How Can We Regain Confidence in Financial Professionals? 13 comments
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Over the course of the last few years, many investors have lost confidence in financial professionals as a group. From advisors to money managers, the volatility of the global markets combined with the increasing complexity of financial products has led investors to question the aptitude of and the incentives that drive these professionals. At the forefront of this movement to re-examine the value added by the money management industry as a whole is Vanguard’s founder John Bogle. Through a number of speeches and interviews, Bogle has been very candid regarding his perception of the failure of money managers to keep their clients’ best interests at the top of the list of their priorities. In an April interview with Gretchen Mortenson in the New York Times, Bogle had this to say: We [the mutual fund industry] own all this stock but we pretty much do nothing… Given their forbearance as corporate citizens, these managers arguably played a major role in allowing the managers of our public corporations to exploit the advantages of their own agency.
Along with questioning their motives, Bogle blames mutual fund managers and Wall Street analysts for not being able to foresee the substantial issues that were developing within financial companies as the credit crisis got more severe:
How could so many highly skilled, highly paid securities analysts and researchers have failed to question the toxic-filled, leveraged balance sheets of Citigroup (C) and other leading banks and investment banks?
His proposed solution to the above mentioned failures is one that I tend to agree with in principle. The fiduciary standard in the United States is taken very seriously and those who are bound by this code are liable for any breaches of their duty. However, institutional money managers do not have the explicit requirement to act as fiduciaries for their clients. In fact, there are a number of conflicts of interest that often preclude individuals at certain institutions from acting solely in the best interest of shareholders. In the face of all this, Mr. Bogle suggests that we force our agents to relearn what being a fiduciary means. A fiduciary, these managers seem to have forgotten, acts for the sole benefit and interest of another. We need to replace the agency society with a fiduciary society, he argues. To achieve this, Mr. Bogle says, the government must apply a federal standard of fiduciary duty to institutional money managers. This would force them to use their stock holdings as a cudgel, to demand that directors and executives of corporations honor their responsibilities to their owners. “We need Congress to pass a law establishing the basic principle that money managers are there to serve their shareholders,” Mr. Bogle said. “And the second part of the demand is that fiduciaries act with due diligence and high professional standards. That doesn’t seem to be too much to ask.”
To be fair, there are plenty of money managers who believe they have a fiduciary duty to their investors and shareholders, regardless of whether there is an explicit obligation or not. Hedge fund managers in the mold of Baupost Group’s Seth Klarman are often very articulate in their explanations of how they put shareholders first. The problem is that the fee structures of many hedge funds and mutual funds incentivize managers to attempt to maximize their own profits, sometimes at the expense of their investors. These perverse incentives often cause the most devastation at firms that are asset gatherers, use excessive amounts of leverage, or have limited risk controls.
This is why Bogle believes that money managers should be held to a fiduciary standard. If financial professionals were held personally liable for taking unnecessary risks, creating conflicts of interest with their shareholders or blatantly acting on their own behalf, then maybe investors would achieve better risk-adjusted returns and face less risk of permanent capital impairment. Sounds great, right? We apply the fiduciary standard that exists for many other professionals to money managers and all of a sudden they are forced to focus on shareholder welfare. Assuming these people are competent and suitably skilled, this has to be good for investors, right? Maybe holding people accountable would not have completely prevented the current crisis, but one would assume that at least on the margin this would have been a positive. I sure thought so, but now I am concerned that this potential solution may not be anywhere near enough. Specifically, in this weekend’s New York Times, there was a fascinating article by Paul Sullivan that makes Bogle’s somewhat simplistic proposal look inadequate. What if the poor performance of money managers in 2008 and early 2009 was not all due to volatile markets, conflicts of interest, the lack of due diligence, or greedy individuals? What if the main driver was incompetence or insecurity? Mr. Crosby [of Pricewaterhouse Coopers] said the survey questioned managers who advised clients with $500,000 to $20 million. Of that sampling, only 7 percent said they felt strongly that they had received adequate training to complete their job to the highest standard. A little more than half said they felt they had received some training. What is shocking is the rest — some 36 percent of wealth managers surveyed — said they believed they were not fully qualified to do their job.
