Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with new guidance from the SEC that is taking an increasingly tough look at proxy voting and how RIAs (and the proxy advisers who give them guidance) are voting their proxies in an age of rising shareholder activism (suggesting that there may be another shoe to drop with additional proxy voting guidance in the coming year as well).
From there, we have several marketing-related articles this week, including a look at how the best approach to prospective clients is better understanding what their biggest worries are (recognizing that when clients feel truly understood after having been asked good questions, they often just presume the advisor will have the skills to solve their problems anyway), a good “probing” question to ask to better understand prospective clients’ real needs, a look at the wide range of reasons that clients actually hire an advisor (hint: it’s not just about solving complex problems or helping them with financial ignorance, sometimes it’s just for the convenience of delegating what they could but don’t want to do themselves!), and ways to field the always-challenging question of “how much do you charge?”
We also have a few investment articles this week, from a discussion of what the inverted yield curve signals (or not), to why there’s actually such a thing as being too diversified in stocks (at least for active managers who are actually trying to outperform), how liquid alternatives may not actually be much of a diversifier to equities (at least compared to just buying old-fashioned intermediate-term Treasuries), and how hedge fund alpha has continued to shrink over the past decade from what appears to be “too much” interest from institutional investors that caused hedge funds themselves to shift their focus and business practice (in not-entirely-positive ways).
We wrap up with three interesting articles, all around the theme of working long hours and the importance of finding balance: the first is an interesting research study that finds it’s not actually working long hours that can cause adverse health effects, but specifically having a workaholic mentality that isn’t able to disconnect from work (even after the long work hours are over); the second provides a powerful reminder on the importance of delegating in order to grow; and the last points out that while being “busy” is almost worn as a badge of honor in modern culture, in practice it’s often just a signal that someone is doing a poor job prioritizing their work and their focus… which means instead of just trying to be Busy, it’s better to try and find Balance by truly prioritizing what really matters most, and learning to let go of the rest that doesn’t really matter in the end (because, by definition, it wasn’t the greatest priority!).
Enjoy the “light” reading!
SEC Takes Action Aimed At Proxy Advisers For Shareholders (Andrew Ackerman, The Wall Street Journal) – This week, the SEC “clarified” its guidance regarding the responsibility of registered investment advisers who engage in proxy voting on behalf of their clients. The primary focus of the SEC guidance was aimed towards consulting firms known as “proxy advisers” that craft recommendations for other RIAs and asset managers about how to vote their proxies, requiring them to provide more disclosure about how, exactly, they craft their shareholder recommendations (and broadly cautioning that proxy advisers be certain to convey accurate information). The world of proxy voting has become increasingly contentious in recent years, as rising shareholder activism (including shareholder engagement amongst RIAs) is leading to more shareholder (and proxy) voting, and the marketplace for proxy advisers has deeply concentrated into just two major players – Institutional Shareholder Services Inc. and Glass, Lewis & Co. – that have a combined 97% market share amongst proxy advisers. Which is especially concerning as some proxy advisers – in particular, ISS – have increasingly been selling “corporate governance consulting services” to the very corporations that might be facing a “no” proxy vote recommendation against their existing corporate governance structures. From the RIA perspective itself, the SEC reaffirmed that under Rule 206(4)-6 of the Advisers Act, firms that exercise voting authority with respect to client investments must adopt and implement written policies and procedures reasonably designed to ensure that the investment adviser votes proxies in the best interests of clients. And signals in the process that additional scrutiny of how RIAs vote proxies, or how proxy advisers craft recommendations, may be the subject of further SEC scrutiny in the coming year, especially if the focus on proxy voting and shareholder activism continue to rise.
