological notion of contributing information to the market can be taken to extremes. Those dogmatically opposed to market exuberance would have been shorting Internet stocks in early 1999 and eventually cast in the sea of bankrupt investors in a shroud of ideological purity. Logotherapy is best saved for the therapist's couch, and shouldn't be bankrolled by one's clients. I'm sure there are some Herbalife investors out there who agree on that count. All told, it can be difficult discern whether and to what extent an investor owes a duty to society as a whole.
As I said, this is by no means an exhaustive survey of possible ground for ethical dilemmas in investing, but a recognition that these quandaries exist. I look forward to comments.