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Is our industry facing a crisis of faith?

30 July 2015 Paul Nixon, Head: Investment Product Enablement Barclays Africa Global Investments and Solutions

FAnews recently received an article from Paul Nixon, Head: Investment Product Enablement Barclays Africa Global Investments and Solutions, about some truths in the investment space which will bring some insight into the value of financial advice – an article we thought worth sharing.

Best interests at heart

Much attention has been paid to the looming impact of the Retail Distribution Review (RDR) and the “twin peaks” model designed to protect consumers and make our financial system safer. 

However, have we considered the other side of the coin? Do we, as investors, feel comfortable with our investment and financial professionals, assured that our best interests are at the heart of a $17 trillion industry in the US and R4 trillion industries in South Africa? 

Sobering realities

The Centre for Applied Research, a global independent think tank, conducts regular research into issues shaping the future of the investment management industry. Their most recent article, ‘Folklore of Finance’, highlights a few sobering realities. A profitable asset management industry (quantified by rising global assets under management) does not necessarily mean a successful one. 

The very definition of success has long been associated with achieving the increasingly elusive alpha or excess return relative to risk taken. But even if alpha were produced with relative ease and frequency, surely true success should also be defined by whether or not investors were able to reach their long-term goals? It appears that a significant imbalance is at play, an obsession with the former while ignoring the latter. 

To reinforce this notion, we turn to US-based research and evaluation firm, Dalbar and Associates. Analysts have been running what they term QAIB or a Quantitative Analysis of Investor Behaviour since 1984. This model basically compares US market returns to those delivered by mutual funds or unit trusts. 

A harsh truth

Since 1984, the S&P500 has delivered rock solid growth of over 11%, despite inflation coming in under 3% over the same period. Investors in equity funds however, received a miserly 3.69% or 1/3 of the market return. Even more concerning, but shedding some light on the results is that the average investor only remained within the respective equity fund for 3.33 years. It is therefore, safe to assume that achieving 1/3 of the market return over a sustained period leaves us little chance of reaching our long-term goals. Investment professionals are failing on both fronts. 

Closer to home, a recent study revealed that 84% of independent financial advisers cite fund ratings from independent agencies as an important criterion when investing client’s money. Once again, this points to misplaced attention on fund performance (a manager’s ability to generate alpha), while ignoring the actual value of financial advice (getting a client to his or her financial goals). 

The Centre for Applied Research argues that the industry is facing a crisis of faith; investors are sharing a deepening distrust from the dissatisfaction of not reaching their goals. This inevitably leads to disintermediation where a growing number of investors believe they can do a better job for less money themselves. Unfortunately, knowledge of investor and human behaviour will show this route to be fraught with danger. The final study we shall draw on closes the gap presented in our discussion. 

The value of financial advice

The Investment Funds Institute of Canada published research in 2013 to quantify the value of financial advice over 3 610 Canadian households. Among the most striking of results was that an “advised household” of 15 years or longer managed to BREAK accumulate 2.73 times more assets. Furthermore, households linked to a financial adviser save at twice the rate of non-advised households (8.6% of income compared to 4.3%). These investors also participate in preferential tax sheltered plans resulting in higher returns. Finally, advised households are an important contributor to levels of trust, satisfaction and confidence in financial advisers and the financial services industry.


Source: The Investment Funds Institute of Canada, New Evidence on the Value of Financial Advice, 2013: Dr Jon Cockerline


 The positive effect of advice on wealth accumulation cannot be explained by asset performance alone, but to a greater savings discipline, avoiding self-destructive and greedy behaviour of trying to time markets and maximising investment returns through paying less tax. 

Editor’s Thoughts:
There is truth in Nixon’s statement that a significant part of the journey to restoring client faith in the investment management industry lies in positioning value correctly. That is, building long-term relationships in managing client wealth holistically - a key enabler in reaching financial goals. Do you agree with this? Please comment below, interact with us on Twitter at @fanews_online or email me your thoughts

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