Does the public hate us?

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Published in 2001, my book Naked Among Cannibals examined how banks had fallen from revered to reviled within a couple of decades. Over the subsequent few years, the finance industry seemed to be gradually winning back the trust of the public, with market research showing improving customer satisfaction and better ratings for ‘ethics and honesty’. But events relating to Storm Financial, Westpoint, Opes Prime, Trio Capital and most recently, CBA’s advice business, have been setbacks to this progress. The watering down of FOFA is a rich source of rancour for major bank critics.

A few weeks ago, I attended a meeting where two Nobel Laureates debated why the public hates the finance industry. Then this week, David Murray’s Financial System Inquiry highlighted major shortcomings in Australian wealth management. The former CEO of CBA, who bought Colonial First State to create the largest fund manager in the country, was expected to be kind to the major banks, but he criticised the industry on many fronts. The Interim Report says in various sections:

“A trend in the wealth management sector is towards more vertical integration. Although this can provide some benefits to members of superannuation funds, the degree of cross-selling of services may reduce competitive pressures and contribute to higher costs in the sector.”

“The quality of personal advice is an ongoing problem … ASIC shadow shopping exercises indicate that consumers often receive poor-quality advice. This poor-quality advice mainly relates to two factors, the:

  • Relatively low minimum competence requirements that apply to advisers
  • Influence of conflicted remuneration arrangements

The price of personal advice has often been hidden by opaque price structures and indirect payments.” 

“The operating costs of Australia’s superannuation funds are among the highest in the Organisation for Economic Co-operation and Development (OECD), and the Super System Review concluded superannuation fees were “too high”. The Grattan Institute estimates fees have consumed more than a quarter of returns since 2004.”

“It is very difficult for the superannuation system as a whole to beat the market over the long run within an asset class, although it is possible for an individual fund to do so. As Nobel Laureate William Sharpe noted:

Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.’”

Far from easing the pressure on the major banks, David Murray has delivered more setbacks, especially to the legitimacy of the revisions to FOFA.

The image of financial services professionals in Australia

Roy Morgan Research has tracked the image of financial services professionals since 1985, and reports:

“Unfortunately, very few Australians trust professionals in the financial services industry, rating them consistently poorly for ‘ethics and honesty’. Not exactly the best foundation for a successful working relationship, is it?”

For ‘ethics and honesty’, only 25% of Australians rate financial planners as ‘very high’ or ‘high’, and it’s even worse for stockbrokers (15%) and insurance brokers (13%). The once-trusted bank manager scores only 38%, down from a healthy 58% in 1985, as shown below:GH Chart1 180714

How did the Nobel Laureates explain the hatred?

At the 2014 Research Affiliates Advisory Panel at Laguna Beach in California, the first session was hosted by their Chairman, Rob Arnott, in discussion with two Nobel Laureates, Harry Markowitz and Vernon Smith. The topic was “Why Does Main Street Hate Wall Street?”, or more prosaically, “Why does the public hate us?”

Harry took it gently. He thought it was mainly a lack of education, and we need to tell the public about the importance of financial intermediation for the functioning of a market economy. But digging deeper, Vernon Smith pointed out that what Adam Smith wrote in his 1776 The Wealth of Nations is often mistakenly quoted to justify self-interested market behaviour. Adam Smith described his system of natural liberty thus:

“Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interests in his own way.”

But Vernon said this can only be understood in the context of Adam Smith’s 1759 Book, The Theory of Moral Sentiments. While people have a right to be ‘self-loving’, part of their maturation is to learn rules of conduct that are ‘other-regarding’. Greed is controlled through socialisation.

“He must humble the arrogance of his self-love and bring it down to something which other men can go along with … we must become the impartial spectators of our own character and conduct.”

