MainStreet Advisors - Indiana Bankers Association
EFFECTIVELY COMMUNICATING INVESTMENT PERFORMANCE TO CLIENTS
OVERVIEW
TODAY’S PRESENTATION WILL ADDRESS THE FOLLOWING: 1. Fundamental Tools for Effective Communication 2. The Importance of Team Buy-In 3. Danger of Poor Communication 4. Behavioral Biases 5. The Role of the Active/Passive Debate 6. Strategies for Amplifying the Value Proposition 7. Summary; Final Thoughts
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION INVESTMENT PERFORMANCE REPORTING IF POSSIBLE, USE A THIRD-PARTY INVESTMENT PERFORMANCE PROVIDER – An independent, third-party provider allows for increased advisor credibility and client comfort – Another good option: a trust accounting system with a performance measurement module – If performance measurement must be done in-house, consider the CFA Institute’s Certificate in Investment Performance Measurement (CIPM) Program – Regardless of how performance is calculated/measured, adopt a clear and consistent benchmarking strategy – A third party provider allows for the easy creation of performance composites
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION BENCHMARKING BENCHMARKS SHOULD BE… – Clear and consistent – Generally accepted by the industry – Standard & Poor’s; Russell, Morgan Stanley Capital International; Bloomberg Barclays; Lipper, etc. – Representative of the portfolio you have constructed – Reflective of both client and advisor goals – Used to demonstrate the relative value of both security selection and asset allocation decisions – Above all else: benchmarks should make sense to clients
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION BENCHMARKING RECOMMENDED BENCHMARKING STRUCTURE FOR A BALANCED PORTFOLIO – For total portfolio performance, consider both a blended (apples-to-apples) and a static (simplified) benchmark – Allows for clear observations on both security and asset allocation decisions – Answers the client question: If I did this myself, how would I have done?
BLENDED BENCHMARK 5.04%
STATIC BENCHMARK
5.00%
4.79%
5.00% 18.01%
2.77% 3.02%
7.29%
4.64%
3.98% 50.00%
45.00% 10.73% 30.05% S&P 500 RUSSEL 2000 MSCI EAFE EM BOFAML NON-US BOND GLOBAL REAL ESTATE COMMODITIES
FOR ILLUSTRATIVE PURPOSES ONLY
4.69% S&P 400 MSCI EAFE BOFAML 1-10YR GOVT/CREDIT BOFAML HIGH YIELD GLOBAL INFRASTRUCTURE LIPPER MONEY MARKET
MSCI ACWI
BB AGGREGATE
LIPPER MONEY MARKET
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION RISK-ADJUSTED RETURNS ANALYSIS SHIFT CLIENT FOCUS TO VIEWING THEIR PORTFOLIO RETURNS ON A RISK-ADJUSTED BASIS – When we look at absolute and benchmark-relative returns alone, we exclude variables over which we have more control as portfolio managers and advisors – This perspective provides the critical context that is a client’s set of preferences and goals – Important risk/return metrics for client discussions: METRIC
DEFINITION
ANSWERS THE QUESTION…
Standard Deviation
A measure of the dispersion of a set of data from its mean
How volatile/spread-out are a portfolio’s likely return outcomes?
Alpha
A measure of performance on a risk-adjusted basis; the active return on an investment
How much excess return was provided through the active management of the portfolio?
Beta
A measure of systematic (market) risk relative to the market as a whole
How likely is a portfolio to respond to swings in the market?
Sharpe Ratio
Average return earned in excess of the risk-free rate per unit of volatility
How does one portfolio compare to another, on a risk/return efficiency basis?
Sortino Ratio
A variation on the Sharpe Ratio that focuses on downside, or harmful, volatility
Volatility to the upside is a good thing! How risky is the portfolio during negative return periods?
R-Squared
A statistical measure that demonstrates the percentage of a portfolio’s movements that can be explained by movements in the market
How good of a fit is the benchmark?
