This Sunday, France won the 2018 world cup in an uncharacteristically high-scoring final against Croatia. The 6 goals scored in this final equal the total goals in the last 4 world cup finals before this. One other standout about the final was there weren’t many fouls.
This got me thinking. Going by the time they spend lying on the ground clutching some part of their body, football players seem to get seriously injured a lot more than other sportspersons. Why is that?
Logically, one (or more) of three reasons must apply as the cause of frequent injuries in football:
- Football is physically tougher than other sports resulting in more injuries
- Football players have fragile bodies and are therefore prone to injuries with minimal contact
- Football players dive i.e. pretend
Football players pretending to fall down injured is not exactly an earth-shattering revelation. We’ve known it as part of the sport for decades since FIFA got tough on rough play. They even have an 81-slide document on fouls and misconduct.
Why do football players dive? Incentives.
What are the incentives to dive pretending to be grievously hurt?
Three big incentives:
– being awarded penalty or free kicks close to opponent goal
– getting opposition players cautioned, or even sent off
– wasting time (watch a footballer lying in pain on the ground, and you can assume his team is in front).
The downside of being caught feigning injury is a cautionary yellow card, almost never enforced.
Overall, diving improves your team’s chances of winning. So, it happens. A lot.
Incentives are not evil. They are a necessary part of any transaction. There would be no reason for a real estate broker to maintain a network to know of good properties if she couldn’t monetize it by charging brokerage from sellers.
In the ideal transaction, incentives of the buyer and seller are completely aligned. It’s where they are not aligned, or even in opposition, is where the damage happens.
Here are 5 common situations in the financial world where the imbalance in incentives applies, i.e when your “advisor” is taking a dive for his own benefit:
1. Unsolicited SMS recommendations: The no-brainer first. Mass spam blast promising triple-digit returns from stock you’ve never heard of. The sender has to be a descendant of Robinhood wanting to reduce income inequality. By making money-losing opportunities available to all except himself.
2. The LIC Agent (Uncle) selling endowment policies: Anyone born before the 90’s probably fell for this one. The tax-saving instrument that offers impressive-sounding cash-back after just 20 years of fixed annual payments. Except, the life cover offered is pathetically inadequate and the return offered is lower than post-tax FD rates. The agent’s commission is up to 25% of the first-year premium followed by only a slightly lower slice of premiums for the life of the policy.
3. When your Bank Relationship Manager Calls: You’re important enough to be assigned this “dedicated” person for all your banking needs. Except they don’t say he’s dedicated to generating income from you.
“Congratulations! You qualify for an immediate personal loan” – At interest rates between 11% and 28% (as of July 2018), the congratulations are due to the lender, not the soon-to-be hapless debtor.
“Great new NFO (New Fund Offer)” – In FY18, HDFC Mutual Fund paid Rs 1,200 Crores as commission to its distributors. Of this, Rs 278 Crores (23%) went to HDFC Bank. ICICI Prudential’s FY18 commissions paid statement smartly does not include the total, but we do know they paid Rs 330 Crores to ICICI Bank as commission. Check Kotak, Axis and other banks and the same will apply. It is not a coincidence your RM is convinced that new fund offered by the AMC from the same corporate family is great. He just didn’t specify who it’s great for.
4. When your Brokerage Relationship Manager Calls: Your point of contact for all your investing and (hopefully for them), margin trading needs
“Recommending a mutual fund portfolio with bias on financials and infra“: Their economists have figured out which sectors are poised to shine over the next decade. Except, if you pay attention, the fund recommendations change every 12-18 months. Most funds offer higher first-year commissions followed by steady trail commissions, with clawback if redeemed within 12 months. So switching you between funds is good business, just not for you.
“Great new IPO opportunity“: Markets have been surging, the number of new demat account openings is at an all-time high. If you’re a promoter, is there a better time than a bull market to offer minority ownership to the public through an IPO? He’s not working alone. The merchant banker on the prospectus stands to make up to 3% of the total funds raised. It also happens to own your brokerage. Commission on the transaction plus a cut of the money invested. See why that IPO is a great opportunity?
5. When your brokerage “improves” their product: This one is subtle. Features to enable seamless trading from your browser, your smartphone, your weighing scale. The gorgeous gamified interface showing price tickers, heat maps, and charting features. Do you know that the shade of red or green used to highlight information on screen has an impact on the actions the user is likely to take? A food delivery app modified its restaurant rating scale of red (poorly rated) to green (well rated), towards more green in order to improve user-perception of the quality of available restaurants. Conversions went up.
Such modifications are subtle, in making it more convincing to buy and sell. icicidirect even had a ‘low bandwidth’ site so poor internet connectivity did not stand in the way of their commissions.
Add to this list, investment advisors offering their services for a fee. In all these cases, just like in case of diving footballers, the cost of unethical behaviour is woefully inadequate to act as a deterrent. The onus is on the investor to understand the products being offered, their true risk and return profiles. A good place to start is the incentive structure.
One way to look at it is to think is the “system” is rigged against you. But that’s the cynic’s way. You can’t escape incentives. It makes sense to look to understand when and how they apply. How direct or indirect they are, the size of those incentives, and the kind of behaviour they are likely to foster.
In other words, make sure you understand “What’s in it for you?“. And of course, do some of your own research and analysis before making investment decisions. Fundamental Analysis Tools for Indian investors.
Who else wanted Croatia to win this one?
Additional Viewing (for fun): What looks like footage from a training camp but is a parody video