Vernon believes our industry is guilty of ‘crony capitalism’ based on privilege. We gamble with other people’s money, offer them returns we don’t know we can deliver, charge hefty fees, take the profits but pass the losses to the taxpayer. Rob echoed the views on cronyism. Consider the recent US bailouts of the most prestigious names on Wall Street. Politically-connected banks were protected, and within months, their executives were paying themselves massive bonuses, and it has continued since. As Chris Brightman, Chief Investment Officer at Research Affiliates, said in his summary:

Much of our industry is a deadweight loss to society, and the public is justified in its disdain.”

Asset consultants cannot pick outperforming managers

On the second day, we heard from Tim Jenkinson of the Said Business School at the University of Oxford. His subject was, “Do Investment Consultants Pick Winners?”. Institutional investors (not uneducated retail) managing hundreds of billions of client money hire asset consultants like Mercer, Towers Watson, Russell and Cambridge Associates to help with fund manager selection. Jenkinson and his team quote statistics which show 94% of ‘plan sponsors’ employ an asset consultant. These are supposed to be ‘the smartest guys in the room’. They tell our biggest investors where to allocate their money. What is the main conclusion of the paper?

“In sum, however, the analysis finds no evidence that the recommendations of the investment consultants for these U.S. equity products enabled investors to outperform their benchmarks or generate alpha.” (Cuffelinks will write a comprehensive review of this study in a future edition).

Why do institutions bother with asset consultants when the managers they pick usually underperform? Well, it’s a ‘hand-holding service’, it protects against ‘headline risk’, and plan sponsors probably don’t even realise how inaccurate the recommendations are. Highly paid executives pay other highly paid executives to protect their backsides, without much idea whether value is being added. This process even has a name – deflection – which is the opportunity to fire someone else so that the institution or its executives are not fired. It’s perhaps the most important service that asset consultants perform.

What about the theories and the academics?

If that’s the real world of investing, what do theoretical models say about capital market prices? Brad Cornell, Professor of Financial Economics at California Institute of Technology (among many distinguished roles) told us that at best we can put a wide range around possible prices, and our models have basic flaws which render them of little practical use. Then Ivo Welch, Distinguished Professor of Finance and Economics at UCLA, said we should have little if any confidence in capital asset pricing models for predicting future returns. Yet these models play a major role in company valuations, M&A activity and defining flows of billions of dollars of capital. We use the models in business schools for capital budgeting and investment plans, but they have negligible predictive capacity. Chris Brightman again:

 “Our clients and business partners pay us to be experts. They want to believe that we know more than we can. We are tempted to allow or even encourage this faith. Overconfidence is necessary for our business success … Not only is there much we don’t know, but also some of what we know isn’t true’.

At the equivalent conference last year, I interviewed Burton Malkiel, renowned author of A Random Walk Down Wall Street. I asked him whether he feels any sense of disappointment at the state of the investment management industry. He replied:

“I think the reason we have not made much progress is that it is probably one of the most overpaid professions there is. It’s an inefficiency, with investment professionals paid regardless of the results. The real problem with us making enough progress in our industry is the misaligned incentives.”

Where does this leave us?

Notwithstanding our shortcomings, Rob Arnott said he likes to think that our industry does add value relative to what most investors would do without our ‘help’. Investors would be undiversified and would typically chase every fad and bubble that comes along. Indeed, the reason that contrarian investing often does add value is that the aforementioned lemmings are common in the marketplace, and likely always will be. It is the job of advisers and educators to encourage a longer term perspective.

In the face of the CBA’s apology for the behaviour of many of its advisers and the additional compensation payments it now faces, we might expect widespread industry remorse. However, what we actually have is a public argument about the merits of a Best Interests Duty, the definition of conflicted remuneration, the reason we don’t need opt-in for fees, and defence of the vertical integration model.

Back at Laguna Beach in California, we drank fine wine, we appreciated the art in the galleries, we ate great food from the kitchens of the luxurious Montage Hotel, and we basked in the sunshine overlooking the Pacific Ocean. Then we jetted back to our well-paid and prestigious jobs all over the world.

