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Absolute Value and Transparency

Is our industry too focused on relative returns?
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As investment advisors, how do we add the most value for our clients?

At Fiduciary Wealth Partners, we’re big fans of index investing as compared to active management. When we talk about how to add the maximum value for our clients, however, I don’t think how we’re performing relative to an index is the most important question.

A recent article on the views of Seth Klarman, who’s one of the most well-respected active investors of our time, got me thinking more about this question. In particular, I couldn’t agree more with the following quote:

“The world has a relative performance orientation. If you beat the market or you beat your peers, you will gather assets, even if you lose money doing it.”

The investment business tends to attract competitive people who like to win, but in striving to be at the top of our peer group, I think the industry is too focused on relative returns.

What’s Most Important to Clients?

As Seth suggests, the quest to beat the market and earn a top ranking as compared to our peers can increase the assets that we manage and make us a lot of money. In doing this, though, do we lose sight of what’s most important to our clients?

If you really listen to what clients say, they consistently want goal-oriented advice that simplifies their lives and offers peace of mind about the financial future.

The industry, however, continues to focus on the importance of having five star-ratings, spending an enormous share of its time and money promising and selling the ability to pick a manager or strategy that can outperform an index (that is, relative performance).

A New Focus

Considering how hard it is to deliver on these promises and how many resources (firm time and client fees) are spent in pursuit of something that research indicates is very elusive, I believe we should be focusing more on other things.

Instead of trying so hard to find and sell alpha, maybe the industry should be spending more time trying to understanding clients’ feelings about risk and reward (not presenting output from questionnaires or Monte Carlo simulations), giving full transparency (openly discussing both sides of a trade, fully disclosing all terms, potential biases and conflicts) and, importantly, making investors comfortable with their investments, so they have a greater likelihood of sticking to their plans.

Where does this lead us?

I believe that if more advisors used index funds, it could reduce what I think are relatively unproductive competitions to find and sell alpha.

This said, humans are inherently competitive, and index funds aren’t for everyone (some people want to pursue the “New New Thing”). If investing in an active strategy or working with a large brand makes a client feel more comfortable and will allow him to stick to a plan more easily then, regardless of the relative performance versus an index, these are the correct choices.

Bottom line, I think the aggressive pursuit of alpha at the potential expense of greater absolute, goal-oriented results should be more openly discussed.

Rather than simply selling relative performance and relative risk metrics (Sharpe ratio comparisons, etc.), let’s spend more time openly discussing both sides of topics, such as active versus. index funds, listening to what clients want to achieve and implementing strategies that increase comfort and peace of mind.

Studies consistently back up this idea, finding that clients don’t change advisors based on performance, they change advisors based on concern that their current advisor doesn’t listen, understand and deliver what they want.

Let’s remain mindful that investing shouldn’t be a competition with others, but the means to reaching client-specific goals.

If we focus on adding true, long-term, goal-oriented value in a fully transparent manner, we may come in for short-term criticism, but in the end I think we’ll do the most good.

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