Risk management has become the hot button topic for advisors who watched helplessly as client portfolios got dragged on the roller coaster ride of the last several years.
It’s not just about providing due diligence on the portfolio managers you hire. The paradigm has changed for everything from how you structure client portfolios, to your own practice, according to Jeff Montgomery, head of AFAM/Innealta Capital. The Austin, Texas, based firm is a large tactical manager of ETF-based portfolios, and Montgomery works frequently with financial advisors on honing their practices.
“Advisors talk about Black Swan events and tail risk – you didn’t hear retail planners talking about tail risk 10 years ago, or if you did it was the top 1% of the group. Now, it’s the new nomenclature,” he said.
Indeed, he reports that the savviest advisors are now harkening back to the old trick question many used to ask clients on the first meeting: “What do you think my number one job is?” Most clients incorrectly guess “To make me rich.” The correct answer is, “My number one job is to keep you wealthy, and my number two job is to make you wealthier.” In the cautious new world of risk management, this old chestnut is the marketing vernacular that the top half of financial advisors Montgomery works with are using.
Of course, there are some newer changes in this vein as well. Larger financial advisory firms have a risk committee that meets once a month. It doublechecks that the largest money managers that the firm uses haven’t had any manager turnover, discusses how the top portfolios are allocated, and economic conditions. “These formal structures were not part of the mix for most financial advisors 10 years ago – or even five years ago,” he said.
The new passion for precision and having a lot of facts at the firm’s disposal is trickling down to the personnel level. Many firms have changed who they hire, demanding more credentials. That extends even to junior staff, who are expected to have a CFA or CFP, or be working towards earning those designations. “The issue of risk management is flowing down through these practices affecting structure, process, affecting talent management - all that rolls into the client value proposition,” he said.
One way several top firms are distinguishing themselves with clients by showing their risk management chops is by doing a lot of scenario planning a la Monte Carlo simulations. What happens if the client’s business lays her off? What happens if a client couple loses one of two incomes? What happens if a catastrophic event robs the client of 25% of his net worth? “Firms that can explain what they do and how they do it are getting more clients,” he said.
Another thing the top firms are doing is taking a proactive stance towards regulation, because many regulators are interested in how firms are implementing risk management. They’re asking if the firm have a process, is it doing due diligence on outside managers, is it doing proper portfolio reviews? To make sure they are shipshape, some firms are going so far as to hire outside auditors, such as Moss Adams or NRS to conduct a mock regulatory exam. These exams are rigorous and represent an extra expense, but worth it for those who want to master risk in the new world.
And the good news is, “You get a free pass on whatever you need to fix,” Montgomery said.