William J. Bernstein, author of several classic books on investing, calls us ‘talented chameleons’ that populate the financial professions. He tells his readers,

“The investment industry wants to make you poor and stupid.”

That’s why at least some of the public hates us.

 

Graham Hand is Editor of Cuffelinks. He was General Manager, Capital Markets at Commonwealth Bank; Deputy Treasurer of State Bank of NSW; Managing Director Treasury at NatWest Markets and General Manager, Funding & Alliances at Colonial First State. He has consulted widely across the finance industry, written for major financial journals and has had two books published.

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18 Responses to Does the public hate us?

  1. Chris Brycki July 18, 2014 at 12:10 AM #

    Great write-up Graham. There have been other studies in the US and elsewhere that have demonstrated the lack of value that asset consultants add: http://www.ft.com/intl/cms/s/0/f20eb888-213a-11e3-a92a-00144feab7de.html#axzz37jSYJD8D
    http://www.ft.com/cms/s/0/90d6d94c-2766-11e3-ae16-00144feab7de.html#axzz37jSYJD8D

    I don’t know how this comes as a surprise to anyone who has seen the performance of some asset consultants’ own funds in Australia. They have been in the bottom quartile over 3, 7 and 10 years. Far from the ‘smartest guys in the room’ this is like getting the kid who failed the class to sit the exam for you.

    As you highlighted, trustee boards simply use asset consultants to abscond all risk and responsibility… then pay themselves like they are the ones making the investment calls. It’s a win win for everyone except the end investor.

    Completely agree with the quotes from Brightman and Malkiel.

    “Much of our industry is a deadweight loss to society, and the public is justified in its disdain.”

    “I think the reason we have not made much progress is that it is probably one of the most overpaid professions there is. It’s an inefficiency, with investment professionals paid regardless of the results. The real problem with us making enough progress in our industry is the misaligned incentives.”

  2. Phil Kneale July 18, 2014 at 10:26 AM #

    The main problem is that we vastly over-pay ourselves. Bank CEO/executive remuneration is ridiculous. Even more absurd are the hordes of fund managers who travel the world at shareholder expense, peering into mines, attending conferences, listening to yarns spun by company executives with the end result that they slightly underperform the index, for which they are paid perhaps four or five times the Prime Minister’s salary. The punters don’t like that.

  3. Rob McGuinness July 18, 2014 at 10:52 AM #

    I think the graph results of the Ethics and Honesty Survey which shows Accountants achieving a 49% rating partly explains why many in the “financial planning” industry have worked so hard to keep Accountants out of the game.
    Accountants have “ethics” as a foundation principle of their profession,and I think this scares the hell out of the salesmen who masquerade as “financial planners”.
    There is no doubt that remuneration arrangements which are based on sales volumes will force a certain type of behaviour in some advisers.it is now extremely disappointing the current government has bowed to Big Bank/Institution pressure to water down some of the FOFA changes – so we still have a long way to go.

  4. Jon July 18, 2014 at 11:01 AM #

    Thanks Graham – appreciated your article on why the industry is so disliked. There is much that a typical advisor/fund manager does that is all about presentation confidence and not about performance.

  5. Bruce Gregor July 18, 2014 at 11:59 AM #

    A great discussion to start Graham! Here’s a brief summary of my view. There is a mismatch of types of investments available and what retirees want. Too much market linked, not enough income with certainty of maturity (or better still life annuity). Too many highly paid people trying to intermediate market linked/equity assets into pretend income/annuity. Retirees fall prey to advisers offering unrealistic outcomes in the absence of properly matched investment types to investor need. If banking and finance provided these people what they want, they would view the institutions more favourably. Much cheaper and more secure for government to play a role in managing better matching of investment offered to investor need. For example privatised mature/old government businesses should be converted by government to government issued retail market debenture ownership (say,5,10,15 yrs) rather than geared up equity where all the value is intermediated out by merchant bankers. These are public assets so why not use them to satisfy a public need? A government run longevity reinsurance pool would take very little capital and could back up conversion of all industry fund retiree needs for lifetime annuity admin. There are too many Phds in banking and asset and investment management who would be better placed working on medical services, mental health and aged care research, vocational training of older workers, third world sanitation and housing innovation etc etc.

