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SAFT ON WEALTH-Serving clients, not beating markets
August 27, 2014 / 8:21 PM / in 3 years

SAFT ON WEALTH-Serving clients, not beating markets

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Aug 27 (Reuters) - It may be that the future of wealth management lies not in beating the market but in helping the client beat her true opponent: herself.

The traditional offering of the investment management industry - putting people into products which outperform - is under siege, hit by a trend of dwindling relative performance and massive defections of money to passive index-based strategies and products.

Charles Ellis, an eminence grise of index investing and the founder of Greenwich Associates, argues that the combination of falling fees for active management and the continued flow of funds into index products is going to challenge the economics and structure of the investment industry as we know it.

Writing in the most recent issue of the Financial Analysts Journal, Ellis makes an important distinction between the two traditional roles of money managers: "Ideally, investment management has always been a 'two hands clapping' profession: one hand based on skills of price discovery and the other hand based on values discovery." here

Price discovery is what most people think of when they think of money management: the process of finding price anomalies in the market and exploiting them to produce outperformance. Values discovery, in contrast, covers almost everything else in the money manager-client relationship and is therefore mostly about changing behavior, an arena in which the vast majority of clients are undone by themselves.

Of this, more in a moment. But first let’s just walk briefly through just a bit of the evidence about active fund management and the value it creates. Adjusting for survivorship bias, only a quarter or less of large- and small- cap growth funds outperformed their benchmarks in the 15 years to the end of 2011, according to Ellis. Among value funds during the same period the figures were 30 percent outperformance among those in small-cap stocks, and 43 percent among those in large-cap issues. This may be because investors are today better as a group, but competing against better opponents and thus less able to outperform compared to the 1960s or 70s when there were more less-sophisticated traders.

Eugene Fama, the Nobel Prize-winning father of the efficient market hypothesis, in 2012 asserted that among domestic mutual funds with at least 10 years of results only the top 3 percent show sufficient skill to cover their costs. Good luck identifying which three out of 100 you should choose.

But even if you, as a wealth manager, don’t buy the proposition that active management is a losing game, you have to accept that a large number of your clients, current, past and prospective, do.


All, however, is not lost.

While many wealth managers have reacted to the rise of index investing by working to strengthen their relationship with the client, all too often that has been in service of making sure that they remain clients and continue to buy active products in hope of beating the market.

The alternative path, what Ellis calls values discovery, is about “determining each client’s realistic objectives - including wealth, income, time horizon, age, obligations and responsibilities, investment knowledge and personal financial history.” The end result is more knowledge, both for the client and the manager, and then a strategy well calibrated to meet those realistic objectives.

The great virtue and beauty of this approach, and what makes it sustainable, is how much actual value it can create. This is about making sure clients save enough, and stopping them from rabbiting off after the latest social media IPO or, worse yet, selling heavily into a correction. All of these self-defeating behaviors are common, and many are arguably made more likely by the return-chasing stance the industry has traditionally adopted.

Investors who think they, or their representative, can beat the market also tend to think they can therefore skimp on saving, or that they can accelerate wealth creation by taking on more risk in hot areas, or that they can “get out” before the big crash.

But even with more sober clients, there is plenty to be done, and done in a way which knits the client to the adviser for the long haul. Planning, for example, for increasingly long life spans, or for the provisions needed for a disabled child. Helping people to understand and mitigate risk, not just in their investment portfolios, but in their careers, family and health. Combine that with low-cost products and you have a winning offering.

All of this is time-intensive, but it is also not easily done by robots or algorithms.

Now, what will the fee structure look like? That is open to debate and there are several models, but what is clear is that the upside is probably lower. Lower, but more secure and attainable.

Many will continue to try and win the price discovery game, but more will win at values discovery.

At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at and find more columns at Editing by Jonathan Oatis

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