Monday , 7 October 2024

4 Tricks Some Financial Advisors Use On Their Clients (+2K Views)

…Trust is obviously a huge aspect of any client relationship in the financialinvesting6 services industry, but there are some red flags people can look for to make sure their outsourced investment advice isn’t coming from a charlatan. Here are four tricks the finance industry plays on their clients.

 

A guest post by Ben Carlson (awealthofcommonsense.com) which has been slightly edited and abridged to provide a faster and easier read.

…Because there are really no independent parties overseeing the fund managers, advisors and consultants who are managing their money, a lot of the time it’s the clients who are left to judge the performance of those investing or making decisions on their behalf….Basically it’s a whatever-they-say goes arrangement. It’s hard for many clients to even know that they have subpar results because the “experts” they’re listening to set the expectations and benchmarks.

Here are four tricks the finance industry plays on their clients:

1. They move the goalposts. One of the most important jobs of any finance professional is to set reasonable expectations for their clients in terms of potential risk and reward. For those who don’t do a very good job at this, one of the go-to moves after a poor period of performance is to simply move the goalposts.

One of the biggest red flags in terms of moving the goalposts is when the pros want you to change their benchmark after the fact. There could be times when a different benchmark might make sense, but I’d say 99% of the time it’s just a way for professionals to make their poor performance look better than it actually was. Benchmarking seems like it should be fairly straightforward but you would be amazed at the sheer number of different benchmarks professional investors can come up with. The worst offenders in the goalpost move typically look to risk-adjust a previously chosen benchmark (translation: lower the hurdle rate).

2. They exhibit style drift. Some money managers or advisors have carte blanche to make fund or portfolio changes as they see fit in a go-anywhere investment style, but these types of strategies are typically few and far between. Most investors have a mandate or set of guidelines they are supposed to follow.

Periods of poor relative performance, however, can tempt money managers to invest outside of their stated mandate and lead to a change the investment strategy. Managing risk is one thing, but often times a change in strategy brings more, not less risk to a portfolio. If a portfolio manager or advisor promised you one strategy and suddenly switches to something else, there are risks involved that most investors probably don’t understand and won’t see until it’s too late.

3. They change the narrative. Everyone loves a good story, so instead of admitting wrong-doing many finance pros will simply change their narrative. Institutional investors in hedge funds are notorious for the narrative shift. At first they were looking for outperformance. Outperformance turned into stock-like returns with bond-like volatility, which turned into absolute returns, which turned into lower drawdowns, which turned into lower volatility, which turned into uncorrelated returns and fund managers are more than happy to follow along with these shifts in narrative and give the investors exactly what they’re looking for depending on the most recent market environment.

An inconsistent investment narrative has a high correlation with an inconsistent investment process. Neither is helpful to the bottom line.

4. They blame someone else. When all else fails, most pros just end up blaming someone else — the Fed, the markets are artificial or being manipulated, risk-on/risk-off, index funds, correlations are too high, the markets are rigged, short sellers, other market participants are irrational or any number of conspiracy theories.

Very few investors ever want to admit that they were wrong for fear of being outed as being anything short of prophetic. At times investors really need honesty and transparency from their financial professionals. It’s never a good sign when someone won’t admit they were wrong or explain why outcomes in the markets don’t go as you would like them to at all times.

Finance professionals who move the goalposts, exhibit style drift, change the narrative or blame someone else are typically trying to save their job.

The types of people you want to work with in the financial services industry (1) set reasonable expectations up front, (2) constantly communicate the pros and cons of your chosen strategy and (3) are completely transparent and honest about your results.