Over 1/3 of people who worked at the 238 private banks and wealth management firms in the survey admittedly felt that they were not qualified to do their jobs? That number is astonishing. If this is a representative sample, it is no wonder that people have lost faith in the money management industry as a whole. They don’t even have faith in themselves. This suggests to me that the combination of a lack of training and insecurity among money managers has played a significant hand in the poor performances of many funds over the last few years.
In uncertain markets, people who do not feel qualified to advise clients are likely to become paralyzed and the inaction that results could be devastating to the portfolios they oversee. Free falling markets like the ones we saw after Lehman’s crash in 2008 and in the early parts of 2009 are challenging for the most secure and experienced managers. I can only imagine how hard it was for the 93% of people from the aforementioned survey that did not feel as though they had received sufficient training.
This data certainly complicates Bogle’s solution to the problems in the money management industry. The combination of conflicting incentives, poor training, and unqualified managers is a scary trifecta for investors. In this case, establishing a fiduciary standard only would potentially solve part of the problem. If managers did not have the necessary skills or confidence to navigate treacherous markets and preserve their clients’ wealth, then all we would end up doing is trying to hold people liable for incompetence. From an investor’s perspective, there is no difference between losing all of your savings due to a manager’s insufficient aptitude and his attempt to maximize his own profits by taking on excessive risk. You are out of luck in either case.
In conclusion, I think the results of the study argue for more training for money managers and potentially even standardized tests to evaluate knowledge and even temperament. It seems clear to me that in-house training programs, certifications like the CFA and MBA degrees are not enough to guarantee that these professionals are qualified to manage millions of dollars of clients’ assets. Maybe along with a fiduciary standard, the leaders of this country could develop a systematic way to continually teach and challenge those who we entrust with our money.
I know that in some other professions, even experts have to pursue continuing education courses and take periodic re-assessments of their skill sets. Without some kind of reform I fear that we are doomed to have money managers who are not qualified to advise clients in the most benign markets, let alone the turbulent markets that we face today.
Disclosure: No Positions
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If 6 years of higher education is not enough, then the curriculum needs to be changed--or the degree candidates. Probably both.
Get rid of the middlemen.
Do you lot have any idea what you are talking about or is this an excercise in wasting space and getting inebriated by your own verbosities?
The root problem is that people have too much confidence in Financial Professionals. This allows the industry to get away with excessive margins, pay, bonuses, political influence, scams and Ponzi schemes. The way forward is for people to educate themselves and to take control of their own financial affairs. This will only happen when they stop having faith in Financial Professionals - when they see that the emperor has no clothes.
We also need to clean up the 'auditing' profession and put severe restrictions on brokers and other advisers in terms of their ability to deceive clients and present phony financial information about their own performance or the potential profitability of investments being sold by the brokers.
I am in favor of completely eliminating stock options for executives or any other employees of publicly-traded companies (PTCs). They work great to incentivize key people at entreprenurial start-ups owned by VCs, but have proven to be an avenue for corruption and despicably poor management decisions at a variety of public companies, and a ripoff of the shareholder base to boot.
For my money, I wouldn't mind leverage restrictions in the capital structure as well for PTCs - part of the recent problem was a bunch of self-dealing execs who levered up companies and tried to cash in on massive stock option positions. These manipulators typically pressure accountants and auditors to generate phony financials, and have no long-term interest in the health of the company they are running - it is merely a financial play geared toward filling their own pockets.
Many formerly strong companies have been hampered, or in some cases bankrupted, by the reckless and corrupt execs who have hijacked the Board and the company at the expense of the shareholder base. This should be criminal, but unfortunately it is not, and as a matter of fact, the Fox News crowd pats these jokers on the back more often than not!