Build Connection By Sharing Your Clients’ Worries (Steve Wershing, Client Driven Practice) – The traditional approach to selling is to talk about the features and benefits of what you offer (a “please buy what I have” approach), whereas relationship-based selling is all about connecting with prospective clients and communicating to them “I see you” (and understand what your concerns really are). The caveat, of course, is that this requires actually understanding what a prospective client’s worries and concerns really are. What’s on your clients’ minds? What do they really worry about? What keeps them up at night? And how well could the advisor capture a prospective client’s attention by speaking directly to these needs? Because the fundamental challenge is that when we as advisors simply talk about what we do, we effectively leave it up to the prospect to connect the dots between what the advisor says they do, and what pressing issues are actually on the mind of the client that they want solved. In fact, it turns out that when prospective clients truly feel heard and understood with respect to their problems, they often assume that the advisor will naturally know how to address those clearly-understood problems. Which means, again, that it’s often more important to demonstrate an understanding of what the client is actually looking for, than simply talking about what the advisory firm itself does and offers.
The Probing Technique That Increases Your Closing Ratio (Kerry Johnson, Advisor Perspectives) – Research from U.S. Trust shows that only 3% of prospective clients engage an advisor because they understand what the advisor provides, while 86% make the decision because they feel they’re understood. Because ultimately, the more needs of the client that can be identified, the more likely it is that the advisor’s comprehensive solution to solve (all of) those problems will be appealing, while advisors who fail to gather such information will face the infamous “It all sounds great, but it’s not for me”. Which means it’s crucial to evaluate the kinds of “probing” questions you ask to elicit discussion from prospective clients, not just about their numbers but about them, to ensure that you do understand them (and that they feel heard) in the first place. So what can advisors ask to elicit this information? Johnson suggests one key question, that can open the door directly to the client’s most pressing concerns that they hope the advisor will solve, by asking “Let’s assume it’s three years in the future… what happened that let you know we had a great financial plan and a great relationship?” And once the prospect begins to provide a response, wait (don’t interrupt – let them keep talking!), and then recap what they said with “If I heard you right, you said you wanted _____, _____, and ____. Is that what you said?” At that point, either the prospective client will provide further clarification, or confirm those are their needs… providing the advisor the perfect opportunity to respond “If we could take a look at ____, ____, and ____ [those 3 needs], would that be helpful?” and turn the prospect into a client.
Helping Prospects Decide If They Need An Advisor (Dan Danford, Advisor Perspectives) – The prevailing consumer view about financial advisors is that we are a “nonessential” expense… something that knowledgeable people don’t need (they can do it themselves), and that are only appropriate for those who are uninformed (and need the advice) or very rich (and need more complex advice that isn’t feasible to figure out on their own). Yet in reality, for many advisory firms, the clients they serve aren’t “just” comprised of the ignorant or the ultra-wealthy; instead, clients are often hardworking, smart, knowledgeable, and well-informed people who choose to pay the cost of a financial advisor for the benefits they receive. Which means they’re not necessarily benefits of just complexity or addressing financial illiteracy; instead, as Danford notes, often the value of an advisor comes down to a “convenience” service of simply handling tasks that clients don’t want to do themselves. Or stated more simply, advisors often get very savvy clients simply because clients choose not to spend their precious leisure time studying stock reports or mutual fund statements. Which is important, because it means both that advisors may want to position their value differently – it’s not about how the advisor gets clients more (e.g., “advisor alpha”), but simply about how advisors save their clients time to focus on what the client really wants to enjoy. Notably, this also means that advisory firms may want to focus their services differently as well; for instance, does the firm seek to educate, or simply to help clients more quickly make informed decisions? The bottom line, though, is simply to reflect upon and consider, what, really, is your value to your clients in particular?
7 Ways To Answer ‘How Much Do You Charge?’ (Bryce Sanders, ThinkAdvisor) – It’s human nature to want to get as much as possible while paying as little as possible… which as a financial advisor, can sometimes make it very challenging to confidently answer the question “how much do you charge?” when prospective clients ask. Sanders suggests a number of different ways to handle the question (depending on your exact business model and approach), including: frame it as cents-on-the-dollar (e.g., a $2,500 fee is just 1% of the client’s $250,000 of AUM, or only “one cent on the dollar”, or just $6.85/day); remind them it’s “pay as you go” (at least with AUM fees, where there’s no upfront commission or charge and clients can simply terminate if/when/as they’re no longer satisfied); provide a point of comparison (e.g., 1% of assets might sound high, but not if you compare it to the tax rate you pay to Uncle Sam or the state, or even what an ATM may charge as a withdrawal fee when calculated as a percentage of the asset/withdrawal); anticipate the question by tackling it proactively first (e.g., by telling the prospect “you should know how we make money…” and then proceed to tell them and affirm that the stated price really is all they’ll pay); or remind clients that cost and advice are on a spectrum, from mostly do-it-yourself, with little cost and little advice, to a full-service advisor with a lot more advice but also a commensurately higher cost… and then let clients state where they’d like to be on the spectrum!
