Sunday, Nov 16, 2008

Gulf News

Dubai: A crisis of trust? The symptoms show everyone selling everything with advice put to the back-burner.

Translated into Gulf News reader-speech, "has the financial services scene in the UAE been selling the wrong products and services? Could that be a factor in the current trust deficit?"

Many readers will have witnessed capital base erosion of over 50 per cent, and with realisations still to take place on realty assets, this is a goodish time to reflect.

With the "Great Reckoning" upon us, the great reflection should have two patterns: a past trend, which magnified by events turn into facts, and a future probability - the need for quality advice.

On past trends, if financial advice isn't largely trusted, what is the cause? "People do what they get paid to do," scream the HR professionals. One fact of the recent past is that financial advice is largely remunerated by product sales and assets under management and not by the quality of advice.

Whether your adviser is a big-brand bank or a cuff-linked salesman, the product wrapper and assets being managed remain the principal sources of remuneration. This means a remuneration range of about 60 per cent of cost-of-sales at the product sales end to a one to two per cent annual gross income at the "assets-managed" end. The result is that the quality of the advice is ditched as irrelevant to the remuneration model. This means remuneration must be connected to the trust-deficit; high liability, yet no income for advice, it's a poor formula.

You might say that good advisers could not have seen the Great Reckoning anyway as it was all a systemic collapse, and the government would halt the collapse and go back to the previously expected world order. But the heroic assumption that the old world order can be restored without change is a weak one. The fact is that there were many signs that something was wrong. The problem, as far as layman-investors are concerned, is that forewarnings have not been aligned with the way financial service products are delivered. Or the way financial advice is remunerated.

Three eclectic random sources help make my point. Source one is Michael Lewis and his book Liar's Poker written in 1989, part of a broader sentiment that wondered out aloud how people who didn't know what they were doing ended up gambling with other people's money. He was talking about the Wall Street, fund manager-investment banker end and not even the cuff-linked salesman end. Product sales over-advice, bravado and confidence over-planning and analysis; a scenario where advice and academics doesn't matter.

Protecting capital

The second source, the Nobel Prize winners from Markowitz and his Modern Portfolio school to Kahnerman and the psychology of investors. Surely good advisers would be aware that protecting capital was as much about managing risk as managing performance, and that seeking great performance was dangerous. Surely there was no point in looking for great performance if many investors would be upset the capital was lost. The point is that research has been out there and verified by some very clever chaps, yet, the findings don't find there way into the layman's balance sheet.

The third source is the school of economists as represented by the likes of Nouriel Roubini's 12 steps to a financial meltdown. With hindsight it is now clear that policy-makers were not listening to the economists. Some academic economists have been predicting meltdown scenarios. Unfortunately, the financial services industry has lived off the heroic assumption that government and all last-resort lenders knew what they were doing. Hindsight tells us that they too were blinded by the same analysis my 15-year-old gives to the crisis's called the, "whatever factor". The current crisis continues to feed off government's previous apparent indifference to potential crisis. This, of course, makes the "trust deficit scenario" difficult to solve.

It also makes the future of "selling trust" more likely. Ian Patterson is a consultant to Financial Services firms and has produced a breakdown that separate the type of financial advisers currently in the field.

The first stage, Patterson calls, "the commodity broker". For me this is the vendor salesman. Patterson describes them as those that provide "transactional advice, limited in scope, knowledge is king with limited personal relationship". If "selling trust" becomes a key characteristic of the new-look financial services world order, this end of the market will be important.

Why? Because there will always be those that will not want to pay for advice. Some investors will be happy to buy the product straight from the factory-gate and pay as close to the wholesale price as they can get. According to Patterson, firms will need to focus on either being a sales or advisory culture.

Personally, I believe the firms with the best career structures will achieve both. Although it's easier to agree that the "sales end" will be characterised by the commission-based model with high staff turnover and limited product range.

The second-stage is the "Service Provider". Patterson refers to this advisor as "solving a wider range of problems and offering a wider range of services based on a good understanding of the client's needs". The third stage is the "Value-adder", who for Patterson is "more relationship based, holistic, and proactive. The adviser is recognised by the client as a problem solver". The final stage is the exalted "trusted adviser", with a "broad range of issues, high degree of client-adviser trust, and a deep personal relationship".

The trusted adviser is built and not born. Sociologists recognise two types of trust and understanding, this will be critical to the new-breed financial adviser - cognitive trust and affective trust.

The former is based on logic and managing client's expectations. It will be knowledge driven. When investors have a need, (and true cognitive trust exists) investors will buy the solution.

Reputation together with breadth and depth of knowledge are critical to developing "cognitive trust". Effective trust is more personal; it's about the feely-findy, sensitive things. It is frequently built on the past relationship between adviser and client. Three points help the practicing "trusted adviser": go the extra mile, do the things for your client that currently does not earn you money; and deliver on promises. Get these things right and the future of financial services may well be yours.

- The writer is chairman of Financial Partners and Mondial (Dubai) LLC

Gulf News 2008. All rights reserved.