Practical analysis for investment professionals
04 August 2016

How Can Investment Professionals Add Value?

How can the investment profession best serve its clients?

At a time when there’s no shortage of confusion, and indeed a shortage of growth, it pays to ask. Interesting questions abound in investing, but the important ones stick around.

The way they are answered tends to change though, so in an effort to take the temperature of our industry, we asked CFA Institute Financial NewsBrief readers where they think the sector can best contribute value to clients.

The results are mind-boggling.


Where do you think the investment profession can add the most value to clients?

Where do you think the investment profession can add the most value to clients?


Asset Allocation Is King.

The vast majority of the 763 respondents clearly view asset allocation and client hand-holding as the two areas where investment professionals can offer the most, with about four out of five participants opting for one of these two choices. This is hardly a revelation. I have spent considerable time and energy writing and speaking about multi-asset investing, of which asset allocation and portfolio construction are critical components, precisely because I believe in that message.

But the magnitude of these preferences compared to the other choices is shocking. A mere 5% (!) of respondents opted for security selection. For a profession that has long considered Security Analysis its bible and Warren Buffett its ultimate role model, we’ve clearly come a long way.

The asset managers among us now realize their limitations in picking stocks and other securities, and asset owners have recognized these shortcomings as well. The implications of this for today’s investment professionals are quite far-reaching. Finance pros have been trained for and performed a different job, one that many have not done well. And now, alas, they are expected to do something for which they have not been trained!

The solution is not to give up on our heritage altogether, though. That’s why I am both pleased with the overall survey results and disappointed by the 5% figure. Multi-asset investing is about pulling all the levers and adding value in any way we can. So the future star of the investment profession is not an asset allocator or a stock picker. The successful investor will be the one who can do both well.

Asset Allocation Is Not King?

An important caveat to my interpretation of the survey results: Some of my colleagues pointed out that respondents might simply have been influenced by “Determinants of Portfolio Performance,” by Gary P. Brinson, CFA; L. Randolph Hood, CFA; and Gilbert L. Beebower, first published in the Financial Analysts Journal.

As later publications indicate, the results from Brinson and company were more about the time series analysis: that, over time, the return variation for a single portfolio of investments, be it the overall market or a number of endowment plans, as used by Brinson and his coauthors, is ultimately driven by asset allocation.

That does not mean that return variations across funds are largely explained by asset allocation, as many who misinterpreted the paper came to believe. As a matter of fact, measured across a number of funds with similar objectives, asset allocation is actually less important a driver of returns than security selection. Roger G. Ibbotson and Paul D. Kaplan, CFA, found that asset allocation only explains about 40% of the return variation in their sample of balanced funds measured over a 10-year period.

The Client Is King . . . Please Hold the King’s Hand.

More than a third (36%) of poll participants thought the investment profession could best serve clients by helping them navigate the emotional roller-coasters that come with investing, steering them away from the impulsive decisions that can damage their portfolios over the long term.

Behavioral finance is accepted in more quarters of academic finance. In practice, this is especially true for wealth managers since retail clients tend to have less experience with market volatility. It is heartening to see that CFA Financial NewsBrief readers agree on this.

So what’s the ultimate lesson of these results? The investment world — as previous generations know — has changed, and investment professionals need to develop new skills to deal with a new reality.

An earlier version of this article was entitled “How to Add Value.”

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, Multi-Asset Strategies: The Future of Investment Management and AI Pioneers in Investment management. He is also a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

16 thoughts on “How Can Investment Professionals Add Value?”

  1. How about helping them change good companies by making them even better? Some CFAs help their clients file shareholder resolutions on corporate governance, environmental and social issues.

    1. Larry Cao, CFA says:

      James,

      That’s a fair point and is beyond the scope of this survey as it was originally intended. An issue that has been bothering many of us is that the public seems to see doctors and lawyers as professions so much so that they’d pay for their service and certification is required to get into those lines of work. Investment seems to be less established as a profession in that sense. We were simply asking the NewsBrief readers how they think our profession adds value.

      Thanks for visiting our blog and sharing your thoughts with fellow readers of the blog.

      Warm regards,
      Larry

  2. Christopher Bradley, CFA says:

    With regards to your remark “That’s why I am both pleased with the overall survey results and disappointed by the 5% figure. Multi-asset investing is about pulling all the levers and adding value in any way we can. So the future star of the investment profession is not an asset allocator or a stock picker. The successful investor will be the one who who [sic] can do both well.”

    Keep in mind that we were given discrete choices when voting. It’s not necessarily to say that stock selection isn’t value additive, but perhaps not considered the “most” value additive amongst those options. No need to be disappointed.

    1. Larry Cao, CFA says:

      Christopher,

      Point taken and I suppose I should be less disappointed.

      From a scientific point of view, asset allocation and security selection have equal potential in affecting portfolio risk and returns. Given that more of us have security analysis training and idolized Warren Buffet, I was hoping that at least half the votes would have been cast in favor of security selection. That’s why I was disappointed.