Let’s Get [Yield Curve] Inverted (Cullen Roche, Pragmatic Capitalism) – The big buzz this month has been the inversion of the yield curve, a phenomenon where the yield on 10-year Treasuries drops below the yield on shorter 2-year Treasuries. Yield curve inversions are unusual, because normally longer-term bonds have higher yields (to compensate for the longer time horizon, and/or the potential for higher inflation in the future). The “slope” of the yield curve (whether longer-term Treasuries yield more or less than the short-term ones is important) matters, because while the Fed tightly controls shorter-term interest rates, it explicitly does not control long-term rates… which effectively means the slope of the yield curve becomes a statement about what the market expects growth and inflation to be (reflected in long-term yields), relative to what the Fed is assuming based on how it sets the short-term rates. Thus, when the yield curve is inverted, it implies the Fed sees a higher risk of inflation than bond traders and the market themselves… suggesting that the market itself thinks that inflation will be declining (which typically occurs as economic growth softens or an outright recession occurs). In fact, the yield curve has inverted before every recession since 1950, although notably not every yield curve inversion immediately resulted in a recession; on average a recession occurs 19 months after the yield curve inverts, and the S&P 500 doesn’t actually peak until an average of a year after the yield curve inverts. Accordingly, Roche suggests that it’s probably not wise to view the yield curve simply as an “on/off switch” (where the economy is automatically doomed or an immediate bear market is inevitable because the yield curve inverts). Instead, it’s really just a signal that economic growth is expected to slow relative to what it has been, and a signal that more difficult times may be coming (but that there may still be time left to make money as an investor).
How Many Stocks Should You Own In Your Portfolio [Or Mutual Fund] (Sean Stannard-Stockton, Intrinsic Investing) – The principle of diversification is one of the few areas of investing where virtually everyone agrees about the value… except, as with almost anything that is “good” for you, Stannard-Stockton suggests that even diversification should be done only in moderation and can still be taken too far. For instance, as shown in Burton Malkiel’s famous “A Random Walk Down Wall Street” book, it turns out that it only takes about 20-25 stocks to diversify enough that the volatility of the stock portfolio is on par with the risk of the overall market; in other words, not only is it impossible to diversify away volatility altogether (even buying every stock that exists still means the investor is subject to the overall volatility of the market), but it turns out it doesn’t actually take all that many stocks to achieve virtually all the benefits of diversification. Of course, for investors who aren’t trying to outperform (i.e., they simply want to own the index itself and perform at that level), there isn’t necessarily much harm in diversifying into the 50th, 100th, or 300th stock either. However, for more active investors, adding more stocks beyond this “diversification threshold” merely reduces the potential for outperformance in the first place, reducing the amount of money that’s placed into the manager’s best ideas in exchange for “additional” diversifying that isn’t actually a diversifying benefit anyway. For instance, a white paper entitled “The Concentration Manifesto” by Cameron Hight finds that the top 20-25 stocks of active managers’ portfolios do tend to outperform… but the typical active manager then dilutes their own good calls by buying another 100-150 stocks that fail to outperform (while adding no diversification value along the way). Which means that while passive index investors may be quite happy and content to continue to own the entire market, those seeking active managers who can outperform should be cautious not to buy managers who so “over-diversify” that they can’t have enough Active Share to beat the market even if they’re making the right investment calls on their best stock picks.
