Home' Trinidad and Tobago Guardian : January 19th 2017 Contents JANUARY 19 • 2017 guardian.co.tt BUSINESS GUARDIAN
STOCKS | BG15
What they do with your money
Published in 2016, the captioned
book is subtitled, "How the
financial system fails us and
how to fix it"
. It was written by
Stephen Davis (Harvard Law
School), Jon Lukomnik (Inves-
tor Responsibility Research Centre) and David
Pitt-Watson (London Business School). Al-
though it references the 2008 financial crisis,
its scope includes the entire financial system.
The text from the inside flap of the cover
serves as a useful introduction:
"Each year we pay billions of dollars to those
who run our financial system, and often we
aren't told that the money has been taken.
These billions may be justified if the finance
industry does a good job, but as this book
shows, it too often fails us. Financial institu-
tions regularly place their business interests
first, charging for advice that does nothing to
improve performance, employing short-term
buying strategies that are corrosive in building
long-term value, and sometimes even conceal-
ing both their practices and their investment
strategies from investors."
At the end of the first chapter "What's the
financial system for?" the authors say:
"We need the financial system to help us
keep our money safe. We need it to trade with
one another. It takes our savings and gives it
to those who can invest our money well, pay
us a return, and make the economy grow. And
it helps insure against risks, particularly cat-
But the big question is: does the finance
industry do its job well?
Some of the other chapters include: "Incen-
tives gone wild", "Not with my money"
"The new geometry of regulation"
Consistent with the subtitle, the authors
offer some practical and common sense guide-
lines to remedy the situation and cite some
companies that are trying to do things right.
Charging for advice
Let's start with that phrase, one to which
most mutual fund or pension fund beneficiar-
ies can relate. We can all agree that paying for
advice that adds value is an acceptable cost of
doing business. However, when we are charged
for advice or similar services, that subtract to
a considerable degree from our earnings, we
might reasonably query or try to resist paying
(perhaps, a daunting task).
Another concern is that it is estimated that
2.02 per cent out of 3.82 per cent of fees in
private equity funds are not reported as fees.
Essentially, they are "hidden costs" to the
Mutual funds are useful mechanisms for
ordinary savers to acquire and maintain a di-
versified investment portfolio. In exchange
for the convenience and skills of professional
management that the fund sponsors provide,
various fees and charges are levied on the fund,
which reduces its overall returns. In addition,
investors usually have easy withdrawal access
to their holdings.
Diversification is useful because, as the
book remarks, if you put all your eggs in one
basket, then the basket could fall and the eggs
could break and then you would be left with
The question is: are the charges levied
against investors' savings in these vehicles
commensurate with the returns credited to
For example, if our return from a fund were
seven per cent or higher, would we object to
paying 1.5 or 2.0 per cent in total charges to
the sponsors? On the other hand, when our
net return is 1.5 per cent or thereabouts, can
the same charges of 1.5 or 2.0 per cent be jus-
tified? In other words, is there a better way to
calculate such fees and charges that is fairer
and more equitable to both parties?
In an era of rapid technological improve-
ments, why is it that high fees persist?
Shouldn't the fee structure trend closer to
0.50 per cent or lower? We need to be aware
of the compensation system currently in place.
For example, asset managers are compensated
based on the amount of money they manage,
not on how well they do it.
Would it be true to say that mutual funds
are a mechanism that allows its sponsors to
generate frequent and exorbitant fees which
bear little relationship to the returns credited to
the owners/investors? Are there far too many
funds to satisfy investors' real needs?
Citing the USA environment, here is what the
writers say about this: "The fund-tracking firm
Morningstar reports on no fewer than 53,000
mutual funds, a number that is very costly to
maintain and makes no sense from the point
of view of the consumer. But it does allow
suppliers to exploit the laws of probability."
Fund sponsors exploit the laws of probabil-
ity by simply offering a very large selection of
funds to the consumer; at least one fund should
out-perform the market in a given period, usu-
ally one year. This winner is then cited as a
reason to encourage investors to switch their
allegiance; this switching generates fresh fees
In summary, we can say that perverse incen-
tives encourage industry actors to do things
that are not in customers' best interest. Too
many sales gimmicks, but not enough genuine
Pension funds are collective schemes which
pool contributions from its members and
sponsors with the view to providing them
with income over their projected remaining
life expectancy. Typically, the benefits will
start after an accumulation period of between
twenty-five and forty years.
Within this framework, long-term relatively
passive investments are the preferred vehicles
while trading strategies should be minimised
and fees should be rigorously managed.
Total annual fees of less than two per cent
may not seem like much, however, over an
extended period of 40 years they can reduce
the benefits to the pensioner by a consider-
One of the more progressive pension plans
is the £100 billion Dutch health sector pension
fund, Stichting Pensieonfonds Zord en Welzi-
jn (PFZW), which has two million members.
Starting in 2011, PFZW surveys members as to
how the fund is perceived and if it is meeting
their needs. Their responses help guide strat-
egy and could influence investment decisions.
In another example, CalPERS (California's
civil service pension plan) has expanded its
fiduciary role to include "...to make sure inves-
tors, businesses and policymakers are respond-
ing aggressively and creatively to the risks and
opportunities associated with climate change
and other sustainability issues."
These are some examples of the ways that
these funds are trying to make themselves more
relevant in an evolving and information savvy
In an ideal world, all financial institutions
would adhere to the core values of a fiduciary.
This would mean conducting their business
in the interest of the customer as opposed to
engaging in self-serving actions that mainly
benefit a select few.
In the USA (and locally), using shares to
compensate senior executives for the attain-
ment of specific targets seemed like a good
idea. However, the system came under frequent
abuses and exceptions, while anomalies and
clarifications were legion, which ensured that
these individuals were still paid even when
profits and/or stock prices were unfavourable.
Instead of focussing on running the com-
pany, these executives spent an inordinate
amount of time following the stock market!
A study was conducted by Income Data
Services, which compared executive com-
pensation to company performance over the
first thirteen years of this century. They found
almost no relationship between the two var-
If the executive were better paid in cash and
he took some of that money (or borrowed) to
buy shares in the company he manages, then,
perhaps, he would make better long-term de-
cisions and the company would prosper and
be better able to withstand external shocks.
Unfortunately, the stock compensation
model is a product of the tax system and will
only go away when the legislators decide to
Queen Elizabeth II
On November 8, 2008, the Queen of Great
Britain is reported to have asked a group of
esteemed economists the following questions:
"Why had no one seen it coming? People had
got a bit lax, hadn't they? Was the problem
complacency? Was it that those overseeing
the market "didn't have any teeth"?"
Subsequently, Luis Garicano, director of re-
search at London School of Economics, gave a
summary answer to these questions:
"At every stage, someone was relying on
somebody else, and everyone thought they
were doing the right thing." Isn't that amazing?
It is unlikely that the financial system will
reform itself of its own volition. Citizen in-
vestors should push to help with reforms so
that the financial system can be safe for users,
In the last chapter, "Capitalism: a brief
owners' manual" we are presented with some
suggested guidelines to help make the system
work better. Prior to that, we are given the fol-
lowing recap of where they believe solutions
to the present malaise lie:
Step 1: Start by being clear about the pur-
pose of the system: understand what "good"
Step 2: Restore accountability to asset man-
Step 3: Promote a culture of ownership in
Step 4: Apply good governance to investing
Step 5: Reset regulation based on purpose.
Step 6: Reboot financial institutions.
The table gives us a starter blueprint for
helping the financial industry serve its cus-
tomers, not themselves.
In the next article, we will review Goddard
Enterprises Ltd 2016 results
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