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Advisors Optimistic, but Clients Haven’t Learned Much
Bank Investment Consultant
Thursday, November 11, 2010
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A couple of interesting surveys were released this week that should give advisors some food for thought in dealing with clients.

When I add a bit of anecdotal evidence, here’s the nutshell: As a group, advisors are optimistic about the use of absolute return funds, but many of their clients are not prepared for these investments.

Absolute return has been back in the news over the past few months, most recently with a survey from Putnam Investments, which launched four absolute return funds in January 2009. According to Putnam’s survey of 256 advisors, 59% said they were at least somewhat likely to recommend absolute return funds to clients, although only one in five said they were “very likely.”

It’s not just the moniker “absolute return” that leads to confusion, although that’s part of it. It’s also the way they’re often presented by fund companies. These are supposed to be the investments that will always produce positive results that are uncorrelated to the broader markets. (I certainly don’t mean just Putnam here, but the industry in general.)

We’ve had a couple stories since the crisis pointing out that much of the absolute-return asset class actually did not post positive returns through 2008 and part of 2009. And when we talked to people in the market about this, some dismissed it as being off base. When they explained why we were too small in our thinking, they suddenly spoke in relative terms, not absolute. (“Well, we didn’t lose nearly as much as the S&P 500.”) They also point out that you sometimes have to use a broader timeline to get a meaningful view. That is, if they lose money one year, then take a look at three-year returns.

            Those are good points if used in the right context. But they belie the idea of “absolute return.”

            To be fair, a lot of advisors are interested in absolute return for the ability to add diversification or minimize volatility in a portfolio, according to Putnam’s survey. But however it’s used, advisors need to be careful that clients have a firm understanding of it.

Which brings us to the second survey of the week, from Northwestern Mutual, which suggests that people don’t have a firm understanding of even simple financial concepts. The online survey of 1,664 people ages 25 to 65 indicate that Americans’ financial literacy is no better than it was in 2006. That is, they’ve learned nothing from the steepest market plunge and nastiest recession of their lives.

A few quick examples: Only 35% know that the average rate of inflation is closer to 3% than 6% or 9%; Half answered (incorrectly) that bonds offer better protection against inflation than stocks; And only 32% know that index funds try to match some underlying benchmark.

Unsurprisingly, they say they want to learn more about their finances. If they really want to learn more, instead of just clicking a box on a survey, they may be reading more and asking more questions. And they may well be enticed by something called “absolute return.”

            I know the first caveat to all of that: A general survey of Americans does not depict your well-healed clientele. This is where my anecdotal evidence comes in. We’ve had advisors tell us at various times that their high-net-worth clients are not, in fact, any more prepared than anyone else to discuss topics like asset allocation in depth. After all, most of them got rich by working in some line of business that didn’t entail sitting around and talking about finance.

I know I’m mixing several things here: One survey says advisors are eager to use absolute return finds; another says Americans in general don’t know any more about finance than they did pre-crisis; and some advisors tell us that their rich clients aren’t any more sophisticated than anyone else.

But I think this mix is a good reminder of an old lesson: education, education, education. Investors need to know exactly what absolute return can do for them before they buy. A good place to start is to make sure they know there really is no such thing as “absolute return.” After that, there can be a place for it in their portfolios, if they really want to learn more about their finances and discuss issues like diversification and volatility.

 

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