A Horse Race Of Liquid Alternatives (Factor Research) – A growing base of data from the mutual fund industry shows that the average mutual fund fails to outperform its benchmark, yet for affluent investors (and many institutional investors) the conclusion has been not to just revert to passive indexing, but instead to re-allocate those dollars to hedge funds in the hopes that they will produce the alpha that mutual funds haven’t. Advocates of hedge funds suggest that the greater flexibility they have with respect to investing may make it more feasible to outperform; critics point out that with the hedge fund cost structure, the higher fees are likely to erode any additional alpha that might have been created anyway. Yet with more and more hedge funds being replaced into mutual fund or ETF formats – increasingly known as the “liquid alternatives” category – there’s more and more opportunity to compare and evaluate the results of hedge funds (at least purchased in liquid alternative format). From a performance perspective, Factor Research does find that most liquid alternatives funds have generated favorable risk-return ratios since 2011. But from a diversification perspective, adding 20% to liquid alts has done remarkably little to improve the overall risk-return ratio of a diversified portfolio (and in fact, several categories of liquid alts result in worse risk-return ratios). Which suggests that while liquid alts have largely generated favorable performance in recent years, it’s only occurred by replicating the upside risk-return potential of equities themselves. Of course, diversification in general doesn’t look as appealing in an environment of strong stock market returns (given that a bull market has been underway throughout since 2011), but even when considering the pullback periods, an addition of liquid alts only slightly improved the max drawdown. In fact, it turns out that from a diversification perspective, a 20% allocation to old-fashioned 10-year Treasuries actually created a better improvement in risk-return ratios and reducing the maximum portfolio drawdown than any of the liquid alternatives strategies evaluated (and the picture looks even better for 10-year Treasuries when including the last bear market cycle during the global financial crisis!). Which suggests that in the end, liquid alternatives still appear to be largely just replicating the risk-return dynamics of equities themselves, and for those who want to diversify out of equities for better defensive characteristics, 10-year Treasuries still provide a remarkably robust (and simple) solution.
Have Institutional Investors Spoiled The Hedge Fund Party? (David Finstad, Institutional Investor) – In the early days of hedge funds in the 1980s and 1990s, star managers achieved outsized returns for their wealthy clients (in a world where the S&P 500 was already compounding at 15%/year on average). After 2000 when the technology bubble burst, though, the focus of hedge funds began to shift from upside return potential to protection of capital instead, where suddenly investors were at least somewhat more patient with underperformance during bull markets in the hopes of getting better asset protection results during the bear market decline. The shift appears to be driven at least in part by a change in the composition of who invests into hedge funds, which early on were primarily wealthy individuals and family offices (who tend to be ultra-long-term investors without a big focus on volatility or risk management for their growth assets), but increasingly became the domain of institutional investors (popularized by institutional managers like Yale’s David Swensen) and their investment consultants. At the same time, the business of being a hedge fund itself grew, with an increase in the fees that hedge funds charge (or rather, could command from institutional investors with the promise of managing their volatility), and a concomitant increase in focus on attracting and retaining assets. The end result? The alpha being produced from hedge funds has “withered” in the past 20 years, from an annualized alpha of 15%/year in the early 1990s, to 6.6%/year in the early 2000s, to only 0.2% over the past 4 years. To some extent, such underperformance has already triggered outflows; since 2008, fund-of-hedge-funds offerings dropped from almost half the hedge fund market to less than 10%. But institutional investors tended to just bring analyst resources in-house to pick their own hedge funds instead… which ironically then created such large concentrated hedge funds that they became too profitable (with one study estimating an average profit margin on management fees of 50% once a hedge fund grew past $500M of AUM), that further undermined performance. So what comes next? Finstad suggests that ultimately, hedge funds need to gain a renewed focus on alpha generation, and only charge fees on the value they really create… with the caveat that by doing so, it’s not clear how many hedge funds are actually good enough to be profitable and sustainable in such a future?