  6. Gordon Siebrecht July 18, 2014 at 2:56 PM #

    Thanks for your report, it is what I have believed to be correct and needs a very open and at all government level debate.

    First I beleive that the FOFA should not be watered down when the cost to the industry is such a low amount compared to the management fees alone paid into Super management.

    AS for ethics and honesty the financial industry has itself to blame when it is become an issue both to the Abbott government and big banks on poor service to the general public.

    I have only used a financial adviser once, it was if I was just there for them to take over my total assets, as for taking my interests first felt it was me that had to please them to take excess fees as a percentage of my total assets.

    The report supplied to me was as if my many years of building the investments and Super fund did not meet their standard, so how can other people feel when it is a degrading situation.

    The duty of care for all requirements and interest first to a client but this is not what is given from the financial industry.

    I have an accountant who has given the best advice and service over 30 years, and fees and charges have been on and hourly basis that I can accept rather than over the amount of my assets I own in my investments as a basis of a percentage charge.

    • Really Gordon July 18, 2014 at 3:20 PM #

      Gordon – really…your one experience with financial planning has led to this conclusion…. What will you think when your accountant is forced to become a financial planner under the licencing requirements to provide the same advice? Maybe it has more to do with the person you went to see rather than the industry as a whole!!!

  7. Peter Vann July 18, 2014 at 4:17 PM #

    There is another simple reason why the public should be disappointed with part of the industry, but most (of the public and many in the industry) in Australia don’t even know it.

    Simply put, the defined contribution industry makes many decisions regarding superannuation and retirement without analysing what impact these decisions have on a member’s end liability (i.e. drawdowns in retirement). As to how any planner can fully advise a client without such analysis is beyond me.

    Imagine the uproar we would be justified making if our banks and insurance companies also didn’t undertake the appropriate asset-liability analysis, management and monitoring for their particular business.

    On CuffeLinks we now see a small, but growing number of people going down the path leading to analysis of a member’s ability to drawdown an income in retirement. That is a start.

    Peter

  8. Ian mackenzie July 18, 2014 at 6:01 PM #

    I am a Retiree.

    I think that some of you people lose sight of what us older investors want. I believe that all we ask is that you don’t lose our money, try to get back for us 2 or 3% better than bank interest and don’t rip us off with exorbitant fees. I for one am sick of the relationship between the big banks lobby groups and the Government at watering down protection from parasites for us investors. That is why I hate the banks.

  9. Paul Meleng July 19, 2014 at 12:08 PM #

    Regardless of public perception , no profession can offer a guarantee of good practice and it comes down to a combination of public regulation, industry sefl regulation, personal integrity of the individual adviser AND the customer’ own awareness of what constitutes best practice AND in the case of investment advice or managment, the customer’s own awareness of realistic expectations.

    In a very real way, the more a profession convinces the public that it is completely safe and good, the more the naive client is at risk because they rely on trust instead of their own knowledge and on knowledgeable independent referral. This is a universal principle. “The great wonder is that the fool and his money ever got together in the first place” .. Woody Allen.

    The wolves are always doing their best to wear the sheeps clothing. Often it is unconscious, it is intuitive to the manipulative self centred personality. They can accumulate degrees and certificates and awards with which to plaster thier office walls and then use the trust engendered to take full advantage of the naive. My accountant buddy and I have a code for it when we see it in someone. We spread our arms, smile and say “Trust me”.

    My first profession was as a Licensed Land Surveyor. Quite unique as one is totally beholden to the regulations relating to land title. The public get to choose their surveyor, but then the surveyor’s total allegience is to the system. Also, very few clients are poor or naive. But within that world one learned to produce real work of a high standard day after day and to look the client in the eye and present one’s sizeable invoice. But we all knew certain financially successful practitioners who charged the full fees but took lots of shortcuts , with their work on the edge of legal, and contributing nothing to the strength of the field marks and records which we all had to use and maintain.