      The only justification favoring asset allocation that much over security selection is that we all realize asset allocation has at least an equal shot at making an impact and it is so far the road less traveled by, maybe that’s where the largest opportunities are.

      Thanks for visiting our blog and sharing your thoughts with us.

      Warm regards,
      Larry

  3. JJ Jelincic says:

    It is not clear to me that you can define a “good” asset allocation if you have not first developed the appropriate goals.

    Some once said if you don’t know where you are going all roads will get you there.

    1. Larry Cao, CFA says:

      JJ,

      Thanks for visiting our blog and sharing your thoughts.

      You made a good point. If we phrased the question in true Econ 101 fashion, it would have read: “All things equal, where can an extra unit of an average investment professional’s input generate the maximum amount of extra utility for his or her clients?” And that is indeed what we meant when we asked the question.

      Warm regards,
      Larry

  4. Henry Verbeek says:

    I’d be interested in comparing client responses to the value proposition to those of “insiders” to the industry.

    1. Larry Cao, CFA says:

      Henry,

      Good point. Our respondents include both those who manage money and their clients. It would be interesting to see how each group’s response differ. Deeper issues remain even then though as we’d still want to know why they vote the way they vote – for example, if clients fail to see the value of security selection, does it really mean security selection is useless or is it just that the clients are unable to see its value for some reason?

      Thanks for visiting our blog and sharing your thoughts.

      Warm regards,
      Larry

  5. Don Steinmann says:

    *Most* value is the key point here. I think hands down it’s in helping clients deal with behavioral issues. According to JP Morgan, over the last 20 years, the S&P 500 has averaged an 8.2% annual return, inflation has averaged 2.2%, and the average investor has averaged a 2.1% annual return. So in an 8% equity growth environment, investors are under performing by 6% and are not even keeping up with inflation. This is the most shocking number that I know of in all of finance. Protecting clients from “buy high, sell low” is the single biggest affect we can have on client returns.

    1. Larry Cao, CFA says:

      Don,

      Thanks for visiting our blog and sharing your thoughts. Understanding behavioral issues are certainly critical to any investment process. Bear in mind though we are all human and we’ll never put all our money in stocks all the time. Nor should we.

      Warm regards,
      Larry

      1. Don Steinmann says:

        Larry, I think you misunderstand. The JP Morgan data is calculated based upon mutual fund investments, that is, funds that investors are were willing to commit to the market. And with those funds, (not all funds) investors have hugely under performed the averages.

        1. Larry Cao, CFA says:

          Don,

          You are absolutely right … if investors want to put all their money in stocks. There are obviously many reasons why they might not want to do that – dynamic asset allocation for example. Risk tolerance is another often cited reason.

          Thanks again for visiting our blog.

          Warm regards
          Larry

    2. I agree. A good company is not necessarily a good investment.

      1. Larry Cao, CFA says:

        Warren,

        Thank you for visiting our blog and sharing your thoughts.

        Warm regards,
        Larry

  6. JRM says:

    My 2 cents: 401K investors and gov’t employees don’t have the option of investing in securities. They typically are given a choice of 10-30 funds or so (maybe up to 75 or 100 at big firms.) For that reason, asset allocation assumes a preeminent position for many investors.

    IRA investors have more choices, but when it comes to security selection, there seems to be little evidence that the skill to identify alpha is very common. I doubt that many CFAs would claim to have superior stock selection skills, though perhaps I am wrong? When about 7% of all stocks drive excess returns, and most of what we see in fund performance is consistent with the assumption that virtually all outperformance is driven by luck – well, why would I think any CFA is any different? The biggest controllable variable, after the amount saved, is asset allocation.

    As a self directed investor, I feel very little need for security selection. I am interested in optimizing my asset allocation. I”ll interject that TAA and alternative funds such as managed funds, or even factor funds, are all interesting, but most don’t have decades of performance behind them, which makes it very difficult to gauge their true impact on an otherwise balanced portfolio. However, portfolio construction can have substantial impact on financial outcomes – a perfectly fine portfolio in one context can be ruinous in another context. Additionally, if the asset allocation is appropriate, security selection could enhance it, but indexation will go a long ways towards ‘locking in’ a reasonable outcome.

  7. Eric Nelson says:

    Larry,

    I guess I look at the poll results differently. Just who are these 5% and what rock have they been living under? Only 17% of professional fund managers have outperformed their index over the last 15 years, a full 57% who were in business 15 years ago went bust. We wouldn’t expect different results from a room full of monkeys throwing darts at stock tables, except that the monkeys would work for bananas.

    As to the importance of asset allocation, please consider the following illustration: a retiree with $1M in 2000 needing 5% a year (adjusted for inflation) who invested in a combo of US/Int’l Total Stock Indexes was on the verge of going broke last month. The retiree who instead invested in a multi-asset class portfolio almost doubled their wealth net of withdrawals: http://bit.ly/2cG2wve

    This is not to say behavior doesn’t matter, because certainly it does as well. Just that asset allocation, something all of us can realistically have a positive impact on, matters a great deal and a great deal more than many academic studies on the matter give it credit for.

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