You can almost hear the sniggers from stock market professionals as another allegedly misguided academic attempts to reform their industry. But the recently published Kay Report, commissioned by the British government, confounds cynicism. It is relevant to investors well beyond British borders. Economist John Kay has taken an important step back to basics in looking at what role equity markets perform, both for the companies that are represented on these markets and for investors involved in the equities game. The last word is pejorative, but equity investing increasingly looks like a game. In the US, the average holding period for shares in the 1960s was eight years. Today it is seven months. Last year, Thomson Reuters found that fund portfolios - that is, funds run by market professionals - were only slightly more long term, holding shares for an average of less than 10 months. Kay says this short-term approach to equity ownership discourages fundamental engagement between shareholders and companies. Longer-term investment encourages greater shareholder activism and a more focused attempt by fund managers to identify good investments rather than good trading opportunities. Writing about his report in the Financial Times, Kay emphasises that better relationships between shareholders and companies have to be based on trust, and this provides a stimulus for better performance. 'Trust usually rests on a long-term relationship: the merchant in a foreign bazaar does not expect to deal with you again, and that expectation governs his behaviour,' he writes. Kay calls on fund managers to hold focused portfolios, and to avoid churning their investments. He is too polite to say it directly, but the implication of the recommendation is that fund managers need to work a lot harder to find the best companies and not rely on the vagaries of market movements to produce returns. For example, recent evidence shows that large British pension funds are increasingly using exchange traded funds (ETFs) to invest in bonds and emerging markets. Rather than building sustainable portfolios, they are buying index-tracking funds. ETFs are a sensible option for private investors, but for professionals who claim they can beat the market with their expertise, this is a quiet admission of defeat. Kay also believes the chain of stock market intermediaries is too long, ranging from nominees to fund managers to financial advisers and beyond. Every link in the chain adds to costs and moves investors further from their investments. Kay would like to see a much shorter chain and wants pride of place given to asset managers, who are best positioned to improve returns and to work with companies to enhance their performance. In the light of daily revelations of scandals in the financial markets, Kay firmly believes less is more. He also believes current regulatory structures are too complex to work well. As he puts it: 'Regulation should impose on all participants ... an obligation to manage their affairs to the fiduciary standards appropriate to anyone who takes responsibility for the management of other people's money.' As matters stand, regulation seems designed to serve the industry being regulated rather than the needs of investors. A small army of lawyers, compliance officers and associated staff work diligently to keep companies out of trouble. But no one is working that hard to protect investors. As trust in the financial sector reaches new lows - and as this also happens to be a rather bleak time for investors regardless of scandals - a new report on the equities business should encourage new thinking. Or perhaps it should produce a reassessment of old thinking emanating from a lost tradition in which investors were more closely tied to their investments. Kay, sensibly, does not call for a new raft of regulations because the record of trying to regulate the industry is far from stellar, but he is seeking to influence attitudes. Meanwhile, back in Hong Kong, we are treated to a dribble of complacent statements by people who should know better. They come from the financial secretary down, rejoicing over how we have managed things so much better than anyone else. If you believe that, prepare for the worst.
