Fiduciary Finance
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Fiduciary Finance

Investment Funds and the Crisis in Financial Markets

Martin Gold

This multi-faceted analysis of institutional investment defines ‘fiduciary finance’ institutions as the third pillar of the financial system, alongside banks and insurers. It documents the role played by investment funds and the money management industry during the recent financial crisis, and provides an unashamedly critical review of the business disciplines which can dominate investment practices. It clarifies the economic significance of the investment industry (circa $60 trillion in assets) and the features which differentiate fiduciary finance from traditional financial institutions such as banks and insurers.
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Chapter 9: Future Financial Crises: What Role for Investment Funds?

Martin Gold


There are two main aspects which are relevant when considering the role investment funds will play in future financial crises and stability of the financial markets. First, there are investment-related issues associated with the constraints applying to fiduciary institutions (and their capacity to influence market pricing). Second, with cognizance that fiduciary investment vehicles capture (but do not create) returns from financial markets, changes to the regulatory environment introduced or mooted since the crisis unfolded in the global financial system, and their ramifications for the various segments of fiduciary finance, are examined. 9.1 9.1.1 INVESTMENT OPERATIONS IN MODERN FINANCIAL MARKETS The Importance of Marginal Opinion Orthodox finance theory assumes that in equilibrium security prices reflect the discounted value of known or expected cash flows, and that investors are a generic but otherwise irrelevant aspect of pricing. However, as Williams (1938) succinctly noted, within financial markets, opinions of value, irrespective of how they are formed, are the ultimate arbiters of price: Both wise men and foolish, will trade in the market, but no one group by itself will set the price. Nor will it matter what the majority, however overwhelmingly, may think; for the last owner, and he alone, will set the price. Thus marginal opinion will determine market price. (Williams, 1938, p. 12, emphasis in original) An informed understanding of the functioning of financial markets (and what is normatively defined as investment) requires a focus upon marginal opinion. An important related aspect is explicit cognizance of the tradable (rather than total)...

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