The mass media recently reported various cases involving investment activities in the capital that which caused losses to thousands of consumers (retail investors) and blamed financial service business actors for their losses.
Many of these investors did not expect such huge losses, thinking they had placed their money in relatively conservative and safe investment products. Hence, investment products in the capital market, particularly mutual funds, deserve more public attention in terms of customers’ understanding, the behavior of business actors and the effectiveness of supervision by the authorities.
The low level of financial literacy of retail investors and consumers is often seen as the main cause of losses for consumers. The public or consumers are often not adequately briefed by brokers or agents on the characteristics and risks of the financial products or investment instruments. And there do not seem to be sufficient government regulations on how investments or financial products should be offered to consumers.
Financial Service Sector Consumer Protection Regulation No. 1/2013 only states that financial service business actors are required to provide reports to consumers regarding the balance position and movements of consumer deposits, funds, assets or liabilities accurately on time and by means in accordance with the agreement with consumers.
Problems may arise when consumers buy investment products whose performances are highly dependent on the actions taken by the party managing the product and whose value can fluctuate following the market movement (marked-to-market), such as mutual funds. The management of securities in a mutual fund portfolio is fully carried out by the investment manager for the benefit of investors, in accordance with the relevant mutual fund investment guidelines. For accountability purposes, investors are to receive monthly statements regarding the mutations and balances of their mutual fund units.
In addition, investors can also see the fund factsheet, which contains the allocation of assets and stocks with the largest volume in the mutual fund portfolio. However,
information about the actions of investment managers in managing mutual fund portfolios through various forms of transactions in the capital market and their reasons is not something that investors can easily find out.
Lack of information for investors results in what is known as asymmetric information, which is an imbalance of information held by parties in a transaction, where investors do not have the same information that the investment managers possess. This imbalance of information after the purchase of a product or during the life of the transaction can lead to a moral hazard situation, namely the tendency of investment managers to take actions that carry higher risks than they should be, as ultimately it is the investors that bear the consequences of this action.
Although moral hazard does not always constitute bad faith or illegal acts, the possibility of one party taking advantage of the other in a transaction makes it necessary for moral hazard risks to be
properly mitigated, especially in the capital market.
In mutual fund products, moral hazard risks occur because investors must bear the losses should there be a decrease in the mutual fund’s net asset value. In fact, they have no control over investment management and have no information about actions taken by their investment managers. Meanwhile, investment managers are still entitled to enjoy a management fee for their services, whether their actions result in a profit or loss. Moral hazard can cause investment managers to buy low cap stocks with high-level price fluctuations in the hope of obtaining large profits, regardless of the high risk of loss.
One of the measures taken by the authorities to overcome moral hazard is obliging business actors to apply the principles of good governance, such as setting guidelines for behaviors that investment managers must comply with as mandated in the Financial Service Authority (OJK) Regulation No. 43/2015 concerning investment manager behavior guidelines. Violations of this provision, as well as other provisions governing mutual funds, will bring certain sanctions to investment managers. This is expected to prevent investment managers from taking action with excessive risks.
However, recent cases indicate that other efforts are still required for further considerations.
Currently, investors do not have access to information on whether their investment managers have done their best in good faith and with full responsibility for the benefit of the mutual fund in accordance with the laws and regulations. If the principle of transparency is expanded to include actions taken by investment managers from time to time and the level of its compliance with applicable regulations, investors will be able to establish their own judgment and exit the fund if not satisfied.
Disclosure of information to the public will also force investment managers to be more careful in taking action because what they do will directly affect their reputation, as well as the number of investors who are willing to be their customers.
Reviewing investment managers’ incentives is also worth considering. If incentives for investment managers are not only calculated based on the value of the asset under management but also depend on their compliance with laws and regulations, investment managers will think carefully before taking steps that deviate from investment guidelines as they are obliged to share the risk of financial loss for any violation they commit.
Regardless of the various efforts, the risks of moral hazard are always present when the party who bears the loss cannot monitor or control the party who takes the action. Therefore, in a crisis situation like this, it is necessary to take a closer look at whether investors’ losses were truly occurring as a result of an economic recession or high-risk actions were taken by those who manage the investments.
When this action is accompanied by bad faith or with intention of enriching oneself in an unlawful manner, firm legal action is undeniably needed.
The writer is senior executive of Bank DBS Indonesia. The views expressed are his own.
Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.