Absolute Value and Transparency
This was originally published by Trusts & Estates, an industry journal for trustees and wealth management professionals serving the needs of high-net-worth clients, family business owners, family offices, charitably inclined donors and non-profit corporations.
As investment advisors, how do we add the most value for our clients?
At Fiduciary Wealth Partners (FWP), this is a question we often ask ourselves.
If you’ve read some of our other pieces, you know we are big fans of index investing as compared to active management. Some active managers have added value on a relative basis as compared to their appropriate indices, but at FWP we believe the evidence consistently points to the advantages of index funds (see related reading the bottom of this post).
When we talk about how to add the maximum value for our clients, however, I don’t think how we are performing relative to an index is the most important question.
A recent article on the views of Seth Klarman, who is one of the most well-respected active investors of our time, got me thinking more about this question. Below is a link to the piece, which gives a good overview of Klarman’s philosophy.
Absolute, Not Relative Returns
In particular, I could not 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.
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 is 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 (i.e., relative performance).
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.
Versus 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 are not for everyone (some people want to pursue the “New New Thing”). As I recently wrote in What’s In A Name, if investing in an active strategy or working with a large brand makes an investor feel more comfortable, and will allow him or her to stick to a plan more easily then, regardless of the relative performance versus an index, these might be 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 discussing both sides of topics, such as active vs. index funds, listening to what clients want to achieve, and implementing strategies that increase comfort and peace of mind.
If we spent more time offering Transparency, Simplicity and Peace of Mind ®, I think it would increase trust in our industry as a whole and help us form more lasting partnerships with clients.
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 should not 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.
Related Reading:
Cash Flow – Nothing More 
How Can Trustees Be Prudently Passive? 
Trust and Fiduciary Services: Questions to Consider