Data & Research November 12, 2012

Investors Behaving Irrationally

Retail and institutional investors are exhibiting behavior that appears to be at odds with their investment goals, a study found.
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Investors are not acting in their best interests as they are becoming more aware of economic instability and misaligned interests amongst investment providers, government and markets, according to a study by the State Street Center for Applied Research. As a result, their investment decisions do not always match their stated goals, and there is ample aggregate evidence of this behavior.   

Institutional investors are faced with challenges in navigating the complexity of certain asset classes. Low-yield markets have increased institutional investors’ appetite for alternative strategies, yet the majority admits the greatest challenge is not having a deep enough understanding of these assets. 

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In addition, according to the study, retail investors’ conservative strategies are cracking their retirement nest eggs.When retail investors were asked what steps needed to be taken over the next ten years to retire, the majority said to invest more aggressively, yet cash is their number-one allocation now and is expected to remain number one over the next decade.

 

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Against this backdrop of investor disconnect between behavior and goals, the study found that investors identified performance as the most important metric for determining the value of their investment providers as well as the greatest weakness of their investment providers.  

Accordingly, the study revealed that when it comes to performance, one size no longer fits all. “Current monolithic benchmarks based on relative performance to peer groups or indices serve the provider,” said Suzanne Duncan, global head of research for the Center for Applied Research. “The investor’s view of value is now more complex and reflects his/her own personal blend of strategies and objectives. In today’s investment reality, the investor is the benchmark when it comes to defining performance.”   

The study also found that investors’ seemingly irrational behavior is actually a rational response to a number of factors impacting the current global investment environment:  

  • Major economic trends, including a steady increase of national debt worldwide, tighter correlations across global markets and a rise in systemic risk;  
  • Mistrust of their primary investment provider to act in their best interest, stemming in part from lack of value delivered versus fees charged—only one-third of investors believe their primary investment provider is acting in their best interest; and  
  • Impediments from politics as well as new financial regulation that most investors believe will be ineffective and expensive. Sixty-four percent of investors believe that regulation will not help address current problems, and 62% believe the cost will be passed on to them. 

The study was based on input from more than 3,300 investment management industry participants across 68 countries. The study report, “The Influential Investor: How Investor Behavior is Redefining Performance,” is available at http://statestreet.com/centerforappliedresearch.

Data & Research November 12, 2012

Advisers Need Growth Strategy Plan

Registered investment advisers (RIAs) must invest in their company to ensure it not only thrives but grows.
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That is the message of “Taking Control of Your Future: Scale, Value and Certainty,” a report from the Alliance for Registered Investment Advisors (aRIA). 

“We have a lot of great financial advisers in the RIA and independent channel, but there is less focus on business management than there should be,” John Furey, principal with Advisor Growth Strategies and a managing member of aRIA told PLANADVISER.

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“Many advisers focus solely on being a great planner. When it comes to thinking about long-term succession and building scale, there is much less focus on that.” It is not sufficient for an adviser to focus on the “day to day,” ignoring the fact that they aren’t experiencing any “pain point,” Furey said, because the fact of the matter is, without a plan, an RIA firm will undoubtedly experience erosion caused by “new competitive forces.” Over the past few years, independent advisers were able to take market share from wirehouses, and that cycle is now over, Furey said.

As aRIA puts it, advisers need to “take control of their future” by creating “scale, value and certainty. Increasingly, the RIA channel is seeing dispersion where larger, more sophisticated entities are gaining share, while other advisory firms are stagnating. The key distinction is effective business planning and the ability to generate people, process and investment to take a firm to the next level.”

It is not enough for advisers to generate healthy profits that entitle them to what aRIA calls a status quo, or “lifestyle practice.” Advisers need to develop a long-term growth plan of 10 years or longer, aRIA said. They need to consider ways to grow organically by reinvesting capital to hire a chief operating officer and/or chief marketing officer—or perhaps partnering with or acquiring other advisory firms.

Admittedly, this is a difficult decision, which is why only about 10% of RIA firms have a “meaningful,” long-term growth strategy. “If you have $1 million in revenue and profits of $200,000 but need to invest $150,000 to grow your business, it’s a difficult and emotional choice,” Furey said. “Most advisers fail to do that and have a plateau effect. What they need to do is put a meaningful investment back into their business.

A strategic plan needs to include a blueprint for exiting the business when the lead adviser is ready to retire.. “Most deals take several years, and in many cases, the adviser has to stay on three to seven years after the deal closes,” Furey said. “We handled a succession plan for a $100 million firm in northern California, and they have a 15-year plan to transfer the business.”

The options advisers can take to grow their business, according to aRIA, include:

1.) Hiring the right talent.
2.) Hiring a business manager in addition to great advisers.
3.) Building scalable systems and processes.

As the aRIA report puts it: “Too many independent advisers may be stuck in the present and could put greater emphasis on taking control of the future. Advisers who fail to plan for the future or decide to do nothing are almost certain to realize eventual fee compression, erosion of margins, challenges in recruiting top talent, a below-market firm valuation, limited liquidity options and degradation of enterprise value.”

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