Incompetence-Based Investing

Good news! Your so-called financial advisor may not be giving you conflicted advice.

Bad news! He may be an IDIOT.

The results are in from a survey of 4,000 advisors and their clients located in Canada.

The Misguided Beliefs of Financial Advisors confirms something I have suspected for quite a while; the vast majority of people in the industry have no clue what the hell they are doing.

Here are some highlights from my friend, Robin Powell:

“The researchers found that, contrary to common perception, it isn’t conflicts of interest that leads advisers to put clients into high-cost, high-turnover, actively managed funds. They tend to invest their own money in the same way and in the same funds and experience similar drags on investment performance.”

It gets worse.

“The average expense ratios of mutual funds in both advisers’ and clients’ portfolios were very similar, at 2.43% and 2.36% respectively. After adjusting for costs, the researchers found the “net alpha” for both advisers and clients were also similar, at around -3%.”

And, the most damning excerpt…

Advisers are willing to hold the investments they recommend. Indeed, they invest very similarly to clients, but they have misguided beliefs. Both clients and advisers exhibit trading patterns previously documented for self-directed investors. For example, they purchase funds with better-than-average historical returns and they overwhelmingly favour expensive, actively managed funds. This similarity suggests that advisers do not dramatically alter their recommendations when acting as agents rather than principals.”

New clients often bring us the most horrific concoctions of financial alchemy one could ever imagine from their past advisors.

When Patrick, our chief technology officer, liquidates the positions, we consider this a form of financial exorcism.

Here are some portfolios that stick out in my mind:

  • Hunger For Yield – 12 MLPs, a South Korea small company ETF and PANERA BREAD STOCK.
  • Time Is Not On My Side – 45 mutual funds that were sold every quarter and replaced by completely different positions
  • Junk Yard Dog – A conservative income strategy for a retiree that consisted of 12 very low-rated junk bonds.

After examining these (often) high-fee accounts, I knew something else had to be going on.  Incredibly, the people who put these monstrosities together actually believed they would work.  These types are far more dangerous than the typical sleazy financial salesperson.

True believers are lethal.

Gross incompetence negates many of the effects of the proposed fiduciary rule.

“Regulations that reduce conflicts of interest — by imposing fiduciary duty or banning commissions — do not address misguided beliefs. When advisers recommend strategies that underperform, they act as an agent exactly as they would as a principal, so aligning their interests would not change their behaviour. Solving the problem of misguided beliefs would instead require improved education or screening of advisers.”

So we have this going for us.

Additional items such as “advisor financed” top advisor rankings and public speaking appearances further solidify the impression that these people actually know what they are doing.

While Canada is not the United States, this report confirms many beliefs we have suspected for a while.

Cheer up, investors! Your advisor is not a crook; he may just be an honest fool.

Source: Misguided advisers: Are they conflicted or incompetent? by Robin Powell


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