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION RISK-ADJUSTED RETURNS ANALYSIS RISK/RETURN ANALYSIS FOR THE TOTAL PORTFOLIO 36 32
MORE RETURN, LESS RISK
MORE RETURN, MORE RISK
28
RETURN (%)
24 20 16
A
IV
12 8 4 0
RF
-4 -8 -12
LESS RETURN, MORE RISK
LESS RETURN, LESS RISK
1
3
5
7
9
11
13
15
17
19
23
21
25
27
29
RISK (STANDARD DEVIATION)
ACCOUNT NUMBER
DESCRIPTION
ANNUAL RETURN
STANDARD DEVIATION
ALPHA
BETA
RSQUARED
BEG DATE
END DATE
123456789
Client Portfolio
15.77
11.64
4.73
0.74
0.86
12/31/11
12/31/16
IV
Benchmark
14.46
14.49
0.00
1.00
1.00
12/31/11
12/31/16
RF
Citi T-Bill 1-Mo
0.07
0.02
0.00
0.00
N/A
12/31/11
12/31/16
A
SOURCE: GREENHILL. FOR ILLUSTRATIVE PURPOSES ONLY
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH YOUR MORE SOPHISTICATED CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES ATTRIBUTION EFFECTS
AVERAGE WEIGHT DIFFERENCE 3.39% 3.00%
HEALTH CARE
-0.13% 0.11%
CONSUMER STAPLES
1.45%
0.10%
INDUSTRIALS
1.4%
-0.04%
TELECOMMUNICATION SERVICES
0.86%
FINANCIALS
0.14% -0.34% -0.53%
-0.02%
UTILITIES
0.01%
CASH
0.01%
INFORMATION TECHNOLOGY
-1.69%
-0.15%
ENERGY
-2.01% -2.84%
MATERIALS
-2.84%
REAL ESTATE
-4
0.33%
CONSUMER DISCRETIONARY
-2
0
2
4
0.04% -0.02% 0.04%
-0.2
-0.1
0
TOTAL ATTRIBUTION
RETURN SUMMARY
ALLOCATION
0.3
1.46
BENCHMARK RETURN
1.19
ACTIVE RETURN
0.27
0.4
SELECTION
ACTIVE RETURN ATTRIBUTION SUMMARY
PORTFOLIO RETURN
SOURCE: BLOOMBERG
0.2
0.1
ACTIVE RETURN
0.27
ALLOCATION
0.07
SELECTION
0.20
CURRENCY
0.00
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES
% AVERAGE WEIGHT
PROPRIETARY EQUITY STRATEGY SECURITY 1 SECURITY 2 SECURITY 3 SECURITY 4 SECURITY 5 SECURITY 6 SECURITY 7 SECURITY 8 SECURITY 9 SECURITY 10 SECURITY 11 SECURITY 12 SECURITY 13 SECURITY 14 SECURITY 15 SECURITY 16 SECURITY 17 SECURITY 18 SECURITY 19 SECURITY 20
SOURCE: BLOOMBERG
CONTRIBUTION TO RETURN (%)
TOTAL RETURN (%)
PORT
BENCH
+/-
PORT
BENCH
+/-
PORT
BENCH
+/-
100.00 2.37 2.73 2.50 3.72 2.81 1.93 1.42 4.14 1.62 3.45 1.84 2.13 2.76 2.14 1.44 2.98 3.77 3.76 2.54 3.26
100.00 0.05 0.44 0.05 0.42 0.36 0.17 0.07 0.14
0.00 2.32 2.29 2.45 3.30 2.45 1.76 1.35 4.00 1.62 3.13 1.77 0.54 1.99 1.78 1.18 2.55 2.53 3.30 1.39 3.03
1.46 0.17 0.14 0.12 0.16 0.11 0.09 0.07 0.01 0.07 -0.02 0.01 0.16 0.13 0.05 0.05 0.07 0.15 0.08 0.04 -0.03
1.19 0.00 0.02 0.00 0.02 0.01 0.01 0.00 0.00
0.27 0.17 0.12 0.12 0.14 0.10 0.08 0.07 0.01 0.07 -0.02 0.01 0.04 0.09 0.04 0.04 0.06 0.10 0.07 0.02 -0.02
1.46 7.69 5.44 5.05 4.27 4.13 4.87 5.13 0.13 4.27 -0.56 0.71 7.89 4.76 2.24 3.43 2.47 4.03 2.13 1.53 -0.84
1.19 7.69 5.44 5.05 4.27 4.13 4.87 5.13 0.13
0.27 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 4.27 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.32 0.07 1.59 0.77 0.36 0.26 0.44 1.24 0.46 1.15 0.24
0.00 0.00 0.12 0.04 0.01 0.01 0.01 0.05 0.01 0.02 0.00
-0.56 0.71 7.89 4.76 2.24 3.43 2.47 4.03 2.13 1.53 -0.84
TOTAL ATTRIBUTION
ALLOC. EFFECT (%)
SELECTION EFFECT (%)
CURRENCY EFFECT (%)
0.27 0.13 0.10 0.08 0.08 0.05 0.05 0.04 0.04 0.04 0.04 0.03 0.03 0.02 0.02 0.02 0.02 0.01 0.01 0.01 0.00
0.07
0.20 0.13 0.10 0.08 0.08 0.05 0.05 0.04 0.04 0.04 0.04 0.03 0.03 0.02 0.02 0.02 0.02 0.01 0.01 0.01 0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES PERFORMANCE DIFFERENCE 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0 -0.2 9/30/2016
SOURCE: BLOOMBERG
10/10/2016
10/20/2016
10/30/2016
11/9/2016
11/19/2016
11/29/2016
12/9/2016
12/19/2016
12/29/2016
THE IMPORTANCE OF TEAM BUY-IN
IT IS IMPOSSIBLE TO EFFECTIVELY COMMUNICATE PERFORMANCE TO CLIENTS WITHOUT BUY-IN FROM YOUR ENTIRE TEAM
– Effective internal communication is the first critical step – Should include ALL client-facing team members; firm management, parties responsible for oversight, etc. – Tips for success: – Build a structured investment research process and decision-making mechanisms – Consistent and agreed-upon benchmarks and benchmarking structure on both internal reporting and client performance reports – Internal communications for stakeholders (conference calls, publications, etc.)
