What caught my eye this week.

I mentioned the other day that I’m getting increasingly grumpy about the supposed victims of financial misdeeds seeking redress for shooting themselves in the foot.

Not a popular stance for a personal finance blogger to take, but the truth.

Paul Lewis for instance on Radio 4’s MoneyBox reliably turns me to the Dark Side like a neophyte Sith Lord as he rails against – oh, I don’t know – Tesco having the temerity to sell apples at ‘rip-off’ prices of more than what it paid for them.

A more serious example came this week in the Financial Times [Search result] in an article about interest-only mortgages.

The FT is not the first publication to warn of a looming crisis from interest-only mortgages. The charge is that borrowers have not saved up enough money to repay the capital at the end of the term.

And to be fair, the FT didn’t quite headline the mis-selling angle in this piece, though it did raise the juicy prospect.

But a victim narrative was certainly foreshadowed in the angle it took and the quotes it used.

The article led by painting a picture of a son being denied the inheritance of the family home because of his mother’s decision to take out an interest-only mortgage:

Linda needs to have a difficult conversation with her son. The expectation was that one day, he would inherit the family home in London where she still lives. But her decision to take out an interest-only mortgage of £182,000 nearly a decade ago has effectively cost him his inheritance.

Well, no.

I don’t know Linda’s circumstances, obviously, but from as much as we can tell here it was her decision not to save up to repay “a penny of the underlying debt” that has cost him his inheritance.

Alternatively, if she would never have been able to find the money to pay for what she bought, then she shouldn’t expect to own it.

That’s not a scandal. That’s shopping.

Later on we have Gary, who claims “we didn’t have things explained to us”. This might point a way forward to the sort of compensation windfall enjoyed by the PPI-paying masses, except that Gary immediately adds “Anyway, our hands were kind of tied at the time — it was more or less our only option.”

I don’t mean to dismiss the issues faced by these people, or make fun of them; I’m sure they have their worries. But they are in the victim role as portrayed by the FT, and it’s a role that needs to be challenged.

Why not a piece saying that the rest of the banks’ customers or shareholders – or the State – will need to bail out these kinds of individuals if they’re not to be turfed from their homes entirely because of their own decisions? Somebody always pays.

As for mis-selling, happily this kind of mortgage’s purpose is made pretty clear in the name itself.

We’re not talking about a Property Financing Multi-Year Upkeep and Retention Vehicle, or some other financial nonsense.

It is an Interest-Only mortgage. As in – slowly now – you only pay the interest.

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The Financial Conduct Authority’s recent report into the asset management industry didn’t go far enough for one frustrated fund manager. Requesting anonymity (but known to us at Monevator) they share their thoughts below…

The report by the Financial Conduct Authority (FCA) into the asset management industry is, in the view of this writer, a lost opportunity.

Nowhere in its 144 pages does it mention the words beta or alpha. Yet the heart of the problem with fund managers is not costs, as the report focusses on, but miss-selling.

Active managers claim to deliver better returns than the average – i.e. to offer alpha – but the reality is that in aggregate active management fails to even deliver beta – i.e. the market return – because of the higher risks and costs associated with trying to achieve alpha.

As regular Monevator readers will know, the evidence is overwhelming. Over meaningful time periods, most active fund managers underperform.

Should not the fact that most private investors fail to understand or take this into account when buying funds be a key concern?

Cut out the middlemen

In its defence the FCA says it didn’t want to use the terms alpha and beta because they are too technical for investors to understand.

This is the second mistake the report makes. It consistently refers to ‘the investor’ yet the reality is that most funds are bought by intermediaries – that is, IFAs and wealth managers.

They are not the principals in the transaction but the agents. That gives then a very different incentive from the owners. As agents they are far less worried about the costs of ownership and returns, and more worried about the risk to their reputations and businesses.

As a consequence they would rather recommend a fund that appears safer than one that is cheaper. It is the old “no one ever got fired for buying IBM” argument.

There is a secondary element to this issue of who makes the purchasing decisions relative to who is the ultimate beneficiary, too. The agent has a vested interest in making his role look more complex and demanding to his customer than it really is.

If the end investor realised that it was not actually that difficult to buy beta then he would do it himself and cut out the middleman – and about 1% in charges.

After all, that is essentially what budget airlines have done by cutting out the travel agent and marketing direct to the consumer. It is the same with many products and services now sold over the Internet.

Massive cost savings are available by bypassing the distribution chain and going direct to the consumer. The consequences can be seen in high streets and shopping centres up and down the land as shops are closed and boarded up.

Truly disrupting the financial services industry

This brings us to the real failure of the report. It is still difficult for asset managers to present hard data, such as turnover rates, information ratio, beta or even compound interest directly to the public for fear of giving advice. Instead the FCA seems to prefer them to use intermediaries, who have a different agenda. This is what is preventing real competition from shaking up the industry, reducing costs and bringing in new ideas.

The FCA says fund management is too complex for the average investor to comprehend. In this writer’s opinion, that argument is fallacious. Mobile phones, computers, cars and TVs are far more complex than the average fund but that does not stop the population buying them and, by and large, making decisions in their best interests.

Why should that logic not apply to asset management?

The reason is of course that there are lot of well paid, and highly intelligent, people who have a vested interest in preventing the public from buying beta, the market return, very cheaply.

Instead, they want to sell alpha, the goal of outperforming everyone else, for a much higher price.

The illogicality of that argument is not lost on them but they respond by saying that while it might be true that, like the children of Lake Wobegon they all claim to be above average, they can always find some element of complexity – often related to tax wrappers – to persuade the investor he should be guided by an expert.

Expecting the public to effectively separate signal from very noisy data, and then factor in risk and costs is deemed far too onerous. Intermediaries get around that problem simply by using past performance, despite all its flaws.

A beta solution

As Upton Sinclair famously said: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.”

There will always be a need for intermediaries for more complex financial situations. However, the reality is that the average investor can satisfy much of his basic investment requirements by purchasing beta cheaply and simply through a passive fund without using an intermediary at all. The FCA report makes this no more likely now than before it was written.

If we really want transparency in this industry we need to use simple clear language to explain directly to investors what they are being sold. The FCA’s reluctance to use technical but clear labels like beta and alpha does not help the process.

Transparency is also aided when goods and services are sold directly by the provider to the consumer. Making it difficult to do this – and encouraging the use of intermediaries – makes transparency more difficult because the agenda of the agent is different from the principal.

Further reading

• The issue of intermediaries is set to be explored in the FCA’s follow-up platform market study, which launched on July 17th.

• You can also download and read its Asset Management Market Study [PDF].

What caught my eye this week.

Ben Carlson has no truck with the gathering notion that ETFs will destabilize the markets, swindle active managers out of their dues, damage the economy, and cause kittens and puppies to be sad.

Writing in Bloomberg, Carlson notes:

Those who are concerned that indexing is causing a market bubble don’t realize that active investors have had no trouble doing so in the past when index funds didn’t exist.

There were no index funds during the Roaring 20s that led to the Great Depression nor in the go-go years in the 1960s that led to the Nifty Fifty blow-up.

These funds had nothing to do with the brutal 1973-74 bear market because they weren’t even invented until 1976.

I entirely agree. Most of you don’t watch much financial news. You don’t regularly hear pundits saying when the market has fallen 0.5% in a day that it’s down to “all the algos and robots and passive dumb money mindlessly driving volatility in the market”.

Markets have always gone up and down. Prices of assets with uncertain future returns will always be volatile.

The only threat we can yet be sure of from ETFs and other index funds is to the financial industry’s bottom line.

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