As to "certifications like the CFA and MBA"" - don't make me laugh. Most MBAs are worthless in terms of the theory and methods learned - they may have sheepskin value as a way of promoting one's career or connecting with other grads in the networking game. The CFA is a very rigorous exam, but much of it is focused on the wrong things - and it does not automatically make somebody a great analyst or money manager, not by a long shot. It is more about memorization of terms and ability to do number crunching - valuable basics, but only part of the game. Bill Miller anyone?
Invest in things you know and understand, don't worry about the "best tax strategy" hypothetically possible, and over time people would be better off. I read about "understanding clients risk profiles" and think that if people would just invest their own money they would learn over time (many times the hard way) what their risk profile truely is and make better decisions with their money.
As a seperate poster said - no need for middlemen beyond the firm executing the trade. And if someone needs some discipline/guidance and wants to pay for that - thats ok - just pay an hourly fee!!
-Bogle
This is insane. This would not protect shareholders. This is would merely be a bonanza for lawyers, while encouraging money managers to be unreasonably timid and useless.
No one knows the future. Even money managers who saw the coming financial problems still lost money because virtually every asset class fell in 2008. It was a once-in-a-lifetime black swan.
The government's responsibility for the financial collapse is massive. Barney Fwank's encouragement of reckless lending by Fannie and Freddie continues even today.
Bernanke, the guy now in charge of monetary policy is one of the culprits who kept his foot on the pedal of easy money even as commodities and house prices went through the roof. He is determined to cause hyperinflation.
The SEC failed to bother to investigate Made-off despite repeated entreaties from one individual in particular.
Bogle is wrong. The government does NOT need to pass yet more boneheaded laws.
All the liberal politicians need to be fired in order to prevent them from irreparably ruining our free market economy and killing millions more jobs.
I would quickly agree that my MBA education (as well as the MBA programs of more famous universities ) was / is NOT adequate to properly prepare someone to manage a complex investment portfolio. (Hence the reason my account name is "An MBA Still Learning".)
However, the curriculum of the CFA program is substantially more advanced. It is a series of 3 increasingly complex exams (not a single exam as "Bill Herbert" implied above). I have passed the Level I exam, but my attempts, so far, to pass the Level II exam have not yet been successful. The Level II exam is signifcantly more difficult than the Level I exam.
While the Level I exam might fit the description of "memorizing terms and number crunching", the Level II exam involves significantly greater problem-solving complexity. Meanwhile, the Level III exam (with which I'm obviously less familiar) involves still more complexity. Consequently, I have the utmost respect for CFA charterholders.
I can credit my partial progress in the CFA program with at least giving me the wisdom in 2007 to steer my investments away from any companies dealing with Collaterallized Debt Obligations (and related derivatives).
Certainly, no certification program is perfect.
I do like the idea of periodic re-certification. (I understand the Credit Default Swaps did not exist until the mid 1990's).
Bryan
In terms of 'financial professionals' I was not aware that there was such a thing. Bankers, financial advisers, brokers, strategist, fund managers, etc, are not required to hold any professional designation in the same way that doctors, lawyers, accountants are.
I hold my CFA designation and a Chartered Accountancy designation, this, arguably, gives me enough education to competently advise people on money matters. But to be honest the most important thing I have learned is that nobody really has a clue what the future holds in terms of market/financial performance and individual investors are much better off focusing on their own needs as opposed to worrying about the market. Individuals should look at their investment/retirement portfolio in terms of their overall goals. There are lots of things one can adjust to ensure you have enough money for college/vacation home/retirement. You can save more, spend less, set up tax efficient plans, etc, it is not simply a matter of good investment performance. I would encourage everyone to be extremely critical of any money manager who claims they can achieve above market performance over the long-term - ex ante there is no way rationale way to support this claim. Simply chasing short-term financial performance is a 'mugs game' where the only guaranteed winners are the brokers and bankers who rake in huge fees - see GS huge profits from 'trading'.
Investing for the long-term with the goal of paying for a comfortable retirement, nice vacation and good college for your kids is the best way to approach the markets.
I have to agree with that 100%. Investment performance alone isn't going to secure anybody's future. Just like walking 30 minutes a day while eating Big Macs won't make you fit. People have to take responsibility for their own financial future.