THE EFFECTIVENESS OF YOUR DISCUSSIONS WITH CLIENTS IS DIRECTLY CORRELATED WITH HOW EFFECTIVELY YOU COMMUNICATE WITH INTERNAL STAKEHOLDERS.
THE DANGER OF POOR COMMUNICATION
– Delays the decision-making process – Can lead to sub-optimal decisions – Inconsistent messaging – or worse – inaccurate messaging in front of clients – While the need for solid analytical skill is a given, you risk diminishing that skill when the story cannot be effectively articulated for clients – Biggest risk: the perception of poor performance
BEWARE BEHAVIORAL BIASES
AS SOPHISTICATED ADVISORS, CONSIDER THAT WE MAY BE MORE SUSCEPTIVE TO COGNITIVE AND EMOTIONAL BIAS THAN OUR CLIENTS FORM OF BIAS
DESCRIPTION
CONFIRMATION BIAS
We assign more weight to data and opinions that support our existing viewpoints. Related to focalism bias, which suggests that we rely too heavily on pre-programmed information when having investment discussions with clients.
FAMILIARITY BIAS
We favor that which is familiar to us. Related to availability bias, which suggests that we assess the likelihood of an outcome based on how many examples of such events come to mind.
LOSS AVERSION
Losses loom larger than gains. We may, ironically, take greater investment risk in an effort to avoid losses than to acquire an equivalent gain.
STORIES OVER ANALYSIS
Narratives are crucial to how we make sense of reality. Despite the fact that the objective analysis of data is required in actionable portfolio decision-making, we inherently prefer stories to data.
RECENCY BIAS
We tend to extrapolate recent events into the future. Do not let yesterday be the only thing to determine what you do with your money tomorrow.
– Studies have found that advisors are, in fact, biased in their clients’ favor… however, not necessarily to their advantage.
THE ROLE OF THE ACTIVE/PASSIVE DEBATE IN PERFORMANCE DISCUSSIONS
NOW – MORE THAN EVER – WE NEED TO BE FOCUSED ON MORE THAN JUST BENCHMARK-RELATIVE INVESTMENT PERFORMANCE
– It is no secret that the last several years have been a challenge for active managers – When relative returns are not objectively favorable, performance reporting needs to be designed to demonstrate other aspects of the value proposition – The impact of management fees: Do you report performance on a gross or net of fees basis? 1 YEAR
2 YEAR
3 YEAR
5 YEAR
10 YEAR
Average LCB Fund Total Return
10.64%
4.67%
6.92%
13.21%
6.26%
S&P 500 Index Total Return
11.96%
6.54%
8.87%
14.66%
6.94%
26th
12th
5th
14th
21st
Rank Needed to Beat S&P 500 (%)
SOURCE: MORNINGSTAR
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
ALLOW YOUR CLIENT TO PASSIVELY STEER THE CONVERSATION Identify a topical discussion point or a client interest, and use that to steer the conversation and paint the broad performance picture. Pick one or two charts, and use them to tell a story. If a venture into the weeds is of value to the client, this discussion will guide you there organically.
RESIST THE URGE TO TALK AT YOUR CLIENT Performance reviews are not presentations. It is an opportunity to address client concerns, answer questions, and reaffirm client goals and objectives.
GIVE CLIENTS A PEEK BEHIND THE CURTAIN Too often, we see advisors underestimate clients. Professional looking materials, detailed and technical economic/market data, and investment process background are more than just window dressing. While most clients will review and understand a small portion of what is provided, strong supplementary materials establish credibility – at the very least. Do not shy away from giving clients a glimpse into the significant depth of work behind constructing their portfolio.
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
THAT SAID, IT IS MORE IMPORTANT THAT WE ARE ABLE TO SPEAK IN PLAIN ENGLISH WATCH THEIR LANGUAGE Findings about using language and selling ‘alternative’ mutual funds
Which would you rather invest in? ‘Liquid alternatives’
Toxic phrases to avoid when talking about alternative investments, according to Invesco 1. derivatives 2. ‘future-proof your portfolio’
23%
3. ‘smooth equity returns’ 4. ‘Immediately allocate 20% of your portfolio to alternatives’
77%
5. nontraditional investments 6. arbitrage 7. ‘strategies usually associated with hedge funds’
‘Alternative mutual funds that are bought and sold like any other fund’
8. ‘We can predict that rates will rise in the future’ 9. ‘These are portfolio managers that I have carefully selected‘ 10. satellite
SOURCE: “THE POWER OF ALTERNATIVES’ STUDY, INVESCO CONSULTING AND MASLANSKY + PARTNERS
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
SOLICIT FEEDBACK While this should go without saying, it is important to solicit feedback on the effectiveness of your investment performance discussions. Discuss your communication methods with each of your clients (we tend to follow a template). Do not underestimate the importance of soliciting feedback from your colleagues – particularly those charged with sharing the message directly with clients.
