Identifying If Your Investment Manager Is Conflicted Could Save You from Financial Ruin

By Edwin Dande, Cytonn Investments CEO

Investors in Genghis Capital recently woke up and realized that their billions of shillings are not accessible simply because majority of their cash was invested in Chase Bank, which was owned mostly by the same shareholders who owned Genghis Capital.

How do we explain that the management at Genghis Capital decided to invest majority of their clients’ cash in a bank controlled by the shareholders of Genghis? Why didn’t they invest the cash in another bank or at least significantly diversified the investments?

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When people think about investments, they tend to think about the core investment parameters such as investment returns, investment risks, diversification, and investment horizon. However, they rarely think about something that greatly affects the outcome of their investments: conflicts of interests.

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A conflict of interest is defined as “a conflict between the private interests and the official responsibilities of a person in a position of trust.” In the context of investments, the private interests tend to be the interests of the owners and management of the investment management company, and the official responsibilities are the responsibilities to the investing clients.

The investment management company is supposed to manage money, primarily taking into account the interests of the investing clients, not the owners of the company. Going back to the example of Genghis Capital, if the company was managing money in the interest of their clients, they would have diversified their investments broadly by putting money into a diversified set of banks and government securities.

However, because Chase Bank was conflicted and also wanted the money, majority of it was steered to Chase Bank and when Chase Bank went under; the clients were left holding the bag. Many investment management companies and financial services firms are owned, associated with or controlled by big diversified financial services brands.

It is important that the management of these investment management companies understand that their duty and fidelity is, first and foremost, to their clients and they should always put the interests of their clients ahead of the owners of the firm.

To help reduce the prevalence of conflict of interest situations that will lead to significant investor losses, we need to take several actions:

1. The various regulators should develop and enforce a strong code of conduct for all financial services players with a keen focus on conflicts of interest;

  1. All investment companies should disclose in detail where they have invested client monies and detail out the relationships, if any, between themselves and where client monies are invested. Where monies are invested in affiliated entities as was the case with Genghis’ investments in Chase Bank, the detailed criteria for making the investment decisions should be disclosed;
  2. The regulator should require investment managers to identify and report to both the respective regulators and audit committees instances of significant conflicts of interest;
  3. Hold executives personally accountable if they do not disclose conflict of interest situations;
  4. Have properly aligned compensation and incentive structures where pay and bonuses for executives of investment management companies are strongly correlated to the returns they deliver to their clients;
  5. Establish detailed asset allocation policies and ensure deviations are documented and explained. We should examine situations where management is allocating a disproportionate amount of funds to assets managed or controlled internally;
  6. Establish truly independent and adequately resourced compliance and risk officers, complemented by strong and independent board committees;
  7. Our regulators should be independent of undue influence and any potential conflicts of interests in order to enforce a culture of identifying and managing conflicts on interests in the regulated entities.

In all the recent cases of financial impropriety such as Uchumi’s, Chase Bank failure, Genghis and Imperial Bank failure, at the core of these failures were conflicted executives. Had there been a strong culture of managing conflicts, we would have saved innocent investors billions of shillings in losses.

As you read this, rest assured that billions of investors’ funds remained invested not based on sound investment decisions, but based on conflicts of interest. It is a matter that the investment community needs to urgently address otherwise more loses are surely going to surface with time eroding funds that should be funding retirements, educating kids and earning returns.

The writer is the Cytonn Investments CEO, Edwin Dande

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