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The miles file

Maybe it is just me but there seemed to be more than a hint of naivete about the latest report to chronicle the ills of the financial services industry. The authors of Tomorrow&#39s Company, a review billed by the group&#39s chief Sir Richard Sykes as a “report to end all reports”, came to the less than startling conclusion that trust must be restored between consumers and providers.

Sure, trust is vital when you are dealing with a product that is largely intangible. A saver or investor is forced to place their faith in a company&#39s integrity and reputation although many appear to be perfectly happy to merely chase past performance.

Yet for Sir Richard, former chief of GlaxoSmithKline and now rector of Imperial College, to put the emphasis almost exclusively on trust is to ignore the commercial realities of doing business in financial services. As anyone who has studied O level economics knows only too well, the main driver of capitalism is the profit motive.

Behaviour is influenced by incentives, whether they be financial or appealing to people&#39s sense of self-esteem.

There is no doubt that financial incentives – commission – have distorted the behaviour of advisers over the decades. Higher commission, particularly among tied and direct salesforces, has led to the misselling of financial products to mostly vulnerable but sometimes greedy savers.

If you reward someone more for selling one product over another, human nature will push them in that direction. But it is a step too far to conclude, as one august columnist in a pink-paged publication asserted, that advisers know they are selling shoddy products to the public.

Take split-capital investment trusts, currently the subject of the biggest-ever investigation by the FSA. It has been alleged that intermediaries knew they were selling inappropriate products, particularly zero-dividend preference shares, to their clients.

I doubt this. The failure of advisers, such as Hargreaves Lansdown which has been fined £300,000 by the FSA over its handling of splits, was a lack of due diligence. They did not investigate quickly enough the changes in the new breed of trusts that employed large amounts of bank debt and became entangled in cross-holdings.

A parallel lies in with-profits bonds. Once marketed as a half-way house between a savings account and the stockmarket, the gradual shift by life companies into equities – 85 per cent of the fund was invested in shares at some companies – changed the nature of this financial proposition. Again, advisers are arguably guilty of failing to spot or explain this change but were not seeking to rook their customers.

The wider point is that incentives for advisers are linked to product sales rather than to the quality of advice they give. There is a very good reason for this. The vast majority of the public have shown time and time again that they are unwilling to pay an upfront fee for such a service. Any intermediary is a business with a profit and loss account. Why waste time on a client who does not yield any income?

Hand on heart, how many advisers have recommended to a 40 per cent taxpayer that they would be better to pay off their mortgage than invest in equities? With the standard variable rate now commonly 6.5 per cent, the investor would have to earn a gross return in excess of 10 per cent from an equity investment to gain a better return.

Given that the mortgage option comes virtually risk-free and the consensus annual return from equities in developed nations is forecast at between 7 and 9 per cent, it is a no-brainer.

But with no financial incentive to recommend this course of action, why should an adviser bother?

It is all very for Sir Richard to propose the equivalent of a Hippocratic oath for those working in financial services but, the last time I looked, doctors were not paid by results. Whether the patient is cured or not – whether he or she lives or dies – has no bearing on the ultimate remuneration of doctors.

The medical profession, mostly funded through our taxes, is perhaps not the best analogy, unless Sir Richard is advocating that financial advice be funded from the public purse, too.

Richard Miles is investment editor at The Times


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