PLAY TO YOUR FIRM’S STRENGTHS Avoid the common pitfall of presenting yourself (or your firm) as something you are not. If you are a boutique or local shop, emphasize your nimbleness and individual client focus. If you are a recognized brand, focus on the breadth of resources you can bring to bear for your clients. Your client is, ostensibly, with you for a reason.
BUILD CUSTOMIZED RELATIONSHIPS, NOT CUSTOMIZED PORTFOLIOS By and large, our clients should have access to all of our best ideas. While some degree of customization is often necessary, avoid the trap of using the portfolio itself to convey to clients that what they are getting is bespoke. The custom-tailored element should be your interactions with the client, and the additional value you can add based on their unique needs.
ADVANCED CONCEPT
THE KEY TO EFFECTIVELY COMMUNICATING INVESTMENT PERFORMANCE OFTEN INVOLVES FOCUSING ON ASPECTS OTHER THAN BENCHMARK-RELATIVE INVESTMENT PERFORMANCE
– With current and prospective clients, do not focus solely on investment performance. The more and better we communicate with our clients – and the broader the set of topics covered – the more likely we are to uncover other areas where they need our advice/consultation. – A more holistic conversation allows for the establishment of goals-based performance and financial advice: – Does the client have a total return bogey? – Does the client have an above average aversion to negative performance periods (or downside deviation)? – Does the client care more about volatility, tax minimization, etc.? – Is the client working towards a specific goal? – Who is the client? What is important to them? What concerns them?
ADVANCED CONCEPT EVEN CONSISTENTLY EXCELLENT INVESTMENT PERFORMANCE CANNOT DEFINE/GUARANTEE A SUCCESSFUL ADVISOR-CLIENT RELATIONSHIP. SUSTAINABLE VALUE COMES THROUGH TRULY UNDERSTANDING THE ISSUES FACING CLIENTS FROM THEIR PERSPECTIVE, REDUCING THE COMPLEXITY IN THEIR LIVES, AND GIVING THEM THE FREEDOM TO PURSUE THE THINGS THEY LOVE.
IN SUMMARY
1. Build a performance reporting process with clear and consistent benchmarks 2. Focus on risk-adjusted returns 3. Earn buy-in from your team; deliver a consistent message 4. Minimize the impact of your personal biases on the conversation 5. Give clients a glimpse of the process, but speak in a language they understand 6. Solicit feedback from clients and partners 7. Customize client interactions, not necessarily client portfolios 8. Answer the question: What matters most to my client?
DISCLOSURES
GENERAL DISCLOSURES
The information and opinions expressed in this presentation are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by MainStreet Investment Advisors. The securities and financial instruments described in document may not be suitable for you, and not all strategies are appropriate at all times. This review is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. The portfolio risk management process and the process of building efficient portfolios includes an effort to monitor and manage risk, but should not be confused with and does not imply low or no risk. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this review is considered reliably sourced, but no representation is made that it is accurate or complete, and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Traditional and Efficient Portfolio Statistics include various indices that are unmanaged and are a common measure of performance of their respective asset classes. The indices are not available for direct investment. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. Investing for short periods may make losses more likely. Any investments purchased or sold are not deposit accounts and are not endorsed by or insured by the Federal Deposit Insurance Corporation (FDIC), are not obligations of the Bank, are not guaranteed by the Bank or any other entity and involve investment risk, including possible loss of principal. This report assumes the reinvestment of dividends and capital gains, if any and does not take into account any transaction costs or taxes. There is no guarantee that companies will continue to issue dividends. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition. The information is not intended to provide and should not be relied on for accounting, legal or tax advice. Diversification does not guarantee investment returns and does not guarantee investment returns and does not eliminate risk.
