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Filtering the Noise: A Defense of the Advisory Role

Joan Alexandre

Investment Analyst, Investment Management Research Group at 1st Global

Dec 13, 2017

The 24-Hour News Cycle 

In the not-too-distant past, there existed the concept of a “slow news day.” Newspapers were the primary mechanism by which people gathered information on current events, only to be topped off with that evening’s local or national broadcast. On Sunday, June 1, 1980, that all changed when an Atlanta-based cable upstart began transmitting. CNN was the first 24-hour television news channel. Said its founder Ted Turner during the inaugural broadcast, “We won't be signing off until the world ends. We'll be on, and we'll be covering it live.”

Turner’s experiment was not only the genesis of the 24-hour news cycle, but also served as the blueprint for myriad channels to follow. Many subsequent entries into this genre focused on finance and the markets. Regardless of whether the populace demanded this level of information inundation, the supply would nonetheless be ceaseless. Of the challenges presented by this marathon broadcasting, perhaps the greatest was — and continues to be — having a sufficient supply of news. Over time, the standards by which an item was deemed newsworthy fell precipitously and was coupled with the rise of the pundit.1

The pundit was the necessary solution to this existential conundrum. In theory, this person should have serious professional or scholarly credentials, making them ideally suited to comment on or analyze events. In practice, it has become commonplace for this “knowledge holder” to be fundamentally ill-equipped for the task. Many are sought for their capacity to drive ratings with little or no consideration given to their credentials or lack thereof. Unfortunately, some regard those who appear on TV as having the requisite knowledge because this “expert” gives credence to the viewers’ own beliefs (irrespective of the legitimacy of the precept). This most certainly tarnishes the legacy of the media as honest information broker, but injury seems most acutely inflicted on those who would use these outlets for their financial comprehension.

Jim Cramer
Jim Cramer, host of CNBC’s Mad Money

It tests credulity to accept that thoughtful individuals consider infotainment a legitimate source of actionable intelligence. Consider former attorney Jim Cramer (J.D., Harvard aLaw School), host of CNBC’s Mad Money, who may display investing skill when trading for his own benefit, but is separately regarded by other capital market experts as a menace to investors who watch his show.

His robust support of Bear Stearns during the March 11, 2008, episode is now legend; however, in his defense, he may have been referring to the safety of deposits held at Bear versus the quality of its equity. That seems a distinction without a difference given that his audience may not have understood the nuance of his recommendation.

Perhaps he can be forgiven this opacity on Bear Stearns, but most certainly not for his Oct. 6, 2008, entreaty to viewers that they should sell whatever funds they would need for the next five years — a five-year span that saw the market return 81.32 percent (on an adjusted basis from the day of his entreaty).

Another whose prognosticative ability may have been an outlier, Meredith Whitney, yelled the equivalent of “Fire!” in a crowded theatre when she opined in 2010 that municipal defaults would reach into the hundreds of billions. That dire warning never materialized; however, scores of investors sold in abject panic — often at fire-sale prices. Ms. Whitney’s reputation as oracle was cemented with her Oct. 31, 2007, call on Citigroup’s eventual freefall; however, she was out of her depth when speculating on the municipal market. Said Michael Scanlon, analyst with John Hancock Asset Management, in the wake of Whitney’s false alarm, “The history of Wall Street is littered with people who got one big call right.”2

The best cake-taking might be Vanguard founder John “Jack” Bogle’s observation that “choice is your enemy, because you choose based on one thing: past performance” reiterating that “past performance does not recur.”3 Many from physicists to philosophers would disagree with Bogle’s temporal perception. The problem with assuming the truth of his null hypothesis — that all historical data is the result of chance — requires one to accept that owning an asset is identical to owning the outcome of repeated rolls of the dice.

Moreover, he insults investors’ intelligence by ignoring their capacity to weigh either absolute or relative valuation criteria when considering an investment. While one should not assume that an asset’s prior performance telegraphs future behavior, historical data coupled with current, material information can suggest a trajectory with some measure of statistical significance. Although there is considerable dispersion in the year-over-year returns of the S&P 500, over time the index has been mean-reverting.

If wealth management professionals served no other purpose than acting as noise dampeners and malarkey filters, they would still be worth every penny — provided they didn’t fall prey to the same incessant carnival barking. Most individual investors are by nature a nervous lot, engaging in answer shopping to confirm their biases. Good financial advisors do many things well. Chief among them is their ability to negotiate with either the fear or avidity that is holding a client’s decision-making process hostage. This is no small task given the unending stream of factually compromised sources to which investors are exposed.

The Intersection of Behavior versus Reason

“The man who said ‘I'd rather be lucky than good’ saw deeply into life. People are afraid to face how great a part of life is dependent on luck. It's scary to think so much is out of one's control. There are moments in a match when the ball hits the top of the net, and for a split second, it can either go forward or fall back. With a little luck, it goes forward, and you win. Or maybe it doesn't, and you lose.” Christopher Wilton, Woody Allen’s Match Point, 2005

In April 2013, the Harvard Business Review published an article illustrating that experts who get “one big call right” are, more likely than not, just lucky. Jerker Denrell, professor of behavioral science at Warwick Business School, analyzed years of experts’ quarterly interest rate and inflation forecasts as reported in The Wall Street Journal and found that those who didn’t stray far from the pack proved the most accurate. Conversely, analysts making outsize, contrarian predictions that paid off once (or twice) were regarded as “market sages” despite most of their forecasts being incorrect. Simply put, the ability to call extreme events is likely an indication of poor judgment. The problem is the notoriety these people receive and the esteem afforded them lie in stark contrast to the value of their unlikely predictions. Where luck bisects skill is obscured and made all the more so when vivid examples disproportionately sway decision-making and more subtle, but accurate information is ignored.

