An Interview with a Reformed Broker

An interview with a “reformed broker”

Q. Before you switched to an index-based approach, how did you invest your clients’ money?

A. During my career, I have been exposed to numerous investment strategies and virtually all shared a common philosophy — a core belief that actively managed mutual funds or separately managed accounts were the best choices to help clients achieve their investment goals. From time to time, I would read studies showing the majority of active managers failed to beat their benchmark index, but I was convinced that large investment firms had the ability to identify those fund managers. I would go to great lengths, using multiple screening tools, to identify the “best” managers in various asset classes and then invest in a diversified mix of funds and managed accounts to implement the client’s asset allocation.

The “great recession” that began in 2008 was a wake-up call. The anxiety it produced for me and my clients was beyond anything I had experienced. Many of my clients started to panic and seriously considered getting out of the stock market completely. While all of this was happening, I researched strategies designed to protect my clients from another bear market. I studied technical analysis, tactical asset allocation and sophisticated algorithms employed by third-party managers. I employed some of these strategies because I felt strongly they were in my clients’ best interest. But the results were not good. They were all textbook cases of “past performance does not imply future results.” I went back to a more traditional approach to investing.

Q. Was there a trigger event that caused you to rethink your investment approach?

A. Yes. Definitely.

Q. What was it?

A. I started reading your articles in Advisor Perspectives and, when I reached out, you were quite adamant that we have a discussion about what you and many people in the industry call “evidence-based investing,” which I recognized as index investing. You sent me numerous studies and invested a great deal of time discussing the benefits of this approach and, over the course of my reading and our discussions, in my opinion, the evidence was clear that index investing was a superior way to help my clients meet their financial goals.

Q. What’s your current investment philosophy?

A. I believe that having the correct asset allocation is the most important investment decision investors make. I recommend the allocation that gives the client the highest probability of meeting their goals, with the least amount of risk. I then use low-cost index funds or ETFs to implement the allocation.

Q. How difficult was this decision?

A. A lot harder than it should have been. Logically, I was convinced it was the best decision for my clients and for me. Emotionally, it almost felt like I was giving up.

For many years, I was taught and believed that it was my job to “outperform” and if I was no longer going to use funds or managers that attempted to outperform an index, then I was “settling.” Over time though, you helped me realize that the evidence pointed to the exact opposite. I was not “settling” for “average performance.” I was in fact giving my clients the best chance of outperforming most other investments.

Q. How did you communicate this change to your existing clients?

A. I scheduled meetings or calls to review their investment plans and to re-profile clients based on our work together. I asked a lot more questions and spent much more time listening than talking. This not only helped me to better understand what was important to them, but also deepened what was already a great relationship. It also helped me focus the meeting on what was most important to the client. At the appropriate time I would mention that I wanted to change how I implemented their asset allocation and asked if an explanation of the new approach would be helpful. If they wanted an explanation I referenced the recommended asset allocation in their investment plan and explained that each asset class that comprised their allocation had an index and that I could best duplicate their allocation by using low cost ETFs and/or funds that were most closely aligned with each asset class.

Q. How did they respond?

A. Unanimously positive. I did not get push back from any clients. Many clients had read articles about indexing, but either did not fully understand it, or were not aware of just how many asset classes they could participate in through index investing.

Q. Has this change impacted your ability to attract new clients?

A. It has. Since we started working together, attracting new clients has become much easier. Whether my initial engagement is in person or over the phone, I have been able to establish better relationships quicker with prospective clients. Once we get to the stage of discussing their investments, I will compare how they currently invest to an index approach and just like with existing clients, the reaction has been 100% positive. Even when I have met people who already use index funds, I have found that they are under diversified, so they appreciate the breadth of my knowledge on indexing. I also added a page to my website that discusses my investment philosophy and have had a few new clients tell me that they decided to meet with me specifically because I was the only advisor they researched that referenced index investing on their website.

Q. How has this change impacted you personally?

A. I have a lot less stress and frustration in my life. I also feel it has helped me be more passionate about my work again because I have the confidence of knowing that my clients’ performance will be in line with their expectations and their assigned benchmarks. I no longer have to explain why we underperformed.

Ramifications

Is this advisor an outlier or a harbinger of the future?

The logic that persuaded him to change his investment philosophy is difficult to dispute. Will others tire of explaining why the portfolios of their clients consistently underperform their risk-adjusted benchmarks?

If the trickle turns into a flood, what are the ramifications?

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