ADDITIONAL DISCLOSURES
The indices are not available for direct investment. Do not include advisory fees, taxes, or expenses which would reduce returns. Past performance is not indicative of future results. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. Investing for short periods may make losses more likely. Diversification is not a guarantee against losses. This information is subject to change at any time, based on market and other conditions. Hypothetical performance shown is for illustrative purposes only and does not represent actual performance of any client account and may not reflect the effect of material economic and market factors. MainStreet does not represent that the hypothetical returns would be similar to actual performance had the firm actually managed the index or accounts in this manner. Hypothetical or simulated performances have many inherent limitations. Past performance is not indicative of future returns and the value of investments and the income derived from them can go down as well as up. Future returns are not guaranteed and a loss of principal may occur. NOT A DEPOSIT | NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
OVERVIEW
TODAY’S PRESENTATION WILL ADDRESS THE FOLLOWING: 1. Fundamental Tools for Effective Communication 2. The Importance of Team Buy-In 3. Danger of Poor Communication 4. Behavioral Biases 5. The Role of the Active/Passive Debate 6. Strategies for Amplifying the Value Proposition 7. Summary; Final Thoughts
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION INVESTMENT PERFORMANCE REPORTING IF POSSIBLE, USE A THIRD-PARTY INVESTMENT PERFORMANCE PROVIDER – An independent, third-party provider allows for increased advisor credibility and client comfort – Another good option: a trust accounting system with a performance measurement module – If performance measurement must be done in-house, consider the CFA Institute’s Certificate in Investment Performance Measurement (CIPM) Program – Regardless of how performance is calculated/measured, adopt a clear and consistent benchmarking strategy – A third party provider allows for the easy creation of performance composites
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION BENCHMARKING BENCHMARKS SHOULD BE… – Clear and consistent – Generally accepted by the industry – Standard & Poor’s; Russell, Morgan Stanley Capital International; Bloomberg Barclays; Lipper, etc. – Representative of the portfolio you have constructed – Reflective of both client and advisor goals – Used to demonstrate the relative value of both security selection and asset allocation decisions – Above all else: benchmarks should make sense to clients
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION BENCHMARKING RECOMMENDED BENCHMARKING STRUCTURE FOR A BALANCED PORTFOLIO – For total portfolio performance, consider both a blended (apples-to-apples) and a static (simplified) benchmark – Allows for clear observations on both security and asset allocation decisions – Answers the client question: If I did this myself, how would I have done?
BLENDED BENCHMARK 5.04%
STATIC BENCHMARK
5.00%
4.79%
5.00% 18.01%
2.77% 3.02%
7.29%
4.64%
3.98% 50.00%
45.00% 10.73% 30.05% S&P 500 RUSSEL 2000 MSCI EAFE EM BOFAML NON-US BOND GLOBAL REAL ESTATE COMMODITIES
FOR ILLUSTRATIVE PURPOSES ONLY
4.69% S&P 400 MSCI EAFE BOFAML 1-10YR GOVT/CREDIT BOFAML HIGH YIELD GLOBAL INFRASTRUCTURE LIPPER MONEY MARKET
MSCI ACWI
BB AGGREGATE
LIPPER MONEY MARKET
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION RISK-ADJUSTED RETURNS ANALYSIS SHIFT CLIENT FOCUS TO VIEWING THEIR PORTFOLIO RETURNS ON A RISK-ADJUSTED BASIS – When we look at absolute and benchmark-relative returns alone, we exclude variables over which we have more control as portfolio managers and advisors – This perspective provides the critical context that is a client’s set of preferences and goals – Important risk/return metrics for client discussions: METRIC
DEFINITION
ANSWERS THE QUESTION…
Standard Deviation
A measure of the dispersion of a set of data from its mean
How volatile/spread-out are a portfolio’s likely return outcomes?
Alpha
A measure of performance on a risk-adjusted basis; the active return on an investment
How much excess return was provided through the active management of the portfolio?
Beta
A measure of systematic (market) risk relative to the market as a whole
How likely is a portfolio to respond to swings in the market?
Sharpe Ratio
Average return earned in excess of the risk-free rate per unit of volatility
How does one portfolio compare to another, on a risk/return efficiency basis?
