Serving clients, not beating markets

August 27, 2014

Aug 27 (Reuters) – It may be that the future of wealth
management lies not in beating the market but in helping the
client beat her true opponent: herself.

The traditional offering of the investment management
industry – putting people into products which outperform – is
under siege, hit by a trend of dwindling relative performance
and massive defections of money to passive index-based
strategies and products.

Charles Ellis, an eminence grise of index investing and the
founder of Greenwich Associates, argues that the combination of
falling fees for active management and the continued flow of
funds into index products is going to challenge the economics
and structure of the investment industry as we know it.

Writing in the most recent issue of the Financial Analysts
Journal, Ellis makes an important distinction between the two
traditional roles of money managers: “Ideally, investment
management has always been a ‘two hands clapping’ profession:
one hand based on skills of price discovery and the other hand
based on values discovery.” here

Price discovery is what most people think of when they think
of money management: the process of finding price anomalies in
the market and exploiting them to produce outperformance. Values
discovery, in contrast, covers almost everything else in the
money manager-client relationship and is therefore mostly about
changing behavior, an arena in which the vast majority of
clients are undone by themselves.

Of this, more in a moment. But first let’s just walk briefly
through just a bit of the evidence about active fund management
and the value it creates. Adjusting for survivorship bias, only
a quarter or less of large- and small- cap growth funds
outperformed their benchmarks in the 15 years to the end of
2011, according to Ellis. Among value funds during the same
period the figures were 30 percent outperformance among those in
small-cap stocks, and 43 percent among those in large-cap
issues. This may be because investors are today better as a
group, but competing against better opponents and thus less able
to outperform compared to the 1960s or 70s when there were more
less-sophisticated traders.

Eugene Fama, the Nobel Prize-winning father of the efficient
market hypothesis, in 2012 asserted that among domestic mutual
funds with at least 10 years of results only the top 3 percent
show sufficient skill to cover their costs. Good luck
identifying which three out of 100 you should choose.

But even if you, as a wealth manager, don’t buy the
proposition that active management is a losing game, you have to
accept that a large number of your clients, current, past and
prospective, do.


All, however, is not lost.

While many wealth managers have reacted to the rise of index
investing by working to strengthen their relationship with the
client, all too often that has been in service of making sure
that they remain clients and continue to buy active products in
hope of beating the market.

The alternative path, what Ellis calls values discovery, is
about “determining each client’s realistic objectives –
including wealth, income, time horizon, age, obligations and
responsibilities, investment knowledge and personal financial
history.” The end result is more knowledge, both for the client
and the manager, and then a strategy well calibrated to meet
those realistic objectives.

The great virtue and beauty of this approach, and what makes
it sustainable, is how much actual value it can create. This is
about making sure clients save enough, and stopping them from
rabbiting off after the latest social media IPO or, worse yet,
selling heavily into a correction. All of these self-defeating
behaviors are common, and many are arguably made more likely by
the return-chasing stance the industry has traditionally

Investors who think they, or their representative, can beat
the market also tend to think they can therefore skimp on
saving, or that they can accelerate wealth creation by taking on
more risk in hot areas, or that they can “get out” before the
big crash.

But even with more sober clients, there is plenty to be
done, and done in a way which knits the client to the adviser
for the long haul. Planning, for example, for increasingly long
life spans, or for the provisions needed for a disabled child.
Helping people to understand and mitigate risk, not just in
their investment portfolios, but in their careers, family and
health. Combine that with low-cost products and you have a
winning offering.

All of this is time-intensive, but it is also not easily
done by robots or algorithms.

Now, what will the fee structure look like? That is open to
debate and there are several models, but what is clear is that
the upside is probably lower. Lower, but more secure and

Many will continue to try and win the price discovery game,
but more will win at values discovery.

(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at and find more columns at

(Editing by Jonathan Oatis)

No comments so far

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see