Four questions that financial advisors and clients need to ask in a post-Madoff, post-meltdown era
Until hard questions are asked, people default to the old answers
5 min read- Advisors must address client concerns about traditional asset allocation's effectiveness post-crisis.
- Investors question whether regulatory reforms truly protect them from future market failures.
- Clients seek guidance on asking better questions to navigate a 'broken' investment system.
- Acknowledge the unrealistic client desire for a 'flawless' investment strategy.
Ben Valore-Caplan, CIMA, is a registered investment advisor who broke away from UBS in 2008 to provide a higher level of counsel to his clients under Syntrinsic Investment Counsel, LLC. He writes out his thoughts about matters relating to investments and sends them to his clients in periodic e-mails. When I read this essay sent out last week, I asked if I could re-publish it for readers of RIABiz and Ben kindly agreed.
The Egyptian Nobel Prize winning novelist, Naguib Mahfouz, once suggested that, “You can tell whether a man is clever by his answers. You can tell whether a man is wise by his questions.” Being in the business of asking and fielding questions, I agree.
People reveal their hopes, dreams, biases, and fears through what they want to know. The questions we ask reveal our intelligence, capacity for learning, and, yes, our gullibility. These truths are particularly relevant in the investment world where so many behavioral factors such as emotion and personality influence how people evaluate economic decisions.
The questions we ask as a society also reveal broader social trends and shifts in conventional wisdom. Now two and a half years into one of the most intense global economic crises in modern history, certain questions have become increasingly common from investment committees, boards of directors, and individuals throughout the country.
Having engaged these questions at some length with people of varying sophistication, financial knowledge, geographic regions, and faith and political affiliations, we have found that these questions are deeper than they first appear.
Concern and frustration
They reveal a level of concern and frustration that has not yet been sufficiently addressed by policy makers, the media, or the investment industry.
Four questions have dominated investing-related conversations in recent weeks.
Regulation needs one simple theme: transparency
1. Does traditional asset allocation modeling still work?
Subtext: We had been told that Modern Portfolio Theory (MPT) was the magic bullet, that our risk could be easily and effectively quantified, that we could plan our futures (pensions, endowments, retirements, insurance policies, etc.) based around a relatively certain return stream over time, that Monte Carlo simulations would sufficiently describe the likely universe. But it didn’t work in 2008. It seemed to work in 2009.
The Real Questions: Now what? How do we invest going forward? Do you (regulators, academics, advisors) know why MPT didn’t work? What are you doing about it?
2. Has the regulatory environment improved?
Subtext: Regulators failed to catch Madoff, financial engineers sold product that was much riskier than they promised, there remain numerous conflicts of interest imbedded in the investment industry, the credit rating agencies mis-rated countless securities, banks are failing with alarming frequency, and Wall Street and the Insurance Companies pay politicians a lot of money.
The Real Questions: Can this carnage happen again? Has anything meaningful been done to make investing cleaner, more ethical, and easier to understand? Who—if anyone—is protecting the investor? Are they trustworthy, competent, and able to take meaningful action?
Story Timeline
3. What should we be asking our advisors?
Subtext: I am smart, careful, and thought I was doing a good job as an investor. I paid attention, hired professionals, kept up with current events, opened my statements, met with my advisor. I thought I was asking the right questions all along.
The 4 biggest investment performance myths -- and how they can torpedo advisor-client trust
The Real Questions: How can I be even smarter, even more careful and do an even better job now that I know how broken the system has become? How can I reduce the risk of another catastrophe?
4. Isn’t there a flawless investment strategy?
Subtext: I know about Madoff’s fraud, Lehman’s allegedly principal protected structured notes, CDOs that experienced default rates over 100 times expectations, Stanford Group’s Antigua-based CDs that really weren’t CDs, auction rate securities that had never failed until they all did, allegedly foolproof hedging strategies that lost 20-80% in 2008 and the near failure of the major annuity issuers. I know this, but I still believe that there is a secret sauce, a silver bullet, a magic formula for investment success.
The Real Questions: Won’t somebody else do the hard work for me? If I pay you enough (maybe even risking everything I own), will you tell me that I don’t have to worry about anything because you will take care of me?
Conclusion
Thus, while I believe that the investment markets and investing have entered a profoundly different era, the four commonly asked questions above reveal a society in the midst of tumultuous transition, recognizing intuitively and experientially that things have changed, but not yet knowing what those changes mean for real life.
By the way, my answers (in short form) are:
1). Not the way it has been used. Yes, we are working on it (as you know if you have been reading our commentaries.)
2). No.
3). We have developed a long list of about 60-70 questions. They are not foolproof.
4). No.
Benjamin Valore-Caplan, CIMA, Managing Partner, Senior Adviser, Syntrinsic Investment Counsel, LLC Denver, CO 80202
Ben.ValoreCaplan@Syntrinsic.com
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