One of the most interesting lines from the new Carl Richards book is when he talks about how hard it is to decipher the many different roles in the financial industry
I know of no other industry where it’s harder to figure out who does what.
It’s easy to shake your head when you read a story about a naive person getting taken advantage of by a financial scam, but I sympathize with people that don’t understand the inner-workings of the financial sector. From an outsiders perspective, it can be a daunting challenge to find competent, trustworthy sources of advice.
A few months ago, State Street put out an excellent research piece called Folklore of Finance that looked at how behavior and existing beliefs sabotage success in the investment management industry. I even wrote about it at the time (see The Lollapalooza Effect in Active Management).
Suzanne Duncan, the head of the department that conducted the research for that report, recently sat down for an interview with Julie Segal of Institutional Investor to shed some more light on her findings. I thought this exchange was very telling:
What did you discover in your research that most surprised you?
How difficult it was for many executives throughout the industry to define success. That is a fundamental question, and what that difficulty tells me is that there is a significant reckoning going on. Most organizations are going through some significant questioning of the business model, the value proposition and their reason for existence. We would be sitting in a room, and when I would drop the question, “How do you define success?” there was silence.
You could see that as being somewhat disturbing, but I think it’s healthy. The industry is asking whether it has it right, and considering that it might not have it right and might need to consider changes. I think it’s triggered by the financial crisis after which so much has changed, whether it’s shifting correlations or the needs of clients or low interest rates. It’s a hard question to answer because the value proposition used to be very simple: the production of alpha, period. Now it’s much more complicated: We need to help investors achieve their long-term goals.
I find it troublesome that those in the industry have a difficult time defining success. It’s a challenge because there are so many competing interests and the incentives in finance have rarely been kind to clients. Helping investors achieve their long-term goals should have always been the goal. But it does sound like the industry is finally coming around to this idea, even if some have to be dragged kicking and screaming to that conclusion.
I’m hopeful that changes in the current way of doing things will result in an increase in honesty, transparency and an alignment of interests that will allow both sides of the client relationship to benefit. I’m also hopeful that the old days of excessive fees, shady sales tactics and unnecessary complexity will continue to fade away. I’m not naive and I know that these types of changes in an entrenched industry aren’t going to be easy. Turning the financial battleship will take time.
The biggest problem I see is a lack of communication. It’s difficult to figure out who does what because most individuals and organizations in finance are terrible at communicating what it is that they do. In the past, most firms have relied on a sleight of hand to gather assets instead of being upfront and honest with their clients or potential clients.
Fund performance has been more important than actual investor returns. Marketing materials and sales pitches have been used in place of education and counseling. Behavioral biases are ignored in favor of proving intellectual superiority. Self-confidence is seen as being more important than self-awareness.
This can’t last forever. The speed of technological change is giving more power to financial consumers than ever before. You can’t cold call an unwitting customer anymore to try to sell them something with a fat commission attached. Maybe it’s wishful thinking, but I think the abundance of information available today is making positive change a possibility whether the old gatekeepers want it to or not.
In the past, people could get away with trying to impress clients by saying they could outsmart the market or their competitors. It’s not going to be enough to say that you can offer a “differentiated” strategy anymore. You’ll actually have to prove your value-add and offer legitimate reasons. I think the firms and individuals that are able to both communicate and educate will have a leg up on the competition in the future.