The investment profession has a problem. The reputation of financial services in general has taken a significant knock since the financial crisis when trust in investment professionals declined to an all-time low. Turning the image problems around in a low interest rate environment, which makes it harder to generate returns, has proven difficult.
The CFA Institute, a body that certifies financial analysts, who are commonly the investment managers of ordinary people’s pensions and savings, has recognized the issue and is trying to address it in its educational programs and by working with the industry and regulators.
Paul Smith, president and CEO of the CFA Institute, says “The challenge in the investment management world is that when an individual sits down in front of their financial advisers, they are worried that they are not very transparent about how they make money, that they don’t have the right skill set and their business motivation might be somewhat questionable.”
Then there is the issue that a lot of asset managers are owned by public companies, which breeds conflicts of interest when trying to serve both shareholders and investors, he adds.
The image problems of the industry started long before the financial crisis and declined in line with financial deregulation, the ascent of financial modeling and algorithms and the changing nature of banking business models.
“The roots of the problem go back far further than 2008,” says Smith. “But 2008 was the watershed moment when I think the public in general and regulators woke up to the fact that the financial services industry was focused on its own corporate profitability and not so much on client outcomes.”
Banks in particular have moved further and further away from their traditional core business of allocating private savings to long-term investments in the real economy. This type of business, often perceived as boring and not as profitable, relied on a reputation and trust built up over time.
Deregulation of the financial markets has encouraged banks to increasingly engage in short-term trading, which turned out to be more profitable for them, but not necessarily for their customers.
In addition to these conflicts of interest, penalties for serious misconduct did not prove to be an effective deterrent, and in some cases was simply a financial consideration that became part of the modus operandi.
Banks and investment banks caused much of the bad press. For the CFA, which focuses on investment management, the challenge is first to distinguish itself from this sector of the industry, says Smith.
“That is not to say that we don’t have our own issues, but the scale of mistrust in the financial services industry impacts everyone within it.”
A 2015 survey by Opinium Research for communication consultancy Lansons confirms that of all industry sectors, insurance services, pensions, investments and banking have a negative image, joined only by tobacco, the energy sector and the government.
For the investment industry the issue is even more crucial than for banks, Smith notes. “Investment banks can claim that they are dealing with professionals. For us, we are the fiduciaries of other people’s money.”
What is worrying him, says Smith, is that post-financial crisis investors have not only questioned whether the industry’s motivation is right, but more fundamentally whether it adds sufficient value for the fees it charges.
Proving that the investment industry can manage its conflicts, that investor interests are put first and that the industry is value for money is no small feat.
The investment profession does not have an immediate value proposition, as it can take years to determine whether an investment portfolio generates sufficient value and the fees are appropriate.
Smith says he wants to drive the agenda positively in three ways.
The first falls into the key remit of the CFA Institute and the education of investment professionals.
“We have to demand higher standards for entry and maintenance of your professional designation. We believe the CFA is the gold standard qualification and we feel that everybody out there who has a fiduciary capacity for other people’s money should have our qualification. The public and regulators should demand it,” he states. “Today the qualification standards are set far too low.”
Business models and fees
Moreover, the organization works with businesses and the employers of CFAs to recognize their conflicts of interest, adjust business models and make fee structures more transparent.
Product manufacturers are under a lot of pressure to justify the fees in the funds that they run and the result is likely to be a diversification of fee models.
Smith predicts that plain vanilla funds will continue to fall in price, especially if they cannot justify their fees in relation to an ETF or an index fund. Advisers, who are constructing portfolios for clients based on those funds, will increasingly charge a service fee rather than charge clients a percentage of the return.
Depending on the service, offering hourly rates can make more sense than a percentage rate, the CFA Institute CEO notes.
Only specialty funds will be able to command a higher fee because they generate higher returns.
“The industry is going to have to pull itself apart a little bit and be a lot more transparent about the potential returns that clients can achieve.”
Smith says the industry will also need to raise the level of discourse toward risk management and away from quarter over quarter investment to a long-term solution provision for clients to meet their individual needs.
“A quarter over quarter result is a zero sum game after fees. ETFs and the property boom around the world are evidence of that because people don’t trust financial products.”
The third area of focus for the CFA Institute is to work with regulators for appropriate regulation.
Smith says his organization is in an excellent position to do that. “We are not a trade body. We are a professional body so we are as interested in the regulators as we are in the practitioners. And we are trying to produce fair transparent markets.”