Squared Away Blog

January 26, 2012

Questioning Wall Street Convention

Walk into your financial adviser’s or broker’s office, and the conversation inevitably leads to your portfolio’s “asset allocation” and “total return.”

Financial planners, the media, investors – we’ve been under Wall Street’s spell for three decades.  But a small chorus of skeptics, bucking the orthodoxy, argues that brokers and planners don’t always match investments with an individual’s goals and needs.  The human gets lost – in more ways than one.

“People are being guided by the asset management industry,” said Boston University finance professor Zvi Bodie, co-author, with consultant Rachelle Taqqu, of “Risk Less and Prosper: Your Guide to Safer Investing.”

The industry’s premise is that “you can’t afford not to take risk,” he said, referring to the tenet that more risk means a larger potential return.  But what happens if you roll the dice and lose?  “They never say that,” he said.

Keen to this critique, Barclays in London and a few other large investment houses have started pitching wealthy clients by focusing on their “unique” circumstances.

This minority view may resonate with baby boomers whose retirement planning was derailed by the 2008 stock market collapse.  (Annualized five-year return for the Standard & Poor’s 500 stock index: —0.25%, according to Morningstar.)

If investor frustration triggers a backlash, it will be long in coming.  It’s rooted in the 1960s, when Edward C. Johnson 3rd of Fidelity Investments began selling mutual funds to everyman.  As defined benefit plans began their descent, Americans tiptoed and then ran into DIY retirement accounts.  The big money managers in Boston and on Wall Street now dominate, and pursuit of investment returns has become the norm, asset allocation the buzz word. The burst of the late-90s high-tech bubble was a notable disaster.

Bodie’s coauthor Taqqu said wealthy people can handle market ups and downs.  But “middle-class people are often taking too much risk.  If they instead think in terms of goals, and what can I do without, they won’t put that [money] at risk.”

In a sign of dissension within the financial industry’s ranks, Allianz in Germany, PIMCO in California and Barclays incorporated trendy behavioral economics into their services for wealthy investors.  Behavioral economics holds that individuals are psychological beings, so applying unbending investment theories based on “rational man” is deeply flawed.

“It’s astonishing that not just an academic discipline but an entire industry was built on these assumptions,” Greg B. Davies, head of Barclays Wealth’s Behavioural and Quantitative Investment Philosophy, said in a recent interview.

Davies said his investment group goes with “irrational man.”  For example, rather than rely on an investor’s own emotionally blurred view of their tolerance for risk, Barclays measures it with a “personality” survey – the financial version of Briggs-Meyers.

The survey asks them to rate statements from “strongly agree” to “strongly disagree.”  Sample questions are: “I fear for the worst;” “I have more experience with investing than the average person;” or I am concerned my money is “not aligned with my long-term goals.”

Davis said the focus is clients’ “emotional comfort.”  Barclays might tailor a portfolio that “gives up a little long-term classical efficiency” – and presumably return – to ensure clients “stick with the journey and achieve their investment goals.”  Translation: prevent client panic.

While Bodie might not see eye-to-eye with Davies, he might agree on this.  Conventional wisdom “forgets to factor in the fact that, to get to the long-term, we have to live in the short-term,” Davies said.