    My old engineering geology lecturer told us “Doctors bury thier mistakes , but Engineer’s mistakes stand out as long term monuments to their error.”

    For financial advice I suspect the answer lies more in public education as to realistic expectatons of both markets and advisers. The call on advisers should be to assume the client is conservative, naive and cost conscious unless the client convinces the adviser otherwise. The best advice I ever heard for advisers is “Your real job is to manage your client’s expectatons”. (not “pay yourself a motza for trying to beat the market and build false hope”).

    In Australia, the advisers were morphing from insurance sales people into good advisers, with people from other older professions infiltrating with their own values and discipline and fund managers were using IT, real aussie innovation etc and making great product and helping the shift from entry fees and sales to ongoing fees and service. But the very success of what was happening, the real investors acceptance of it and then the intro of compulsory super with choice meant the banks were losing savings accounts and term deposits to super and cash management trusts. They made the move to “integrate” and buy into the advice game.

    But they did not buy into the efforts at increasing professionalism of the leading private practitioners. Instead, they milked it for all they could and filled the waters with mud..

    The great shame is that in Australia the banks aquired such a large portion of the advice business, then ran a sales culture as bad or worse than the old insurance plan game we had all been working hard to bury. They did not shift from up front fees to either trail or dial up adviser service fees. Any one of those fee types is adequate for a viable advice business. They went for maximum up-front regardless of the amount PLUS trail PLUS maximum adviser service fee. Terrified retirees gave them their trust and their money because they felt sure that the big conservative name was the one protection that they felt they could trust.

    A classic example irony is a non alligned adviser using the Colonial wholesale index funds to construct a client’s portfolio for a management fee of nil entry and around 0.5% per year and charging an optional half percent to serve the clients total ongoing advice and management needs for a total of 1% per annum. Meanwhile the advisers owned by the same parent bank as the product were charging a fresh 4% upfront and full trail and extra fees to shift clients from the old Commonwealth fund to the new RETAIL version of the colonial product. They were not breaking the law or losing or embezzling the clients money, they were simply wearing it out. Not what Chris Cuffes team at Colonial intended when they created that ground breaking financial product.

    All that we who know could do was watch and seeth as the opportunity to move the profession to a better level was wasted.

    As to salaries. One has to be a very good medical specialist with peoples lives in your hands every day to earn 500k and a very senior engineer to be on 250k.
    Time for the money business to get real.

  10. Martin Mulcare July 20, 2014 at 12:29 PM #

    Thanks, Graham,
    I am delighted that you were willing to publish your article with such a blunt title. There is little doubt that the mood has deteriorated to “hate” for a significant share of the population.
    If I may add another example of the lack of integrity shown by the banks, even when they are attempting to restore trust their “spin” is deliberately misleading – and successfully so. You mentioned “CBA’s apology for the behaviour of many of its advisers”. If only they did apologise for the behaviour of “many” of its advisers! They couldn’t even do that honestly. Ian Narev’s “apology” on 3 July only said: “Poor advice provided by some of our advisers between 2003 to 2012 caused financial loss and distress and I am truly sorry for that.” There was no mention at all of poor behaviour. And you are right – there is certainly no sign of remorse. No wonder they are hated….

  11. Matt July 20, 2014 at 6:39 PM #

    Exactly expresses my sentiments about the industry. I feel like rubbishing the investment management industry much more but would feel a traitor because I have done so well out of it.

  12. Geoff Walker July 21, 2014 at 5:46 PM #

    A pity to see the Interim Report serving up yet once more the old canard : ‘Properly measured, the average actively managed dollar must underperform the average passively managed dollar, net of costs.’

