The Globe and Mail, Report on Business
Published October 15, 2011

By Tom Bradley

I’ve written in the past about the tension between the investment profession and the investment business. As asset managers, we need to find a balance between managing portfolios to achieve the best return for our clients, and making a profit for our firms’ shareholders. In a recent paper published in the Financial Analysts Journal, Charley Ellis says the industry has failed to find that balance. “We are losing the struggle to put our professional values and responsibilities first and our business objectives second.”

Mr. Ellis is a thoughtful, well-connected industry observer. He’s consulted to investment firms for decades and written a number of books, including an industry standard, Winning the Loser’s Game: Timeless Strategies for Successful Investing. In his article, entitled “The Winners Game,” he outlines three errors that are leading to this inappropriate balance between values and business objectives.

First, we’re defining our mission incorrectly. It’s no longer reasonable to tell clients that our focus is on beating the market. Evidence shows that it’s hard for active managers to outperform the indexes because there are so many skilled, well-informed people competing against each other. As Mr. Ellis said to me recently, “The more smart people there are trying to beat the market, the less likely it is to happen.”

The second error cuts to the heart of the profession-business balance. Mr. Ellis says we have our priorities wrong. “As investment management organizations have been getting larger, it is not surprising that business managers have increasingly displaced investment professionals in the senior leadership positions or that business disciplines have increasingly dominated the old professional disciplines.” He goes on to say, “When business dominates, it is not the friend of the investment profession.”

I could write at length about these two errors of commission, but it’s the third error, one of omission, where Mr. Ellis’s perspective is the freshest. He calls it, “the largest problem and the best opportunity for our profession going forward.” While we’ve been trying to beat the market, outsmart each other with innovative products and feverishly gather assets, we’ve given short shrift to something that will help our clients more than anything else – effective investment counselling.

In conversation with Mr. Ellis, it becomes clear that he doesn’t consider investment advice to be rocket science, but rather basic blocking and tackling. From my perspective, it involves putting a plan in place with a prescribed long-term asset mix. It means executing the plan in a simple and consistent way. It means looking ahead and preparing for the down periods as being inevitable as opposed to being a surprise. And most assuredly, sound counsel means spending more time with clients when markets and emotions are at extremes, not less.

The industry’s biggest failure is not its products and services per se, but how clients use them. It’s been well documented that, in aggregate, investors suffer from a behavioural gap – their portfolios don’t do as well as the funds and products they invest in. That’s because they trade too much, chase past performance and generally stray from their plan. Don’t get me wrong, there are plenty of bad investment products out there, but the gap comes largely from misuse.

Unfortunately, the industry is doing more to widen the gap than narrow it by advertising last year’s best performers and introducing a constant stream of new products. Pumping a hot fund through multiple distribution channels is hugely profitable, but ensuring that it’s used correctly by the appropriate clients is not. Investment counselling is bad for business in the short term – it takes time, costs money and is not very scalable.

Mr. Ellis’s article may serve as an indictment of the industry, but as the title implies, there is plenty to be positive about. If we recalibrate our priorities a little, be more ruthless about eliminating products and business practices that hurt clients, and think more about client returns as opposed to fund returns, we’d be taking a big step in the right direction. All of this might hurt profitability (and I’m not even sure about that), but as Mr. Ellis points out, it’s certain to be successful. That’s the kind of risk/reward tradeoff all investment professionals are looking for – possible short-term pain, certain long-term gain.