The Trust Mandate: The behavioural science behind how asset managers really win and keep clients by Herman Brodie and Klaus Harnack (Harriman House, 2018) is a short book (about 130 pages of text). It starts by looking at some seeming anomalies regarding which managers attract the most asset inflows—notably, not necessarily the best performers. A lot of “soft factors” go into the decision to hire (and fire) an asset manager. People search for “personal character traits to help them make predictions about the manager’s future behavior or, at least, to reassure them that the positive impressions they have gained elsewhere are justified.” They want an asset manager who is trustworthy, who is both willing and able to act in their interests.
Trust, the authors explain, is “inseparable from risk or vulnerability. There is no need for trust in the absence of risk…So, in a risk-oriented business, like asset management, trust is a genuine asset—a form of social capital.”
The authors cite a curious finding regarding the relationship between trust and market efficiency. In an efficient market, as we know, prices should respond fully and swiftly to the arrival of firm-specific news. And yet, prior to Sarbanes-Oxley, “this rapid adjustment tended to occur only if the firm was incorporated in a high-trust region. If the firm happened to be based in a lower-trust region, investors were less likely to take the information at face-value. Their hesitation caused the initial stock price reaction to be more sluggish.”
Think, for instance, of post-earnings-announcement drift. The region of the U.S. with the highest level of trust was the Northwest; with the lowest, East South Central (Kentucky, Tennessee, Mississippi, Alabama). Following the introduction of the Sarbanes-Oxley Act, “the effect was eliminated. Regulation, it appears, has the possibility to raise the minimum level of trust in all firms—even in a sophisticated and well-developed capital market like in the US.”
How does an asset manager inspire a potential client to trust him? The authors offer a range of suggestions, from the fragrance of hand cleansers in the washrooms of the asset manager’s offices to the trade-off between warmth and competence where “one additional unit of warmth, so to speak, will bring providers closer to a high-trust relationship than one additional unit of competence.”
The authors have struggled mightily to tease out the many strands in a trusting client-manager relationship. Ideally, we want to deal with someone who is, let’s say, talented, diligent, shares our values, and isn’t a jerk. But how do we rate these attributes? Are we willing to hire a less talented investment manager who isn’t a jerk over the jerk who is extremely talented? Probably. I assume that most asset management firms have already figured this out and keep their talented jerks hidden from public view. Or make them CEOs. (And, no, I won’t name names.)