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Conquering "Performance" Anxiety

If you think investor expectations about account performance are unrealistic now, just wait a few years, says Merrill Lynch vice chairman Launny Steffens. You ain't seen nothin' yet."Without understanding what the appropriate benchmarks are, many investors are going to be disappointed, even with the most exceptional risk-adjusted returns, because their reference will be the top returns in the hottest

If you think investor expectations about account performance are unrealistic now, just wait a few years, says Merrill Lynch vice chairman Launny Steffens. You ain't seen nothin' yet.

"Without understanding what the appropriate benchmarks are, many investors are going to be disappointed, even with the most exceptional risk-adjusted returns, because their reference will be the top returns in the hottest sector, hottest investment or hottest mutual fund that's around," Steffens told an audience of mutual fund executives at an October event organized by the Forum for Investor Advice.

Indeed, some financial advisers say a growing number of impetuous clients are demanding to know why their portfolios aren't generating the astronomical annual returns they see advertised on television. "All of a sudden, people are saying, 'I wanna do better than this indexed product,'" says Lou Harvey, president of Dalbar Inc. in Boston.

Here's a case in point: Veteran producer Michael Bradley was chatting with an investor recently when the investor mentioned that he was seriously considering dumping his full-service brokerage firm. He was generating 10 percent returns, but he wanted to move to Janus Funds where his wife was enjoying 24 percent year-to-date returns.

"I asked him what kind of risk tolerance he had ... and he didn't have any risk tolerance," says Bradley, a producer with First Union Securities in Louisville, Ky. "I told him that he had to understand that his wife was managing her account through Money magazine, and that those accounts up 30 percent year-to-date also have the potential to be down 30 percent next year. I told him he ought to stay right where he was."

Performance Reporting Remedies Illustrating a client's risk tolerance and comparing his returns to an appropriate benchmark has become more important than ever. And, almost by accident, large brokerage firms seem fairly well prepared to provide this perspective--through enhanced performance-reporting tools they originally developed for fee clients. In fact, most are extending these enhanced performance-reporting services down to plain-vanilla transaction clients in order to tame these wild expectations.

First Union Securities is one of those firms. "There is no question that we've had more conversations regarding what performance expectations ought to be, especially with these phenomenal returns we've witnessed," says Pete Quinn, retail division chief at First Union Securities. "As we go forward, we're working on a number of initiatives that further enhance that conversation, including enhanced performance reporting for all our clients across the firm."

Merrill Lynch has also made some strides in performance reporting over the past year. Today, Merrill clients receive an annual report explaining account returns several ways:

1) on a time-weighted or dollar-weighted basis,

2) on a monthly or rolling 12-month basis,

3) with risk-related data integrated into the reports, and

4) with both standard indexes and customized indexes that provide comparable benchmarks reflecting the client's asset allocation.

Merrill corporate produces the reports and sends them to brokers to share with their clients during annual financial checkups. Reps also have the ability to produce portfolio performance reports from their workstations.

"We generally discourage portfolio reviews in terms of the bottom line," says Ed Ventura, vice president and marketing manager of accounts and services marketing at Merrill. "It is important for clients to understand that investment returns should not be viewed in terms of a single number, but in terms of meeting their goals within the level of risk they are willing to assume."

Jeff Hack, chief administrative officer of sales and marketing at Salomon Smith Barney's private client group, agrees. Despite the increasing number of "do-it-yourself investors at E*Trade who want to see a single number at the end of the quarter," the real value behind enhanced performance reporting is the broker's commentary that accompanies reports, he says.

"I would bet that 99 out of 100 investors have a hard time explaining the difference between time-weighted and dollar-weighted returns," Hack says. "There is the potential to draw the wrong inferences from performance numbers if they're not properly explained. The real value is not being able to produce the [performance report] pages, but in having financial consultants deliver a coherent explanation of what's going on."

On a quarterly basis, SSB's nondiscretionary fee-based clients receive two-page or longer reports illustrating their account performance relative to contributions and in terms of absolute performance, and compared to standard benchmarks. SSB corporate generates the reports and sends them to reps, but SSB reps can also produce them on demand via their workstations.

Commission accounts receive summary pages in their statements showing time-weighted performance relative to withdrawals and contributions.

Managed account customers receive additional data on how their money manager performed, how the account performed versus relative benchmarks, both before and after fees, and how it performed based on contributions.

In August, SSB rolled out its most sophisticated performance-reporting tool ever, an Intranet-based report generator called Orion. "The trickiest thing in terms of delivering good quality performance reporting for an investor is understanding what is the appropriate level of sophistication to report on and what are the appropriate comparative measures," Hack says.

Overall, the key is to reinforce reasonable expectations with clients and then provide detailed performance reporting, Quinn says. "It's a pretty simple formula we try to use with our clients," he says. "Set the expectation on the front end, build the right kind of portfolio, monitor it on an ongoing basis and give them feedback on how that whole process is operating."

Are We Overreacting? To confuse the issue, some brokers insist that these extensive performance-reporting capabilities are generally unnecessary at this point. The overwhelming majority of clients just aren't that interested, they say. And the research may support those sentiments.

According to a 1999 investor survey conducted by J.D. Power and Associates for Dow Jones Newswires, 53 percent of investors at national brokerages firms ranked information and research as their No. 1 source of satisfaction, more than double the 24 percent who ranked performance No. 1.

In fact, only about 10 percent of retail clients actually read their performance reports, says Christopher Cale, CEO of a performance-reporting consulting firm called Portfolio Logic in Plano, Texas.

Apparently, the investors who are most likely to obsess about bottom-line performance are not your typical wirehouse clients. They're younger, online investors who take a more hands-on approach. For example, online investors ranked performance disproportionately high in the J.D. Power report (see chart above), with 34 percent saying performance is most important.

And although these aggressive investors may become the wirehouse clients of tomorrow, they certainly aren't the wirehouse clients of today, says one Merrill Lynch producer on the East Coast. "If I had 15,000 dollars invested in the market and couldn't afford to lose any of it, I'd concentrate on performance, too," he says.

Ironically, SSB has some of the more sophisticated performance reporting systems, yet Hack isn't sure that it's the clients that care. He concludes: "There's no groundswell for information here. The industry is way ahead of the curve on this."

"The simpler the performance report, the better results you get from your clients," insists Christopher Cale, a performance-reporting consultant based in Texas. For most retail clients, dollar-weighted and time-weighted returns provide an understandable and meaningful measurement:

* Time-weighted return: The industry standard, time-weighted return gives equal weight to each time period covered in the report, regardless of the differences in the amount invested. The logic is that money managers have no control over cash flow. The Association for Investment Management and Research requires time-weighted reporting in its presentation standards (

* Dollar-weighted return: Dollar-weighted return is also a meaningful number and incorporates the effects of cash flow. Periods having greater asset balances are given greater weight.

"Most clients using investment advisers are not the most sophisticated investors, so you're going to have to put things in layman's terms," says Scott Cross, performance report manager for Securities America in Omaha, Neb. "You could inundate them with information, and the client will ask you, 'What really happened?'"

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