Earlier this year I took part in a round-Britain roadshow for financial advisers organised by AJ Bell. It was, on the whole, an encouraging experience. Advisers are far more receptive now to evidence-based investing than they were when I first started speaking on this subject a few years ago.
But the response from one middle-aged adviser on that roadshow has stuck in my mind. “The problem with advisers,” he told me at the end of my presentation in Wilmslow, “is not that we don’t mean well. We do. It’s just that we’re not very bright.”
I have no issue whatsoever with the first part of his assessment; my impression too is that the vast majority of advisers genuinely want the best for their clients. But I was rather taken aback by the candour of the second part.
“I wouldn’t say that,” I replied politely. “There are some hugely intelligent advisers out there,” which of course there are.
Sometimes, though, I have to say I see the point he was making.
Schroders Financial Adviser Survey
Last week, for example, Schroders published its 2019 Annual UK Financial Adviser Survey. One of the questions advisers were asked was this: In what areas do you believe that active investment has the
potential to deliver consistent, superior long-term returns?
To be fair, it’s not a great question to ask. All active management, of course, has the potential to deliver superior returns, in just the same way that everyone who buys a lottery ticket has the potential to win the jackpot. That doesn’t mean it’s a sensible use of their money.
Leaving that aside, though, the advisers surveyed were given four options: all areas, most areas, limited areas and no areas. Staggeringly, 88% of advisers answered either all or most. Not a single adviser out of 130 surveyed answered none.
I don’t use the word “staggeringly” lightly. There are reams of academic papers dating back decades which show that only a fraction of active managers outperform the market on a cost- and risk-adjusted basis over meaningful periods. Scorecards like SPIVA from S&P Dow Jones Indices and the Active/Passive Barometer produced by Morningstar remind us of the fact time and again.
As for consistent performance, the overwhelming consensus among those who have studied this area in any detail is that there is hardly any. Fund performance across the world, and across every asset class, is characterised by randomness. There is no sector anywhere in which active managers have consistently beaten the market over long periods. None.
Yet here we are, at the end of 2019, and the vast majority of UK financial advisers are still pinning their hopes on actively managed funds to deliver market-beating reruns for their clients.
A global problem
It’s not just UK advisers, of course. Even in the US, where the awareness of active management’s failings is so much greater, most advisers continue to recommend active funds. In fact, the take-up of low-cost index funds by advisers is higher in the UK than in most other countries.
The question is, why haven’t more advisers seen the light? A paper entitled The Misguided Beliefs of Financial Advisors, published in January 2018, helps to provide some answers. The researchers surveyed 4,000 financial advisers and their clients, all of them from Canada. Interestingly they found that advisers generally invested their own money in the same high-cost, high-turnover, actively managed funds they recommended for their clients.
After adjusting for costs, they discovered that advisers and their clients performed as badly as each other, trailing the market by around 3% a year.
Compounded over many years, that level of underperformance will leave a huge dent in anyone’s retirement pot. So why would advisers want to earn such dismal returns? The answer, of course, is that they don’t. It’s their beliefs that are misguided.
Force of habit and groupthink
I’ve written many times before on why advisers continue to place so much faith in active management. Before RDR, the payment of commissions was the biggest factor. Nowadays, I suspect, the main reasons why advisers predominantly use active funds are force of habit and groupthink. That’s what they’ve always done, and that’s what most of their peers continue to do.
True, fund managers can no longer entice advisers to use their products by paying commissions, but they can still build rapport in other ways — through golf days, for example, corporate hospitality, and “educational” events offering valuable CPD points.
I often hear from advisers who say they accept the case for evidence-based investing on an intellectual level, but are worried about the commercial impact of changing direction. What will clients say if I tell them I’ve changed my mind? Will they be willing to pay the same fees if I put them in a portfolio of low-cost index funds?
Best for advisers as well as clients
My own experience is that advisers who take the plunge don’t regret it. In fact they find it liberating. Instead of worrying about the markets and how their various funds are performing, they simply put their clients’ portfolios on auto-pilot and focus instead on areas where they really can add value.
Advisers who switch to an evidence-based approach also report commercial benefits. Yes, it means redesigning your value proposition, your processes, marketing and client communications. But it frees up time to work on your business, attract new clients and really get to know them, and properly develop your staff.
Yes, far too many advisers have misguided beliefs that need to be addressed. And yes, I sometimes despair at quite how long it takes them to discover the truth. But, on the whole, most advisers want the best for their clients, and they’re certainly not unintelligent. A new era of evidence-based, client-focused advice is only just beginning.
Picture: Nik MacMillan via Unsplash