Sortino Ratio
A variation on the Sharpe Ratio that focuses on downside, or harmful, volatility
Volatility to the upside is a good thing! How risky is the portfolio during negative return periods?
R-Squared
A statistical measure that demonstrates the percentage of a portfolio’s movements that can be explained by movements in the market
How good of a fit is the benchmark?
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION RISK-ADJUSTED RETURNS ANALYSIS RISK/RETURN ANALYSIS FOR THE TOTAL PORTFOLIO 36 32
MORE RETURN, LESS RISK
MORE RETURN, MORE RISK
28
RETURN (%)
24 20 16
A
IV
12 8 4 0
RF
-4 -8 -12
LESS RETURN, MORE RISK
LESS RETURN, LESS RISK
1
3
5
7
9
11
13
15
17
19
23
21
25
27
29
RISK (STANDARD DEVIATION)
ACCOUNT NUMBER
DESCRIPTION
ANNUAL RETURN
STANDARD DEVIATION
ALPHA
BETA
RSQUARED
BEG DATE
END DATE
123456789
Client Portfolio
15.77
11.64
4.73
0.74
0.86
12/31/11
12/31/16
IV
Benchmark
14.46
14.49
0.00
1.00
1.00
12/31/11
12/31/16
RF
Citi T-Bill 1-Mo
0.07
0.02
0.00
0.00
N/A
12/31/11
12/31/16
A
SOURCE: GREENHILL. FOR ILLUSTRATIVE PURPOSES ONLY
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH YOUR MORE SOPHISTICATED CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES ATTRIBUTION EFFECTS
AVERAGE WEIGHT DIFFERENCE 3.39% 3.00%
HEALTH CARE
-0.13% 0.11%
CONSUMER STAPLES
1.45%
0.10%
INDUSTRIALS
1.4%
-0.04%
TELECOMMUNICATION SERVICES
0.86%
FINANCIALS
0.14% -0.34% -0.53%
-0.02%
UTILITIES
0.01%
CASH
0.01%
INFORMATION TECHNOLOGY
-1.69%
-0.15%
ENERGY
-2.01% -2.84%
MATERIALS
-2.84%
REAL ESTATE
-4
0.33%
CONSUMER DISCRETIONARY
-2
0
2
4
0.04% -0.02% 0.04%
-0.2
-0.1
0
TOTAL ATTRIBUTION
RETURN SUMMARY
ALLOCATION
0.3
1.46
BENCHMARK RETURN
1.19
ACTIVE RETURN
0.27
0.4
SELECTION
ACTIVE RETURN ATTRIBUTION SUMMARY
PORTFOLIO RETURN
SOURCE: BLOOMBERG
0.2
0.1
ACTIVE RETURN
0.27
ALLOCATION
0.07
SELECTION
0.20
CURRENCY
0.00
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES
% AVERAGE WEIGHT
PROPRIETARY EQUITY STRATEGY SECURITY 1 SECURITY 2 SECURITY 3 SECURITY 4 SECURITY 5 SECURITY 6 SECURITY 7 SECURITY 8 SECURITY 9 SECURITY 10 SECURITY 11 SECURITY 12 SECURITY 13 SECURITY 14 SECURITY 15 SECURITY 16 SECURITY 17 SECURITY 18 SECURITY 19 SECURITY 20
SOURCE: BLOOMBERG
CONTRIBUTION TO RETURN (%)
TOTAL RETURN (%)
PORT
BENCH
+/-
PORT
BENCH
+/-
PORT
BENCH
+/-
100.00 2.37 2.73 2.50 3.72 2.81 1.93 1.42 4.14 1.62 3.45 1.84 2.13 2.76 2.14 1.44 2.98 3.77 3.76 2.54 3.26
100.00 0.05 0.44 0.05 0.42 0.36 0.17 0.07 0.14
0.00 2.32 2.29 2.45 3.30 2.45 1.76 1.35 4.00 1.62 3.13 1.77 0.54 1.99 1.78 1.18 2.55 2.53 3.30 1.39 3.03
1.46 0.17 0.14 0.12 0.16 0.11 0.09 0.07 0.01 0.07 -0.02 0.01 0.16 0.13 0.05 0.05 0.07 0.15 0.08 0.04 -0.03
1.19 0.00 0.02 0.00 0.02 0.01 0.01 0.00 0.00
0.27 0.17 0.12 0.12 0.14 0.10 0.08 0.07 0.01 0.07 -0.02 0.01 0.04 0.09 0.04 0.04 0.06 0.10 0.07 0.02 -0.02
1.46 7.69 5.44 5.05 4.27 4.13 4.87 5.13 0.13 4.27 -0.56 0.71 7.89 4.76 2.24 3.43 2.47 4.03 2.13 1.53 -0.84
1.19 7.69 5.44 5.05 4.27 4.13 4.87 5.13 0.13
0.27 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 4.27 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
0.32 0.07 1.59 0.77 0.36 0.26 0.44 1.24 0.46 1.15 0.24
0.00 0.00 0.12 0.04 0.01 0.01 0.01 0.05 0.01 0.02 0.00
-0.56 0.71 7.89 4.76 2.24 3.43 2.47 4.03 2.13 1.53 -0.84
TOTAL ATTRIBUTION
ALLOC. EFFECT (%)
SELECTION EFFECT (%)
CURRENCY EFFECT (%)
0.27 0.13 0.10 0.08 0.08 0.05 0.05 0.04 0.04 0.04 0.04 0.03 0.03 0.02 0.02 0.02 0.02 0.01 0.01 0.01 0.00
0.07
0.20 0.13 0.10 0.08 0.08 0.05 0.05 0.04 0.04 0.04 0.04 0.03 0.03 0.02 0.02 0.02 0.02 0.01 0.01 0.01 0.00
0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00
FUNDAMENTAL TOOLS FOR EFFECTIVE COMMUNICATION ATTRIBUTION ANALYSIS ATTRIBUTION ANALYSIS PROVIDES FOR A ROBUST INVESTMENT PERFORMANCE DISCUSSION WITH CLIENTS, PARTICULARLY FOR PROPRIETARY STRATEGIES PERFORMANCE DIFFERENCE 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0 -0.2 9/30/2016
SOURCE: BLOOMBERG
10/10/2016
10/20/2016
10/30/2016
11/9/2016
11/19/2016
11/29/2016
12/9/2016
12/19/2016
12/29/2016
THE IMPORTANCE OF TEAM BUY-IN
IT IS IMPOSSIBLE TO EFFECTIVELY COMMUNICATE PERFORMANCE TO CLIENTS WITHOUT BUY-IN FROM YOUR ENTIRE TEAM
– Effective internal communication is the first critical step – Should include ALL client-facing team members; firm management, parties responsible for oversight, etc. – Tips for success: – Build a structured investment research process and decision-making mechanisms – Consistent and agreed-upon benchmarks and benchmarking structure on both internal reporting and client performance reports – Internal communications for stakeholders (conference calls, publications, etc.)
