I suppose it happens to everyone eventually. For me it always seems to be when I am buying a suit. I get the salesperson that gives me the impression that any suit in the store would be great for me. I am not a fashionista by any means. I like good-looking suits, but my hope is that clients will view my wardrobe as appropriate and professional and then never give my clothes a second thought. I prefer they think about their goals and whatever financial issues are on their minds. So, when I shop for a suit, I am looking for nice but not too nice. I harbor no ambition to be in GQ.
The usual turn of events begins with the salesperson either not asking what I am looking for or ignoring my response. I've had some odd colors shown to me and once even got a "Diddy wore this at MTV awards" from one over zealous helper. That is not the way to intrigue me. I advise a mature, conservative clientele about their life savings. Besides, no ensemble will ever make me as cool as Diddy.
Sadly, I see far too many financial "advisors" that behave like the suit salesmen I have encountered. You can see some of this in many of the discussions about "alternative" investments. I long ago lost count of the articles claiming that traditional diversification doesn't work and that in this low rate environment, the need for income is such that we must seek out alternative investments if clients will have a successful retirement. Many of the conferences at which I have spoken seem to have multiple sponsored sessions about these products. I can't help but think that some of the interest from attendees is simply a matter of trendiness but most of it, I fear, stems from a lack of diligence, security or perspective.
Diligence
I am highly skeptical about the death of modern portfolio theory (MPT) not because I think MPT has everything nailed down, but largely because many making the pitch for alternatives as a solution mischaracterize what we should expect from MPT and/or are not offering compelling evidence of a sound alternative. The pitch usually goes something like this. "Our program has low correlation to the equity markets, which enhances diversification. In our back testing, we found a 10% allocation increased returns and lowered standard deviations."
That sounds so reasonable, doesn't it? One irony is that it sounds reasonable precisely because it is stated in the language of, and fits the model of, modern portfolio theory -- increased return and/or lower standard deviations due to low correlation.
Take two simple portfolios beginning January 2000, rebalanced annually, and ending in December 2009. The "lost decade" is a common time frame for these back tests and often cited in the criticisms of MPT. In portfolio A, we have 60 percent in an S&P 500 index and 40 percent in five-year Treasury bonds. In Portfolio B, we put 10 percent in an alternative I will call the XYZ Special Opportunity, 50 percent in the S&P 500 and leave 40 percent in five-year Treasuries. Since XYZ didn't lose money, had a lower deviation and was poorly correlated, Portfolio B should have done better. Indeed, the annualized returns were only a hair higher for Portfolio B but the standard deviation was roughly 20% less than that of A, thus producing a better risk-adjusted return.
What was the XYZ Special Opportunity? Well, it is a hypothetical holding that returned nothing every year. Zero return, zero standard deviation and zero correlation. The magical result of a better risk-adjusted return from the snazzy alternative product could have been obtained by literally stashing money in a mattress or burying cash in the backyard. Similar results will occur if you replace stocks with just about anything that held its head above water and wasn't highly volatile.
I am not here to suggest that if you use alternatives, you are ignorant. Rather, I wish to simply admonish readers to stay true to your professional duty to really understand what you are recommending. We are paid only, and directly, by clients so we look at all products rather skeptically. I may address the economic merits, or lack thereof, of some alternative investments at another time. For now, please, if you can't do the due diligence to make sure there is more there than just statistics, you should pass.
Insecurity
In addition to due diligence efforts, a true professional advisor keeps the client's needs at the forefront. If a suit makes my backside look bigger than usual, I need to know that but too many sales people won't go there. One of the most significant days in the development of a professional advisor is the day he summons the courage to tell a client what they need to hear instead of what the client wants to hear.
There is a certain art to delivering such messages, of course. Instructing them nicely, with a smile helps as does well thought out rationale. I would argue, though, that one thing that makes delivering bad news easier is the security and stability of the advisor's business.