Tag Archives: income

CFA Institute Study: Disclosing Fees, Conflicts Vital To Adviser-Client Relationship

What do investors want? It’s an issue of critical importance — and concern — to CFA Institute, an organization committed to the highest standards of ethics, education, and professional excellence in the investment profession. And at no time in the history of the investment management industry has this question mattered more. Longstanding business practices are under scrutiny, stoked by acrimonious debates in the United States over the duty owed by the person giving investment advice, and by the availability of low-cost automated financial advice globally. These issues are poised to change the investment industry as we know it. Simply put, understanding the needs of investors is critical to strengthening client satisfaction and loyalty in a rapidly evolving industry. For these reasons, CFA Institute partnered with global PR firm Edelman on From Trust to Loyalty: A Global Survey of What Investors Want . In it, we investigate trust within the investment community, surveying retail investors and institutional investors around the world to examine how much they trust the financial services industry, and comparing this to the general population surveyed in the annual cross-sector Edelman Trust Barometer . While investors have a slightly more positive view than the public, our survey shows there is much more room for improvement. When asked if they trust the financial services industry to do what’s right, 61% of retail investors agreed, 57% of institutional investors agreed, and only 51% of the public agreed. Moreover, the number from the public is up 8% from five years ago — an improvement, but hardly impressive in absolute terms. These findings have practical implications for the investment management profession. The survey also explored what dimensions influence that level of trust by giving respondents actions to rank in importance and satisfaction. The gaps are eye-opening and provide a roadmap for firms who wish to strengthen their value proposition and build loyalty with investors. Paul Smith, CFA, president and CEO of CFA Institute, has argued that shortcomings like these and a lack of trust are factors that hold the investment industry back. “Building trust requires truly demonstrating your commitment to clients’ well-being, not empty performance promises or tick-the-box compliance exercises,” he has said. “Effectively doing so will help advance the investment management profession at a time when the public questions its worth and relevance.” Assessing the Gaps Between What Investors Want and What They Get Both retail and institutional investors share the view that financial professionals are falling short on issues of fees, transparency, and performance. Among retail investors, the most important actions from an investment firm are that it “fully discloses fees and other costs” and “has reliable security measures.” These even surpass protecting their portfolio from losses. Among institutional investors, “acts in an ethical manner” rated as the most important attribute, followed by “fully discloses fees and other costs.” That’s not to say that performance is unimportant — 53% of retail investors and 60% of institutional investors cited “underperformance” as the biggest factor that would lead them to switch firms. This was followed by “increases in fees,” “data/confidentiality breach,” and “lack of communication/responsiveness.” Fee Transparency Even More Important Than Returns The survey reveals that the biggest gaps between investor expectations and what they receive relate to fees and performance. For many investors, understanding fees — how much they are paying and what they are paying for — ranks above returns in their priorities. Seventy-nine percent of retail investors said it was important to them that their investment firm clearly explain all fees before they were charged, and 73% said generating returns similar to or better than other firms was important. Click to enlarge Retail investors say they are prepared to pay fees, even higher fees, if they feel these costs will add value or deepen existing services. In what areas are retail investors willing to pay more? Better protection from portfolio losses (38% say they would pay more for this) Reliable security measures to protect their data (35%) Investors also want more context to understand specific portfolio management strategies, reflecting their increasing desire to be engaged. The top client service action retail investors want is that a firm “helps me understand why my portfolio is positioned the way it is.” This is expected by 70% of retail investors, but only 46% say investment firms are adequately delivering on this — a large gap that firms should close. Disclose Conflicts of Interest Investors surveyed also want upfront conversations about conflicts of interest, with fees structured to align with their interests. They want to be sure that their managers are acting in their best interest at all times, and it is in the best interest of investment managers to clearly communicate their commitment to conflict management and resolution. As regulators and industry professionals alike grapple with the conflicts of interest associated with a variety of investment advice business models, investor preferences are clear: They want the best solutions for their unique needs, and not just the lineup of products that the adviser can receive compensation for selling. Retail investors surveyed prefer to have access to the best product for their unique needs (76%), rather than choosing from a constrained set of products, even if choosing from constrained offerings would lower their out-of-pocket expenses for investment management (24%). Click to enlarge Institutional investors had similar priorities and concerns, and in addition, they identified gaps related to the depth of understanding an investment firm has in helping them solve their problems. For these investors, they expect a firm they hire to think beyond a specific mandate and show they truly understand their organization’s priorities, liability structure, and political dynamics. Rise of Robo-Advising The study reveals key regional and demographic differences in what investors value from financial professionals, with implications for robo-advisors. Looking ahead three years, the majority of investors in Canada (81%), the US (73%), and the UK (69%) say they will still value the guidance of an investment professional to help them versus having the latest technology and tools. However, the majority of retail investors in India (64%) and China (55%) and half of investors in Singapore believe having access to the latest tech platforms and tools will be more important to executing their investment strategies. Younger respondents also strongly preferred technology to human guidance, so this is an important trend for the future. What does this mean for financial professionals? It’s simple: Investors expect more than just performance. While markets may be uncertain, there are many factors that investment professionals can control in how they conduct their business and work with clients — and these are very valuable. From transparency around fees and investment decisions to aligning their interests with their clients’, investment firms have great potential to build greater trust among investors. Show your commitment to advancing ethics and trust:

Over-Rated: Do Fund Asset Classifications Tell The Whole Liquidity Story?

By Hamlin Lovell, CFA Suspensions of dealing by the credit mutual funds Third Avenue and Stone Lion have prompted various knee-jerk requests for a simple rule of thumb to help avoid recurrence: Beware Level 3 assets. It is reported that Third Avenue owned 18% in Level 3 assets. Many credit funds have zero or less than 1% of their assets in this category. Behavioral finance teaches us that we are susceptible to messages that simplify the complex. Unfortunately, financial market liquidity may not be amenable to such simple rules. Level 3 assets are assets for which a fair value can’t be determined by observable measures such as models or market prices. Though they are commonly dubbed mark-to-model, any unobservable input applied to modify a market price can also lead assets to be classified as Level 3 despite their valuation not being entirely model driven. Furthermore, relying on the Level 1/2/3 breakdown as a proxy for liquidity can result in both false positives and false negatives. Let’s start with the false negatives. Absent or insufficient market prices or dealer quotes can be reasons for Level 3 classifications, but they are not the only reasons. For instance, derivatives with non-standard maturities may be valued by interpolating between broker quotes on those derivatives with standard maturities. So a six-week currency option might be valued roughly halfway between a one-month and a two-month quote, but if the fund in question offers quarterly dealing, there need not be grounds for concern about asset/liability mismatches. But Level 3 is a broad range. At the other end of the spectrum, Level 3 could include private equity that might never be monetized, leading to an immortal “zombie” fund. Many assets might fall between these negative extremes; structured credit, for example, can be self-liquidating if cash flows from underlying assets accrue to various tranches according to the predetermined schedule. Some short-dated structured credit assets could generate cash flows faster than, say, zero coupon or payment-in-kind (PIK) bonds, where there may be indicative broker quotes – but you’d only find out if the borrower could repay (or refinance) at the maturity date! So using Level 3 categorizations to avoid illiquids is a crude tool. Of course, for those investors not worried about missing some adequately liquid assets falling under the Level 3 umbrella, a “Level 3 is bad” rule should still avoid many of the least liquid and completely illiquid assets. Less discussed and of greater concern are the false positives that can arise from assuming Level 1 and Level 2 must be liquid. That assets have an exchange price or some form of counterparty quote does not mean they can be traded in unlimited amounts, as the price or quote may only be good up to certain volume levels. Indeed, Third Avenue claimed it cannot liquidate “at rational prices,” which may imply they could sell at discounted prices. Any asset’s liquidity needs to be seen in the context of the fund’s position size, and I have seen funds take months or years to exit some Level 1 or Level 2 securities when they are holding a substantial multiple of volumes. The bottom line is that valuation methods should not be used to draw inferences about liquidity. Credit Ratings Third Avenue owned significant amounts of assets with a CCC credit rating, which may be deemed extremely speculative. The impulsive response here is to suggest that funds with higher credit ratings are more liquid, or less risky, or both, than those with lower (or no) credit ratings. Let us remind ourselves that some asset-backed security vehicles stamped AAA and backed by subprime mortgages ended up worthless and illiquid during and after the 2008 crisis, to the chagrin of institutional investors ranging from Norwegian pension funds to German municipal banks. Some money market funds that were perceived as super-safe cash substitutes also had to suspend dealing in 2008, and they were, broadly speaking, required by Rule 2a-7 to hold assets bearing the highest two short-term credit ratings. Since September 2015, money market funds are no longer bound by this constraint , as Dodd-Frank requires them to ensure assets meet a range of appropriate criteria. “Unrated” Assets When an asset is unrated, it generally means that the issuer has declined to pay for a credit rating rather than that the ratings agency has declined to provide one. The amount of C-rated issuance seen in the United States and Europe over the past two years shows that agencies are perfectly willing to provide some of the lowest credit ratings to companies that may be stressed or distressed. Convertible debt is often not rated, but this does not necessarily mean it is less liquid. I recall convertible bond funds largely comprising unrated names in 2008 paying out plenty of redemptions on time. In any case, credit ratings are not necessarily a reliable proxy for liquidity. Some credit assets reportedly see higher volumes after they get downgraded or default, partly because some holders become forced sellers and specialist distressed investors then become interested in the higher potential returns on offer. So, neither valuation hierarchies nor credit ratings can necessarily guarantee fund liquidity. Nor can regulation – both US mutual funds and US money market funds are now allowed to suspend dealing, and the SEC has approved Third Avenue’s suspension. Investors and advisers need to broaden and deepen their levels of analysis to get a better handle on liquidity risks. Quantifying fund liquidity is not only nuanced but also fluid, particularly as there can be seasonal variations, with calendar year-end reportedly a less liquid time. Investors and asset management companies may be drawn to the apparent certainty of putting funds into a small number of boxes, buckets, or categories, but this may prove to be a false comfort. Exact estimates of fund liquidity could prove to be spuriously precise, so the concept needs to be presented in broad brush terms that allow plenty of margin for error. Disclaimer: Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Be A Proactive Investor

