How do advisors explain the benefits of active management to clients?

by David WismerMar 13, 2019Advisor perspectives

How do advisors explain the benefits of active management to clients?

by David WismerMar 13, 2019Advisor perspectives

Financial advisors favor third-party active management for a wide variety of reasons: access to modern analytical strategies, emphasis on risk mitigation, the ability to be responsive to current market conditions, and the ability to deliver high levels of client satisfaction over full market cycles.

Over the past four years, our editorial staff has interviewed dozens of advisors across the United States. They are a diverse group, representing many business models in the industry and whose firms come in all “sizes and shapes.” What they all share is a strong desire to find investment solutions for their clients that will stand the test of time.

Simply put, this means employing strategic approaches that can generate competitive returns in both bull and bear markets through the use of strong risk-management techniques. It also means adopting a planning and investment philosophy that can accommodate investors with different levels of financial sophistication and risk tolerance. For this, they turn to active investment management.

In today’s highly competitive arena of financial advice, developing a value proposition for an advisory firm is critically important. The vast majority of advisors we have interviewed believe that their use of third-party actively managed strategies for client portfolios is an important part of their firm’s value proposition.

In fact, a 2014 study from Pershing, developed with research firm Harris Poll, provided “a data-driven perspective on unique value propositions—the clear statements that explain what sets an advisory firm apart.”

This study, “What Do Top Advisors Say—and What Do Investors Really Think? A Study of Advisor Value Propositions,” identified eight of the most powerful value proposition statements for advisory firms among high-net-worth investors. While all eight statements thematically reflect many of the beliefs of the advisors we have interviewed, five statement areas are of particular interest.

TOP-RATED ADVISOR VALUE STATEMENTS FOR HIGH-NET-WORTH INVESTORS (% RATING HIGHLY)

While this research on value propositions is very informative, how do financial advisors and wealth managers express their philosophical and pragmatic beliefs in active management to clients … in their own words?

For this issue, we looked at how several advisors have addressed the question:

How do you talk about active management to your clients?

David Quick • Dallas, TX
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“One simple analogy I use relates specifically to their journey of retirement. I describe this as the longest vacation they will ever take and the need for the appropriate vehicles to carry them through that vacation. No one would consider taking a trip across the country in a car that had only one gear—the forward gear, constantly pressed to the floor. There are times you need the car to slow down, to stop, and to be put into reverse, depending on your destination, your progress toward your goal, and driving conditions. Same thing with an investment strategy, in terms of needing all the options available to make the required adjustments along the road. I believe this approach will make for a more comfortable and productive journey for my clients over the long haul.”

Jerry Ganz • Green Bay, WI
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“I explain that the S&P 500 is really irrelevant to the return performance they need to fulfill their investment goals. They require returns at a manageable risk level that will meet their own personal plan-based requirements, not ‘market returns,’ whatever they may happen to be in any given year. One of our third-party managers has an excellent software program that can look graphically at a probable range of expected returns, showing the probabilities of highs and lows within that range. Clients can clearly see where their returns will likely fall over time.”

Johnathon Davis • Lexington, KY
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“The key selling point for active management is its ability to react to current market conditions. This is a fresh concept for most of my clients, who have been uncomfortable seeing their accounts move up and down based on the volatility of the markets. Our money managers use a quantitative approach to help smooth out that volatility, which becomes especially important during bear markets. The recent financial crisis showed investors, especially retirees, the dramatic impact a stock market decline can have on their holdings at the time when they need to access their money most.”

K.C. Crahan • Shelbyville, KY
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“When I present recommendations, I tell clients it is probably not what I would have recommended a few years ago and probably not what I will recommend several years from now. This helps them understand that markets constantly change, and their investment plan and portfolio need to be flexible. We want the opportunities that are presenting favorable outlooks now, while avoiding weaker-performing areas. While I am willing to consider a range of investment alternatives, risk management and capital preservation are at the core. I explain to clients, for example, that if they can achieve about 75% of market gains in a bull market, but manage around the big losses in a bear market, their portfolio will be far better off in the long run.”

Cheri Johnson • Gig Harbor, WA
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“I explain to clients that we need investment tools that are built for today’s market and tomorrow’s market. I show them a simple chart of the S&P 500 over the last 20 years, and it instantly becomes apparent to them how the market has gone through some dramatic cycles up and down. Why would one not want to try to take advantage of following major trends, when there have been at least five major established trends since the late 1990s? Of course, it is easy to see them with perfect 20/20 hindsight—not so easy when you are in the middle of them and a trend is in the process of shifting. This is why we employ the service of professional third-party active managers for client portfolios. They have very sophisticated models, employing a quantitative and analytical approach that attempts to stay in sync with the trends.”

Phylyp Wagner & Matt Quattlebaum • McLean, VA
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“One of the key components to building a successful financial-planning practice is to be the quarterback of the process, showing leadership and clear direction. We try to explain complicated financial-planning processes in simple language and motivate people to take action. Clients need to have a clear and realistic set of expectations, and part of that is demystifying Wall Street gibberish. We tell clients that there are only three technical terms they need to know, and then explain as simply as possible the concepts of alpha, beta, and R-squared. When we are done, they usually have a good idea of what we are trying to achieve: managing risk within their portfolios while trying to achieve competitive returns.”

The opinions expressed in this article are those of the author and do not necessarily represent the views of Proactive Advisor Magazine. These opinions are presented for educational purposes only.

This article first published in Proactive Advisor Magazine on August 3, 2017, Volume 15, Issue 4.

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