THE EFFECTIVENESS OF YOUR DISCUSSIONS WITH CLIENTS IS DIRECTLY CORRELATED WITH HOW EFFECTIVELY YOU COMMUNICATE WITH INTERNAL STAKEHOLDERS.
THE DANGER OF POOR COMMUNICATION
– Delays the decision-making process – Can lead to sub-optimal decisions – Inconsistent messaging – or worse – inaccurate messaging in front of clients – While the need for solid analytical skill is a given, you risk diminishing that skill when the story cannot be effectively articulated for clients – Biggest risk: the perception of poor performance
BEWARE BEHAVIORAL BIASES
AS SOPHISTICATED ADVISORS, CONSIDER THAT WE MAY BE MORE SUSCEPTIVE TO COGNITIVE AND EMOTIONAL BIAS THAN OUR CLIENTS FORM OF BIAS
DESCRIPTION
CONFIRMATION BIAS
We assign more weight to data and opinions that support our existing viewpoints. Related to focalism bias, which suggests that we rely too heavily on pre-programmed information when having investment discussions with clients.
FAMILIARITY BIAS
We favor that which is familiar to us. Related to availability bias, which suggests that we assess the likelihood of an outcome based on how many examples of such events come to mind.
LOSS AVERSION
Losses loom larger than gains. We may, ironically, take greater investment risk in an effort to avoid losses than to acquire an equivalent gain.
STORIES OVER ANALYSIS
Narratives are crucial to how we make sense of reality. Despite the fact that the objective analysis of data is required in actionable portfolio decision-making, we inherently prefer stories to data.
RECENCY BIAS
We tend to extrapolate recent events into the future. Do not let yesterday be the only thing to determine what you do with your money tomorrow.
– Studies have found that advisors are, in fact, biased in their clients’ favor… however, not necessarily to their advantage.
THE ROLE OF THE ACTIVE/PASSIVE DEBATE IN PERFORMANCE DISCUSSIONS
NOW – MORE THAN EVER – WE NEED TO BE FOCUSED ON MORE THAN JUST BENCHMARK-RELATIVE INVESTMENT PERFORMANCE
– It is no secret that the last several years have been a challenge for active managers – When relative returns are not objectively favorable, performance reporting needs to be designed to demonstrate other aspects of the value proposition – The impact of management fees: Do you report performance on a gross or net of fees basis? 1 YEAR
2 YEAR
3 YEAR
5 YEAR
10 YEAR
Average LCB Fund Total Return
10.64%
4.67%
6.92%
13.21%
6.26%
S&P 500 Index Total Return
11.96%
6.54%
8.87%
14.66%
6.94%
26th
12th
5th
14th
21st
Rank Needed to Beat S&P 500 (%)
SOURCE: MORNINGSTAR
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
ALLOW YOUR CLIENT TO PASSIVELY STEER THE CONVERSATION Identify a topical discussion point or a client interest, and use that to steer the conversation and paint the broad performance picture. Pick one or two charts, and use them to tell a story. If a venture into the weeds is of value to the client, this discussion will guide you there organically.
RESIST THE URGE TO TALK AT YOUR CLIENT Performance reviews are not presentations. It is an opportunity to address client concerns, answer questions, and reaffirm client goals and objectives.
GIVE CLIENTS A PEEK BEHIND THE CURTAIN Too often, we see advisors underestimate clients. Professional looking materials, detailed and technical economic/market data, and investment process background are more than just window dressing. While most clients will review and understand a small portion of what is provided, strong supplementary materials establish credibility – at the very least. Do not shy away from giving clients a glimpse into the significant depth of work behind constructing their portfolio.
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
THAT SAID, IT IS MORE IMPORTANT THAT WE ARE ABLE TO SPEAK IN PLAIN ENGLISH WATCH THEIR LANGUAGE Findings about using language and selling ‘alternative’ mutual funds
Which would you rather invest in? ‘Liquid alternatives’
Toxic phrases to avoid when talking about alternative investments, according to Invesco 1. derivatives 2. ‘future-proof your portfolio’
23%
3. ‘smooth equity returns’ 4. ‘Immediately allocate 20% of your portfolio to alternatives’
77%
5. nontraditional investments 6. arbitrage 7. ‘strategies usually associated with hedge funds’
‘Alternative mutual funds that are bought and sold like any other fund’
8. ‘We can predict that rates will rise in the future’ 9. ‘These are portfolio managers that I have carefully selected‘ 10. satellite
SOURCE: “THE POWER OF ALTERNATIVES’ STUDY, INVESCO CONSULTING AND MASLANSKY + PARTNERS
HOW DO WE AMPLIFY THE VALUE PROPOSITION?
SOLICIT FEEDBACK While this should go without saying, it is important to solicit feedback on the effectiveness of your investment performance discussions. Discuss your communication methods with each of your clients (we tend to follow a template). Do not underestimate the importance of soliciting feedback from your colleagues – particularly those charged with sharing the message directly with clients.