    The argument goes that since the market as a whole delivers index performance, and one of its two sectors, the passively-managed sector, also delivers index performance, then the other sector, the actively-managed sector, must also in aggregate deliver index performance, before fees. Therefore, since the actively-managed sector utilises more resources, incurring greater costs, it must deliver lower net-of-cost performance than the passively-managed sector.

    But it is not true that the passively-managed sector necessarily delivers index performance. Too many people who should know better equate ‘passively managed’ with ‘indexed’. In reality, indexed investment is only one component of the passively-managed sector.

    There are large numbers of passive investors whose portfolios look nothing like reflections of the index, and, more importantly, there is no reason why when aggregated their portfolios and performance should reflect the index.

    Conclusion : No conclusion can be drawn about the relative performances of the actively-managed and passively-managed sectors of the market.

  13. Alan July 22, 2014 at 3:08 PM #

    Vernon has the answer: “We gamble with other people’s money, offer them returns we don’t know we can deliver, charge hefty fees, take the profits but pass the losses to the taxpayer. ”

    I am a retiree investing ample funds quite well by myself and done with parasitic financial planners trying to persuade me they have some better insight into how to use my savings.

    Be honest with yourselves – you are just speculating with the life savings of Australians and simply hoping for the best.

  14. SMSF trustee July 22, 2014 at 4:34 PM #

    Alan, what exactly are you doing differently to what a fund manager would be doing with your money?

    I also am investing my own money in an SMSF. Most of it is with fund managers; some of it is in direct shares and term deposits. The fund managers do a great job of getting me exposure to hundreds of investments, which they research extensively and exit when there isn’t any value. Sure they don’t get all their calls right, but they deliver good distributions and capital growth from the asset classes I’ve chosen them for.

    I really don’t get all this antagonism to a group of people who for the most part are trying to do the right thing by investors. I certainly don’t think they speculate with my money.

    Disclaimer, I used to be a fund manager and a lot of the managers I now invest with are former competitors. The industry in Australia is very high quality in my view.

    I also use a financial planner who I find very helpful.

  15. Alan July 23, 2014 at 5:10 PM #

    SMSF trustee, in answer to your question as to what I doing differently to a fund manager – probably not much, but my point is that that we can do it ourselves without a fund manager or financial planner for equal if not better results:
    – I don’t charge myself a fee for investing my own funds.
    – I choose when and where to invest and when to sell
    – I stick with shares that have a consistent record of dividend growth along with capital gain and sufficient dividend cover. The aim is to produce sustainable income growth for a long retirement.
    – I avoid non-dividend/income shares as purely speculative and direct property because of the stamp duty, taxes, commissions, tenants and overall complexity.
    – A diversified range of shares, TDs and hybrids has given quite satisfactory returns.

    Financial advisors steered people into Basis Yield, UBS Property Securities Fund, RREEF Paladin Property Securities Fund and Australian Unity Property Securities Fund. Basis Yield went into liquidation and the others all lost >70% of pre GFC invested funds. As a former fund manager I am sure you can recall other funds that spectacularly failed to deliver.
    But as you have found managed funds that produce good distributions and capital growth then I can understand why you would be content. However, that has not been the experience for many, hence the antagonism the article above examines.

    We do not need the dubious services of financial planners, despite their attempts to persuade us of their indispensability.

  16. Alan August 2, 2014 at 11:08 AM #

    This article shows the risks and losses from taking so called ‘expert’ financial advice.

    http://www.canberratimes.com.au/business/macquarie-private-wealth-the-silver-doughnut-that-left-a-hole-in-investors-nest-eggs-20140801-zzcst.html

    People lost their life savings from trusting financial advisers and their commission linked managed funds. Goldman referred to investors as muffins. They promise a lot but when it goes pear shaped they shrug their shoulders and say, didn’t you understand that past performance is no guarantee of future results.

  17. Alex August 7, 2014 at 8:54 PM #

    Well written, touching many challenging issues. Keep up this good work.

    Someday investors will realise earning the cash rate (miserable but close to the rise in the CPI) is not so bad.

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