Reeducate the Advisers

In November 2005, the banks began a hasty procedure of selling off their holdings in provident and mutual funds. As the banks relinquished their ownership, the funds found themselves losing their assets.

From November 2005 to May 2006, these funds lost a whopping NIS 14.5 billion in assets. Of that, NIS 9 billion was lost by the two mutual fund management companies owned by Bank Hapoalim: PKN (which lost NIS 5.3 billion) and Lahak (which lost NIS 3.8 billion).

There is a substantial difference between PKN and Lahak. Bank Hapoalim has sold PKN, to the Prisma group, but it still owns Lahak.

It is a very interesting question what happened over there at Bank Hapoalim, where these two companies were savaged by massive withdrawals. And there is no question that the answer lies in the investment advice granted at the bank's branches, which had always urged Hapoalim customers to invest in PKN and Lahak; but the moment PKN was sold, all that changed.

Capital market players suspect it's the advisers at the bank branches indulging in sweet revenge. Revenge - for all the years they had been forced by the bank to advise customers to buy units in the two funds, knowing full well that PKN and Lahak were among the worst performers in the industry. The moment the advisers felt they were no longer obliged to pitch the twain (even though Lahak still nominally belongs to Bank Hapoalim) - they let their real opinion shine forth, and extracted the clientele from the wretched funds.

But if sweet revenge it be, it picked the wrong target.

The bank was hurt

The main casualty of the revenge is Prisma (ie, Markstone), which bought PKN and which has nothing whatsoever to do with Bank Hapoalim. 

If it is sweet revenge, it also has a positive message. It demonstrates just how warped advice at the banks had been in the past, as long as the banks owned the provident and mutual funds; but it also shows just how fast the investment advisers adapted to the new circumstances. Once given freedom, they did the right thing: they advised customers to get out of those funds and choose something better. Though in the case of PKN, that advice is hollow: it has new managers now.

But it may not be sweet revenge after all. Nobody is really sure that it's a whole new era after all. Instead of a fresh new spirit among investment advisers, it may be the same old spirit, just wearing a new dress. Then the advisers urged investors to choose the bank's own provident and mutual funds; now they're driving investors to the bank's deposits. The price is being paid by the mutual funds industry, most of which is not owned by the banks any more.

One bank, a small one, called us yesterday, with hurt feelings. It felt insulted by the suggestion that the banks have changed their incentive to advisers at the branches at the expense of the mutual funds. "Over here," the bank argued, "we deliberately did not change the incentive at the branches at all. The incentive when the bank owned the mutual funds remains unchanged." There was no reason for the branch to change its treatment of advice to clients just because the assets had changed hands, it said.

That bank is evidently the only righteous bank in Sodom. The others, mainly the big ones, did change their incentives when they sold their mutual funds.

They had good reason: selling the funds sharply reduced the bank's income from selling units in the funds to its customers. Today, deposits are much more profitable for banks than selling units in mutual funds. It is natural for the bank to reward its advisers more when they push deposits than when they push mutual funds.

Sadly, the result is precisely what the reform sought to eradicate: a bias toward granting non-objective advice, based on the bank's good, not the client's.

The small bank admitted to us that for years, investment advisers at the banks had been taught to advise based on the bank's own benefit, and the reform requires them to adopt a new mode of thought. Advisers at the banks have to undergo reeducation, it explained.

Are they? Doesn't look like it. The watchdogs suggest letting the banks collect a fee for selling units in mutual funds, so they profit equally from plugging mutual funds and deposits. The public might not like that, though.