Brian Kantor: Unintended regulation costs mustn’t outweigh benefits

Yesterday we published a user’s experience of dealing with a financial consultancy. One of the biggest concerns was how costs were eroding the investment growth. In the piece below, well known Investec economist Brian Kantor takes a look at the South African financial arena. His main takeaway, he hopes an analysis of the perhaps unintended costs and consequences, as well as the benefits, of additional more expensive financial regulation in SA will be undertaken. And as any investor is told, beware the costs involved, as this is what eats away at the future profits. Some interesting insight. – Stuart Lowman

By Brian Kantor*

Brian Kantor, chief economist and strategist, Investec Wealth
Brian Kantor, chief economist and strategist, Investec Wealth

It may be argued that one of the important functions managers of private wealth provide is that we can help save our clients from themselves. That is when we act on their behalf, in a conservative way, conscious of risks as well as returns, with wealth entrusted to us, we may well help prevent clients making disastrous investment decisions all on their own, as they may well be inclined to do. Such poor financial decisions may cost them far more than the fees we charge for our advice and record keeping. Earning extra returns for clients ahead of the fees incurred is not the only purpose of our fiduciary duties. Saving wealth owners from themselves is as or even more important.

A study made by US economist Robert Litan seems to agree. As reported in the Wall Street Journal (On Line Edition Oct.4) in July 2015, Litan testified before the US Congress against a US Labor Department plan to regulate financial advisers. His cost-benefit analysis estimated that, during a market downturn the proposed regulation of financial advisers, with associated higher fees for advice, could cost investors—especially those who aren’t wealthy—tens of billions of dollars. Hurt them by depriving them of good financial advice, such as advice against panic selling, that they may well have chosen to accept were fees for advice lower.

The regulation of financial advice can raise the cost of advice and if so will come at a price, or an extra fee, that many clients may prefer not to pay.

Read also: RDR: Another storm heading for financial advisers – expert

Hence the greater likelihood of poor investment decisions made without useful advice, and not only the mistake of buying at the top of the market and selling at the bottom. Also advice that should and would discourage any naïve or greedy propensity to ignore the relationship between a promised return and the associated risk of receiving much less, or indeed no return at all. The Litan evidence would have been in the form of by an examination of the comparative track record of investors achieved with or without investment advice – in the light of the observed sensitivity of demand from clients for advice to the fees charged for advice.

The story in the WSJ is only partly about the benefits and costs of financial advice. It is much more but how his testimony cost Mr. Litan his job. A veteran of forty years with the Brookings Institution, Mr. Litan offended left thinking Massachusetts Senator Elizabeth Warren, who is sponsoring the intended legislation. He was accused of concealing a conflict of interest in a letter Warren wrote to the head of Brookings, by not disclosing that his study was supported by the Capital Group, a very large mutual fund manager in the US. This conflict of interest accusation according to the WSJ was made to quote WSJ “not withstanding”  that the first page of  Mr. Litan’s testimony says: “The study was supported by the Capital Group, one of the largest mutual fund asset managers in the U.S.”  Senator Warren called that disclosure “vague”—while the WSJ named this accusation, “an obvious falsehood”.

A private company with an interest in opposing regulation may often sponsor research in think tanks or universities. Even more often a government agency may sponsor research inside or outside of government itself with an equally obvious and opposing political and bureaucratic interest in implementing additional regulation. Ideally the research, regardless of its sponsor or conclusions, should be allowed to inform public opinion and the legislative outcomes that may follow. Disclosure of sponsorship is both ethical and wise so that any possibly convenient conflict of interest argument will not prove decisive in any adjudication process.

Read also: How to choose a financial advisor

The quality of any research can surely be tested and cross examined regardless of its provenance. As is the evidence of the so described “expert witnesses” in our courts, that is paid for by one or other of the litigating parties. An expert witness, talking to the book of a pay-master, in disregard of the evidence, will soon be found out as biased in any thorough cross-examination and such advice will be correctly ignored.

In South Africa, the Treasury and the Financial Services Board have been much involved in regulating the quality of investment advice provided to savers and by Financial Advisors. Clearly quality advice is highly desirable.

But, as in the US it surely also comes with a price, in the form of higher fees or costs, that potential clients may judge as not worth paying for.

One hopes (but doubts) that a similar analysis of the perhaps unintended costs and consequences, as well as the benefits of additional more expensive financial regulation in SA, has been undertaken for our market place. A study of the kind provided by Mr. Litan, that allows for the danger that many more savers will go inexpertly or inadequately advised and so make poor and very costly financial decisions, because such advice is deemed too expensive.

There are always benefits to be had from every regulation of market forces.

There are also always associated costs, some more obvious than others. Both the additional benefits and the full extra costs, associated with an intended regulation, should be calculated, as fully as they can, regardless of where the chips may fall.

*Brian Kantor is the Chief Strategist and Economist at Investec Wealth and Investment in South Africa.

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