How Being A Workaholic Differs From Working Long Hours (Nancy Rothbard & Lieke ten Brummelhuis, Harvard Business Review) – The classic view of a “workaholic” is someone who can’t stop working, and is constantly tethered to the job, working long hours, unable to disconnect from work and unwind. Yet recent research finds that there’s a difference between just working long hours, and the actual problem of being unable to unwind and “switch off” from work. In other words, there’s a difference between the behavior of working long hours, and the mentality of feeling “compelled” to keep working. As it turns out that the number of hours an individual works isn’t necessarily tied to any of the classic health issues and complications of being a “workaholic” (at least for those working “only” up to 65 hours/week), but the mentality of workaholism (being mentally unable to disconnect from work) was associated with more health challenges (from risk of cardiovascular disease and diabetes, to sleep problems and emotional exhaustion). In other words, it’s not about the number of hours that one works, but specifically about the individual’s ability to unplug and stop thinking about work after it’s over; it’s the obsessing about work that actually creates the additional workaholism stress, not necessarily the work itself. And notably, the problematic health issues of workaholism hold up even for those who are deeply engaged with and “love” their work (although those who did not love their work fared even worse). Which means in the end, even for those who otherwise love their work, it’s crucial to create some structure for yourself about how to stop working and “switch off” work for at least a few hours at the end of the day.
Learn To Love Delegating (Scott Hanson, Investment News) – Few advisors are naturally wired to be good delegators, instead being the ones that have the responsibility to do all the work for clients themselves, and thus being the ones to do it. Yet as an advisory firm grows, eventually there is a capacity wall that all firms hit, where it becomes necessary to hire staff to do more of the work… and the advisor has to begin to learn how to delegate tasks. As particularly in the context of advisory firms, good technology tools alone can only carry the business so far, when the bulk of what advisory firms do for clients is still driven by human beings (i.e., advisory and client service staff). And the challenge is that when advisory relationships themselves are so valuable, there’s a justifiable fear in handing off tasks that could damage a hard-won client relationship. Yet ultimately, delegating is the key to growing a business much larger than the original advisor (and what he/she alone can do), frees up the advisor to do the work that really inspires them, creates opportunities for team members to have meaningful careers, and in the end also benefits clients by providing a wider range of services and solutions. The key point, though, is simply to recognize that while in the early years, the advisor-founder does everything because he/she must do everything, in the long run an unwillingness to delegate eventually puts a cap on the growth potential that can keep the business from moving forward until the fear of delegating is overcome.
Why Advisors Should Eliminate The “B” Word (Ron Carson, Investment News) – It’s common courtesy to ask someone “how are you” when connecting, for which the increasingly common response is something to the effect of “I’m good… but busy”, often followed by a joke that at least it’s “better than the alternative” (of not having any business coming in at all!). In modern culture, being “busy” has almost become a badge of pride, and the path to success is presumed to be paved with being continuously busy and engaged, from the “lean in” movement to the “sleep revolution” and the “hustler mentality” of always going for it. (And no shortage of tools from self-help podcasts to daily affirmation and calendar reminders to keep our hustle on track.) Yet Carson suggests that in the end, perpetually saying “I’m busy” really just communicates: 1) we’re not great at managing our time; 2) we’re not engaging in our day (instead we’re reacting to all the “busy” of it); and 3) we almost certainly aren’t giving the person who’s asking our undivided attention (as busy people are virtually always mentally distracted by all the “busy” they’re worrying about!). So what’s the alternative? Instead of focusing on being Busy, focus on being Balanced, which leads to control, which leads to focus, which gives us the capacity to prioritize what truly matters. Accordingly, Carson suggests an exercise he calls “The Six Most and the Vital One”: 1) At the end of each work day, write down the 6 most important things you need to accomplish the next day (no more than 6!); 2) Add up to one “vital” task beyond the 6, if it truly has to take current priority; 3) When you arrive at work the next day, concentrate on the first task (and only the first!) until it’s done, then move on to the next and so forth; 4) Carry over any unfinished tasks to the next day. The end result: you may not be able to finish everything on the list, but by definition you’ll finish whatever is most important first… and if a large number of tasks keeps carrying over every day, day after day, it’s a signal that you still need to establish better Balance and say “yes” to less!
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you’re interested in more news and information regarding advisor technology, I’d highly recommend checking out Bill Winterberg’s “FPPad” blog on technology for advisors as well.