Viewed through the lens of wealth management, the greatest difficulty for advisors occurs when clients present with the paradox of extreme loss aversion coupled with the expectation that outliers are foreseeable. For instance, how many clients called their advisors after the Brexit vote to ask why they didn’t have any investments exploiting the surprise results and subsequent market rout? Certain things should not be touted as a competitive differentiator; airlines should never use their safety record as a selling feature, and financial advisors should not sell performance.

This is not to suggest advisors cannot be consistently skilled investors; however, the discipline that consistency necessitates does not often lend itself to bold forecasts. That money’s perceived utility persists in counterpoint between those who share the belief that it “is a just a way of keeping score”4 and those who see it as “only something you need in case you don't die tomorrow”5 adds to the challenges faced by wealth managers. If a client’s thorough financial plan revealed the probability of a retirement-income shortfall, would it matter to the client that his portfolio was beating his neighbor’s? How then can wealth managers bolster clients’ immunity to repeated assaults by colorful but compromised media chatter?

The Antidote to Madness: Strategic Planning — More than a Collection of Tactics

Beyond retirement planning, financial advisors are embracing the concept of full lifecycle financial planning employing an asset/liability matching approach. Wealth management clients may have fairly complex needs prior to retirement, and planning should be as concerned with cash flow analysis in the accumulation phase as it is with income replacement in the decumulation phase. Complex compensation packages, multiple near and immediate-term liabilities, caregiving obligations, estate creation needs, charitable donations, healthcare spending and catastrophic loss mitigation strategies are among the many considerations necessary when creating a plan.

In addition to a comprehensive financial plan, many clients will benefit from an investment policy statement (IPS). The IPS has features of a financial plan, but it is perhaps best at translating and codifying a client’s loss aversion into a benchmarked investment strategy. In the absence of a comprehensive financial plan, effective allocation occurs in a vacuum. When approaching asset management from a balance sheet perspective (considering both assets and liabilities), the investment objective may be different from simply maximizing a portfolio’s Sharpe ratio. Effective planning can determine the allocation that will apportion assured cash flows when obligations come due; an asset only (AO) portfolio does not provide the same level of risk mitigation. Comprehensive planning is not without some burden to clients, but if the result is a feeling of tranquility when considering their future, the effort’s rewards far outweigh any initial hardship.

It seems incongruous that robo-advisor services and passive fund flows should have gained so much traction in recent years. However, if the only perceived value of financial advisors resides in their respective abilities to “beat the market,” it is a natural extension of the fundamental misunderstanding of comprehensive wealth management.

Moreover, market performance that seems to plot an infinite vertical trajectory appears to cloud investors’ memories and judgment to the fact that markets typically exhibit parabolic behavior: things that go up eventually come down and, on occasion, in direct proportion to their rise. It bears repeating that one could consistently beat the market and yet still run out of money in retirement — rendering scorekeeping merely academic and wholly unbeneficial. Contrary to Jack Bogle’s premise that the past does not recur, it seems we find increasingly creative ways to duplicate past mistakes. American writer and humorist Mark Twain opined that “if history doesn’t repeat itself, it certainly does rhyme.” Perhaps it is English novelist Terry Pratchett’s repurposing of Twain’s observation that best represents our fragile memories: "History doesn't always rhyme. Sometimes it just screams 'Why aren't you LISTENING?!' and lets fly with a brick."

If ever there were a time for financial advisors, it is certainly now.

 

About the Author

Joan Alexandre is an investment analyst in the Investment Management Research Group (IMRG) at 1st Global, where she conducts due diligence on existing and prospective investment managers, collaborates in the review of strategic asset allocation, contributes to decisions regarding investment selection and manager roles, and structures the output to support the investment decision-making process. She has been in the financial services industry since 2008 when she received an opportunity at a startup company. Prior to joining 1st Global in 2017, Joan has managed market data services, served as a financial advisor and investment analyst/wealth strategist, and provided consulting services for multiple private companies.

Sources

1 Pundit is a derivation of the Sanskrit word Pandit meaning “knowledge owner.”
2 Nelson D. Schwarz, “A Seer on Banks Raises a Furor on Bonds”, New York Times, Feb. 7, 2011.
3 Jack Bogle, “The ‘Train Wreck’ Awaiting American Retirement,” FRONTLINE, PBS, April 23, 2013.
4 Paraphrase of Haroldson Lafayette "H. L." Hunt, “Money is just a way of keeping score.”
5 “Carl Fox” as portrayed by Martin Sheen. Wall Street. 1984.

 

Securities offered through 1st Global Capital Corp. Member FINRA, SIPC. Investment advisory services offered through 1st Global Advisors, Inc. All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Past performance is no guarantee of future results. Neither asset allocation nor diversification assures a profit or protects against a loss in declining markets. An investment cannot be made directly in an index. Sharpe Ratio: A ratio of a portfolio’s return above the returns of a riskfree asset, such as a Treasury Bill, to the portfolio’s Standard Deviation.


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