Investment industry needs to put some skin in the game- Times 14 July 2009

Fund managers from around the world gathered recently to discuss the future of their industry and how to restore consumer confidence in financial services — but for a real insight into consumer attitudes to financial services, I needed to look no further than a fellow passenger on the flight to the conference.

He was totally disenchanted with banks, brokers and investment managers. He said that he had seriously considered burying cash in a tin box in the garden. He simply did not trust anyone in financial services.

I put it to him that he was sitting in an aircraft flying several thousand feet above the ground. He had put his trust in the pilot. Why? He thought for a moment, then answered with a phrase that we have heard elsewhere during the credit crunch. He trusted the pilot because “he had skin in the game”. In other words, the pilot had his life on the line along with the passengers. He had as great an interest in reaching the destination safely as everybody else.

This was the phrase used about the banks that had bundled up bad mortgages and sold them on. They no longer had “skin in the game” and, therefore, had no interest in whether the original loans were a good risk or not and whether individual homeowners could repay their mortgages. Regulators in the United States are planning legislation to ensure that this doesn’t happen in future by requiring the orginal lender to retain some of the risk.

But how might this apply to the investment industry? Would consumers be more prepared to trust fund managers if they took on some of the risk? Managers are usually paid whether the investor makes a profit or a loss. If they accepted some of the downside, consumers might have more faith.

It could work like this. Say that the consumer invests £100,000: if the fund manager produces a return on that money, they collect a percentage of the profit; but if the fund fails to return the original £100,000, the manager pays the investor a percentage of the loss.

In this way fund managers have to put some money where their mouths are, to share in the risk. This may temper the more extravagant claims for some investment funds and force managers to be more realistic about what they can achieve, but it could also boost confidence. It might also shake some of the worst-performing funds from the many thousands on the market. And this need not apply merely to fund managers: all those advisers who take a fee or commission for recommending investment products might win more respect from their clients if they shared some of the risk. If they really want to win the hearts and minds of consumers, surely they need to keep a little skin in the game.