‘86% of big-cap fund managers trailed S&P 500 in 2014’
Market Watch (New York) 12 March 2015
‘Ex-FSC [Financial Services Council] chief John Brogden regrets ongoing financial planner scandals’
The Australian 20 March 2015
What do these headlines have in common?
They show the financial services industry is deeply flawed on a global basis.
The Market Watch (New York) article quoted the research of S&P Dow Jones Indices:
‘Based on data as of Dec. 31, 2014, 86.44% of large-cap fund managers underperformed the benchmark over a one-year period. This figure is equally unfavorable when viewed over longer-term investment horizons. Over 5- and 10-year periods, respectively, 88.65% and 82.07% of large-cap managers failed to deliver incremental returns over the benchmark [index].’
These findings are consistent with every other research paper produced on the performance of managed funds versus the index. Time after time, the results show that over the long term more than 80% of fund managers fail to earn their fees by underperforming against the relevant index.
The research also measured the performance of managers in 17 different investment categories — large-cap, mid-cap, small-cap, value, growth, multi-cap, core and real estate. In each and every category, the index whipped the pants off the majority of fund managers.
The financial services sector is seriously big business. Skimming 1% to 2% in fees off the top of the investment pool for ‘active’ management is a multi-multi-billion dollar industry.
Contrary to what the largely ignorant investment public think, good, mediocre or poor performance is largely irrelevant to the success of a fund management business. First and foremost, the name of the investment game is funds under management.
All efforts are made to increase the investment pool. The more in the pool, the greater the amount that can be siphoned off for profits, and by extension, executive bonuses.
The big end of town knows it can never spruik its sub-par performance record to achieve the ‘more funds under management’ objective. Therefore, the institutions focus on a (far more reliable) three-pronged approach — marketing, public relations and a tied sales force.
Any outperformance (however brief that may be) is seen as a welcome bonus to complement the three pronged business plan.
The Financial Services Council represents the who’s who of the investment industry.
According to the FSC’s ‘Scrutiny of Financial Advice’ submission to the Senate in December 2014:
‘The Council has over 125 members who are responsible for investing more than $2.2 trillion on behalf of 11 million Australians. The pool of funds under management is larger than Australia’s GDP and the capitalisation of the Australian Securities Exchange and is the third largest pool of managed funds in the world.’
For the majority of the 125 members, throwing a few bob in the tin to fund an industry lobby and PR group is nothing more than a rounding error. The FSC’s aim is to promote the investment industry’s agenda to government and to make it look rosy in the eyes of the public.
It’s for this reason the financial planning scandals would have been such a disappointment for the ex-chief. No amount of spin can make silk from that sow’s ear.
The FSC’s December 2014 submission to the Senate’s ‘Scrutiny of Financial Advice’ inquiry contained five major recommendations. Each recommendation was nothing more than window dressing.
The elephant in the investment industry’s room is the institutional employment or ownership of financial planners. No one in the industry is prepared to tackle this glaring conflict of interest. Pharmaceuticals businesses cannot own doctors. Investment institutions should not own planners. Simple. Full stop. End of Story.
The tied sales forces are provided with incentives to recommend their institutional master’s consistently underperforming managed funds.
This flawed advice model is replicated the world over. The problem is the ‘too big to fail’ end of town has so much political sway, the public will continue to pay (globally) for the industry’s greed.
When planning scandals erupt, the industry goes to the PR manual and looks up the chapter titled ‘Damage Control’. All the right PR noises are made — apologise profusely, suggest greater powers to the regulator, harsher enforcement penalties and higher education standards.
The community is somewhat reassured these ‘rogues’ will receive their ‘just desserts’ by the system.
The institutions (eventually) hold ‘transparent’ reviews and stump up a few million dollars to right the financial wrongs of the poor advice. These compensation payments are designed to portray them as good corporate citizens.
In reality, this is chump change that is (somewhat) gladly paid to protect the cozy little conflict of interest arrangement they have going on.
When its all over, they sit around the board room table and say ‘Phew. Dodged another one.’
The institutions cannot risk the public joining the dots and figuring out how the investment business really works — incentivise a sales force to sell mediocre performing products that in turn increases the pool of funds from which the institutional masters extract a fee (far greater than their ability deserves) that then funds executive salaries and bonuses and the marketing machine that keeps the whole cycle going.
To divert the harsh glare of the public spotlight, the industry PR machine is well equipped for damage control — ‘move on, nothing to see here’.
In a nutshell, investors the world over are being ripped off to the tune of tens of billions of dollars because institutions are permitted to employ or own financial planners.
To paraphrase John Lennon ‘Imagine all the people accessing truly independent financial advice. You may say I’m a dreamer, but I’m not the only one. I hope someday you’ll join us and the world will be as one.’
People power is a force far greater than the industry’s PR machine. People power makes governments take notice and can invoke change.
In a perfect world, institutions should be banned from employing, owning or incentivising financial planners. Failure to abide by the independence rules would result in the offending institutional executives facing jail terms and harsh financial penalties. No if, buts or maybes.
In a perfect world, financial planners could only charge for advice on an hourly fee basis. Receipt of ‘kickbacks’ in any way, shape or form would result in an immediate ban from the industry.
In a perfect world, the public could be assured the advice they received was free of bias. It still may not be the best advice, but at least the stench of the advice being nothing more than a front for an institutional product would be removed.
Without reliance on a tied sales force to automatically increase funds under management, investment managers would need to genuinely earn their management fees.
In this perfect world, poor performing fund managers and ‘sales focussed’ financial planners would be looking for new careers.
Imagine this world: truly independent advice, much lower management fees, less waste of your dollars being spent by institutions on PR and marketing, greater focus on delivering superior investment management.
This is way too much imagination for the institutions or their tied sales forces. This is a world they have no desire of ever visiting.
The reality is this world does exist, provided you are prepared to do a little searching for it.
Low cost self managed super funds (for as little as $700 per annum) make it possible to take control of your own retirement capital. Investors can access low cost index funds (the same ones that 80% of managers cannot outperform) via an online broker.
Independent advice is available from investment newsletters that have no other agenda other than to make recommendations they believe will assist you in achieving your desired objectives. The more successful the newsletter is in delivering on their promise, the greater the number of subscribers. A transparent agenda.
In the real world, this form of investment self sufficiency is in the minority. The investment industry still holds sway over the agenda.
However, my gut feel is a GFC MkII event will significantly alter the balance of power…especially if markets do not produce a swift (central banker induced) recovery.
There’s nothing like heavy financial losses to focus community anger. People power will begin to ask questions about the whole structure of the financial system.
Central bankers will go from heroes to villains for their role in reflating assets with phony money. Institutional conflicts of interest will be placed under greater scrutiny. Governments will face pressure as to why they allowed this calamity to happen.
All this gnashing of teeth and wringing of hands will be too little too late for those who lacked the imagination to consider a different world.
Take the time now to imagine a world in which you develop a healthy and well founded mistrust of the institutions that inhabit the world of financial services.
Central banks have created disaster after disaster with their academic theories on how to keep the debt super cycle going. Do you think this time is going to be any different? Investment institutions (and their army of hangers-on) have built a $2.2 trillion gravy train. Do you really think they are going to act in your best interest to minimise their cut of this action?
If you answered ‘yes’ to the above, then you had better start imagining no possessions in your future.
Alternatively, for those whose imaginations permit them to think outside the institutional square, the decision to create your own world of financial independence is likely to pay tremendous dividends in the coming years.
Editor, Gowdie Family Wealth