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The financial services
industry can not always be trusted to
negate its inherent    conflicts of
interest, argues the University of Sydney’s MIKE RAFFERTY. In research recently completed for the AIST, Rafferty’s Workplace Research Centre found super members are best served by having their own direct representatives at    the decision-making table. Since the 1950s, the US dollar has carried the following official motto: In God We Trust. It may seem strange that god is invoked to give credibility to the world’s most used currency in a country that has a constitution that separates church and state.

This claim was largely Cold War rhetoric to contrast with those godless Russians. And at the time the US government also promised to keep its currency tied to gold. Today the link to gold is gone, and Communist Russia is no more, but the motto remains. Money is complex and in modern societies is based to a large degree on trust. It involves you trusting that the piece of paper you carry in your wallet will be redeemed for something useful and equivalent to the monetary value it bears.   

The same sort of trust applies to finance. It requires a high degree of trust    to hand over your savings to a bank    or to your super fund. We hope that savings institutions will look after our savings prudently so that when the time comes to withdraw those savings their value has been protected. But how is that trust established and protected? Savings institutions are generally regulated by governments to ensure that the people in charge of those institutions don’t run off with our money.   

But trust is more than just preventing theft. How do we also make sure banks and funds use our money wisely? In other words, how do we make sure they perform in our best interest? This is an even more difficult task than just preventing theft. Over the last two decades or so in Australia, we have attempted to answer this question by relying on disclosure and the market. By making institutions nominally compete for our savings, and requiring them to disclose their returns, governments have hoped that our self-interested actions will ensure that banks and super funds perform for us.

And so the story goes, with the smartest people in the room managing our money, good things will happen. Unfortunately, the finance industry has built giant empires and many fortunes around self-interest of another kind – its own. The finance industry may have smart people working in it, but it also has many conflicts of interest between what is in the interests of the industry
and its many players and the interests
of the general public. And we have
known for a long time that markets are
not always good ways of protecting
against these conflicts of interest. On the contrary, sometimes it just
allows some self-interested players to
make huge gains at others expense.   

And
as the global financial crisis has unfolded
we now have insights into just how big
the gains were for some, and    how
costly they were to us. There are
other ways that we make institutions
perform in our best interests. One
mechanism is to have a voice on the
decision-making body. From parliaments
controlling our taxes to companies
controlling our investments, representation
is a well established way of tying the
decision-makers to our best interests.
Representation doesn’t guarantee
performance, and we know that bringing
together people with diverse
personalities and backgrounds is not
easy.   

But without direct
participation, representation is one
of the best mechanisms humankind has
established to ensure    our interests
are protected. In particular it helps
to deal with one of the finance
industry’s key problems – too many
conflicts of interest. To take one example,
many superannuation/pension funds are
run by trustees who are both meant to
represent fund members and are
effectively employees of the financial institution running the fund. Research by legal scholars and financial economists have identified this sort of conflict as quite damaging to fund performance.   

Even industry insiders like Vanguard’s John Bogle has been extremely critical    of such conflicted arrangements. In the Australian superannuation industry, representation is a feature of one type of fund, the not-for-profit funds. These include public sector, industry and company funds and they typically have equal representation of workers and employers.   

In research* we have just completed on the link between governance and performance in the superannuation fund industry we found that there was a link between representation and better fund performance. Using almost 5 years of fund data for default funds, where most members have their savings, and employing a well-established fund performance methodology, we found that funds with representative trustees outperformed those with appointed trustees by up to 2.4 percent per annum.   

So while the US government asks you to trust in the dollar and god, for superannuation fund members our research    suggests you may be best trusting in representatives of your fellow fund members, and making sure that the fund you are in has people with their savings at stake on the fund board.   

 

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