PLAY TO YOUR FIRM’S STRENGTHS Avoid the common pitfall of presenting yourself (or your firm) as something you are not. If you are a boutique or local shop, emphasize your nimbleness and individual client focus. If you are a recognized brand, focus on the breadth of resources you can bring to bear for your clients. Your client is, ostensibly, with you for a reason.
BUILD CUSTOMIZED RELATIONSHIPS, NOT CUSTOMIZED PORTFOLIOS By and large, our clients should have access to all of our best ideas. While some degree of customization is often necessary, avoid the trap of using the portfolio itself to convey to clients that what they are getting is bespoke. The custom-tailored element should be your interactions with the client, and the additional value you can add based on their unique needs.
ADVANCED CONCEPT
THE KEY TO EFFECTIVELY COMMUNICATING INVESTMENT PERFORMANCE OFTEN INVOLVES FOCUSING ON ASPECTS OTHER THAN BENCHMARK-RELATIVE INVESTMENT PERFORMANCE
– With current and prospective clients, do not focus solely on investment performance. The more and better we communicate with our clients – and the broader the set of topics covered – the more likely we are to uncover other areas where they need our advice/consultation. – A more holistic conversation allows for the establishment of goals-based performance and financial advice: – Does the client have a total return bogey? – Does the client have an above average aversion to negative performance periods (or downside deviation)? – Does the client care more about volatility, tax minimization, etc.? – Is the client working towards a specific goal? – Who is the client? What is important to them? What concerns them?
ADVANCED CONCEPT EVEN CONSISTENTLY EXCELLENT INVESTMENT PERFORMANCE CANNOT DEFINE/GUARANTEE A SUCCESSFUL ADVISOR-CLIENT RELATIONSHIP. SUSTAINABLE VALUE COMES THROUGH TRULY UNDERSTANDING THE ISSUES FACING CLIENTS FROM THEIR PERSPECTIVE, REDUCING THE COMPLEXITY IN THEIR LIVES, AND GIVING THEM THE FREEDOM TO PURSUE THE THINGS THEY LOVE.
IN SUMMARY
1. Build a performance reporting process with clear and consistent benchmarks 2. Focus on risk-adjusted returns 3. Earn buy-in from your team; deliver a consistent message 4. Minimize the impact of your personal biases on the conversation 5. Give clients a glimpse of the process, but speak in a language they understand 6. Solicit feedback from clients and partners 7. Customize client interactions, not necessarily client portfolios 8. Answer the question: What matters most to my client?
DISCLOSURES
GENERAL DISCLOSURES
The information and opinions expressed in this presentation are not intended to constitute a recommendation to buy or sell any security or to offer advisory services by MainStreet Investment Advisors. The securities and financial instruments described in document may not be suitable for you, and not all strategies are appropriate at all times. This review is not intended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerning the manner in which any client’s account should or would be handled, as appropriate investment strategies depend upon the client’s investment objectives. The portfolio risk management process and the process of building efficient portfolios includes an effort to monitor and manage risk, but should not be confused with and does not imply low or no risk. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this review is considered reliably sourced, but no representation is made that it is accurate or complete, and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Traditional and Efficient Portfolio Statistics include various indices that are unmanaged and are a common measure of performance of their respective asset classes. The indices are not available for direct investment. Past performance is not indicative of future results, which may vary. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. Investing for short periods may make losses more likely. Any investments purchased or sold are not deposit accounts and are not endorsed by or insured by the Federal Deposit Insurance Corporation (FDIC), are not obligations of the Bank, are not guaranteed by the Bank or any other entity and involve investment risk, including possible loss of principal. This report assumes the reinvestment of dividends and capital gains, if any and does not take into account any transaction costs or taxes. There is no guarantee that companies will continue to issue dividends. The price of equity securities may rise or fall because of changes in the broad market or changes in a company’s financial condition. The information is not intended to provide and should not be relied on for accounting, legal or tax advice. Diversification does not guarantee investment returns and does not guarantee investment returns and does not eliminate risk.
ADDITIONAL DISCLOSURES
The indices are not available for direct investment. Do not include advisory fees, taxes, or expenses which would reduce returns. Past performance is not indicative of future results. The value of investments and the income derived from investments can go down as well as up. Future returns are not guaranteed, and a loss of principal may occur. Investing for short periods may make losses more likely. Diversification is not a guarantee against losses. This information is subject to change at any time, based on market and other conditions. Hypothetical performance shown is for illustrative purposes only and does not represent actual performance of any client account and may not reflect the effect of material economic and market factors. MainStreet does not represent that the hypothetical returns would be similar to actual performance had the firm actually managed the index or accounts in this manner. Hypothetical or simulated performances have many inherent limitations. Past performance is not indicative of future returns and the value of investments and the income derived from them can go down as well as up. Future returns are not guaranteed and a loss of principal may occur. NOT A DEPOSIT | NOT FDIC INSURED | MAY LOSE VALUE | NOT BANK GUARANTEED | NOT INSURED BY ANY FEDERAL GOVERNMENT AGENCY
