Why having real skin in the game matters when it comes to heeding investing advice
Tread carefully if you are the only one bearing the risk, Martin Pelletier warns.
Being a former sell-side research analyst, an active investor in both public and private markets and an entrepreneur, I’ve witnessed many successes as well as many failures.
One of the most important factors that separates the winners from the losers is when decision-makers have real skin in the game, such that they — and not just their stakeholders — will suffer a direct financial impact if they are wrong.
It is a phenomenon I’ve noticed in my own career, where the personal cost of making a bad call on a stock recommendation as an analyst was a lot less than that of making a bad investment on behalf of a client. Being a business owner upped the ante considerably, as any wrong move could prove disastrous in an oligopolistic investment industry dominated by the Canadian banks and their brokerage houses.
Having real skin in the game has been a tremendous motivator in making the strategic decisions that have allowed us to operate effectively in an environment where independents are being squeezed out due to margin compression and the lack of distribution options for their investment products.
Unfortunately, there are still plenty of fields where decisionmakers have transferred all of the risk along to stakeholders such as taxpayers, business owners and shareholders.
For example, the federal government moved this year to implement some of the most profound and punitive tax changes in Canadian history on small business owners on the advice of a few very vocal academics. When these changes begin to affect the economy, it will eventually come back to cost the government, but what will it cost those academics? Will business owners and regular Canadians get their “fair share” of tenure and government-backstopped defined-benefit plans?
Then there are those pundits in the media calling for the Bank of Canada to raise interest rates multiple times over the next 12 months. It would be interesting to know just how many of them have an actual mortgage.
Meanwhile, regular Canadians happen to be heavily in debt with a household debt service ratio now reaching the highest level since the end of 2008, according to a recent Bloomberg report. For some further perspective, the same report indicated that Canadian households are in fact the most leveraged in the G7 with $1.69 of debt per $1 of income.
Perhaps the Bank of Canada should be asking what will happen to consumer spending and our housing market, both huge components of GDP, if they heed the advice of these aforementioned pundits.
Taking it to a more micro level, we have seen the consequences of a mismatch of public company compensation programs that are completely misaligned with shareholder interests. For example, you have situations where management can take home nearly $100 million in compensation over five years while their company’s share price falls by over three quarters. We have also witnessed the repricing of management stock options following a large correction. If only the shareholders who put their hard-earned wealth in were able to hit the same reset button.
Finally, this misalignment also occurs in the investment industry with over 96 per cent of the investment professionals being salespeople or dealing representatives with inherent conflicts to sell in-house products or those with higher fees such as deferred sales charges. With there being no legal fiduciary duty to act in the client’s best interest, it will cost these investment professionals and their firms little to nothing if poor recommendations are being made.
In conclusion, when it comes to reading the advice of those in the media or making investment decisions, take a step back and see who is actually bearing the risk. If you are the only one, tread carefully.
Financial Post Martin Pelletier, CFA, is a portfolio manager and OCIO at TriVest Wealth Counsel Ltd, a Calgarybased private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.