The funds management industry  has profited from manufacturing too  many bad, unnecessarily complicated  products, according to Alan McFarlane,  the former managing director of global  equities boutique Walter Scott, and  had for too long supported the “malign”  commissions-based remuneration  system still used by many financial planning  dealer groups.  Voicing his personal opinions, and  not those of Walter Scott as a company,  McFarlane said the fat profits on offer in  the industry had attracted an influx of  managers and spurred the development  of too many complex products in the  name of risk management, benefiting  practitioners far more than investors.  Even though investment outcomes  can never be guaranteed, the industry  as a whole put too much faith in the  effectiveness of diversification – and  new products – to offset risk.

McFarlane  likened some managers to Johann  Tetzel, the Catholic Church’s seller of  indulgences in pre-Reformation Europe,  who exploited the ignorance of believers  to fund the construction of St Peter’s  basilica in Rome.  “We have a lot of fund managers in  the business of Johann Tetzel,” McFarlane  said, adding that some managers  and their salesmen “put a huge premium  on hope, and hope has been able to sell  itself at 180 basis points per annum”.  To justify his claim that the industry  was overpopulated with managers and  products, McFarlane pointed to findings  from the 2009 Investment Company  Fact Book, published by the Investment  Company Institute in the US, which  showed the worldwide total of mutual  funds reached 69,032 in 2008.

This  population dwarfed the number of  stocks in the MSCI All Country index,  including small companies, which was  6,616 on January 20, 2009.  The industry was under a burden  of proof to explain how this growth in  products benefited investors, particularly  since the margins claimed by fund  managers remained very lucrative, he  said.  McFarlane steadfastly opposed trail  commissions as a source of income for  financial planners, and said the controversial  pay mechanism encouraged the  development of new and often unnecessary  product, creating an unjustified  level of complexity in the industry.  “The moment you make the economic  incentive the commission, it’s  tough to keep the story pure.

And it’s  tough for an investment team to shut  their ears to the pleading of sales teams  who want new products.”  This meant the industry as a whole  became prey to “an anxiety to not miss  the next big thing,” which drove some  manufacturers and their sales staff  to continually bring new products to  market.  But if financial planners “were paid  a salary, and told that in the fallow years  they’d be looked after,” their prime motivation  might not be to sell, but to build  solid, long-term investment portfolios  for clients.  “What we need to do is come up  with a model that involves good salesmanship  of sound long-term investment  products, but without the malign  factors associated with a high-churn,  high-commission model.”

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