During volatile times in the market, like what we have been experiencing since May, it’s difficult to see through the disparaging news headlines (Oil is Collapsing! Bear Market in Stocks! US Is In A Recession!) and to not lose the forest for the trees. Investing is a long-term game with seemingly unlimited number of opportunities and it’s imperative as an investor to not get caught up in the day-to-day swings (and explanations) of the stock market. It’s times like this where a word like “casino” gets tossed around as a synonym for the stock market. And you know what, in the short run, the market is a lot like a casino. One day the market is up, the next day the market is down. Don’t believe me since it feels like the market has been down a whole lot more than it has been up lately? Well, would you be surprised to know that over the past 200-days developed world equities have been up 47% of the days and down 53% of the days. Pretty close to a 50-50 coin flip, right? Percentage Of Positive Performance Days For Stocks Proactive Investor But long-term investors know that the stock market isn’t really like a casino at all. The “payoff odds” in the stock market are not static like they are in a casino. Hitting the right number in roulette will always pay 35:1 but investing in the right stock could return 10% or it could return 10,000%. Therefore, it’s key to think of investing in terms of probabilities instead of binary outcomes. Investing is not about calling the top or bottom in the market exactly right. It’s about understanding if there are more positive investment opportunities in the market than there are negative opportunities (or vice versa). Put another way, it’s about properly identifying where the market currently falls on the risk/reward spectrum. This way, you as an investor can be proactive rather reactive to changes in the market. We have known for quite some time that this is the longest running cyclical bull market in a secular bear market , so a selloff like the one we are in now was bound to happen sometime. And in the long term, that is actually great news for investors because future returns have undoubtedly improved thanks to the opportunity to buy stocks on “sale.” But this is where investor psychology really comes into play. If your risk antennae was not tuned up to the fact that the probability of a selloff had increased (i.e. the opportunity set had shifted from more buying opportunities to more selling opportunities), then it’s really difficult to realize after a 15-20% decline that the opportunity set is ALREADY shifting again back into your favor. You are reacting to the declining market and when you are reacting, it’s hard to make the correct rational decision. To sell stocks into a declining market is always hard because in the back of your mind you know you missed out on the optimal time to get out and it’s so easy to tell yourself “I’ll sell out of stock XYZ just as soon as it rises 5-10%.” Of course, in a slide like we are in now, it’s very rare for the market to ever give you that 5-10% gain, and so you sit on the underperforming stock far longer than you would have liked. However, if an investor is proactive in identifying where we currently sit on the risk/reward spectrum, there is a very good chance that that investor had begun to shift his or her portfolio into more defensive sectors and perhaps into cash as well. While they would have been undoubtedly early and missed out on some of the gain back in May, they are already mentally prepared to begin to take advantage of some of the positive opportunities that are presenting themselves in this correction. This is why at Gavekal Capital, we focus so much on risk management. Yes, risk management is about protecting the downside. But more so, it’s about being proactive in your investment process so that when the risk/reward spectrum flips in your favor you are ready to take advantage of it and capture the gains in your portfolio. Disclosure: None.