From the April 2007 issue of Investment Advisor • Subscribe!

April 1, 2007

Review Your Review

A few small changes can enhance your client reviews

By now, you probably have received the performance numbers for the first quarter and are in the midst of setting up your appointments for your client reviews. Before you have your first client meeting, take a step back and ask yourself the following questions: "Do the reviews I conduct instill confidence in my clients? Do they see me as a performance promiser or as an advisor? Am I sharing my knowledge with my clients or just reporting on numbers? Am I meeting the clients' expectations?

In other words, do clients see the value you bring to the table? Two things typically must occur for this to happen during the client review: 1) You must maintain control of the meeting; and 2) Your clients must remain focused on their long-term goals.

This is much easier said than done. The biggest obstacle we face is not the unpredictability of the markets, but how your clients are affected emotionally.

Maintaining control of the review is key in a situation where irrational human behavior affects the investor's decisions. If these irrational behaviors are not managed, they could derail the client review session and impair the client's ability to move forward with an appropriate portfolio strategy.

In our May 2006 article, "Profiting by Behavior," we discussed clients' irrational behavior and its effects on the markets. In this article we will focus on clients' emotions or human behavioral biases that could cause problems during the client review.

These behaviors can never truly be eliminated, but we can identify the framework and tools that may help you manage them.

Your client's behavioral biases are not always obvious. Get your clients talking and carefully listen for sources of irrationality:

  • Underestimation of the range of
  • Potential outcomes
  • Over- or underreaction to the markets
  • Faulty reasoning
  • Unrealistic expectations
  • Short-sighted decisions

Three of the most common irrational behaviors to be aware of are overconfidence, anchoring, and recency. By managing these behaviors, both you and your client should see enhanced success.

Overconfidence and anchoring

The overconfident client is one who is more confident in his ability to control the markets than in the process or plan developed to achieve long-term goals. The client may let emotions dictate his investment decisions. Generally speaking, this is a bigger problem for men than women.

One way to rein in an overconfident client is to apply structure to the meeting for both you and your client by using an agenda.

An agenda sets the tone and provides a great source of discipline. It can be easy to dismiss the importance of meeting agendas but, if used correctly, they can be extremely beneficial to both you and your client. A "best practice" tactic is to send out the agenda a few weeks before your meeting.

Clients who may be anchored are looking at the prior returns of a company, fund, or market value as their definition of success. For example, a client will overly rely on the past as a prediction of future earnings, and is less likely to be swayed in her beliefs no matter what new information comes out.

The problem with anchored clients is that many times they have unrealistic expectations. To avoid anchoring and help manage expectations, you need to have an easy-to-understand process for manager and fund selection. We suggest using the "four Ps," for reviewing, retaining and firing. These four Ps cause the discussion to be about the "fit" in the overall portfolio as opposed to the specific benchmark. The four Ps are:

People--key personnel from portfolio manager to internal sales representative;

Process--clear and articulate decision-making process;

Philosophy--well-defined and articulate management style and suitable for respective client needs;

Performance--Is it explainable? Was the performance different from its benchmark and peers? Have the managers taken on more risk than necessary to achieve that return?

Structuring your reviews around the four Ps helps clients consider whether an investment is still a good fit for the portfolio--and if not, why not--based on more than just return. The four Ps establish the framework for making sound investment decisions on an ongoing basis.

Keep in mind which "P" is last on the list--performance. While it is important, it doesn't warrant the client review's full attention--the other three factors are critical to meeting the client's goals. In other words, the review becomes an analysis of performance as opposed to a report on performance.

The Recency Effect

Clients who are easily swayed by the latest and greatest investment fad will likely want to divest from an underperforming asset class or fund and buy one that has outperformed in recent months. These clients, stricken by the recency effect, want to follow whatever hot-selling product is garnering the most media attention.

To help manage this behavior, it is imperative that you incorporate an investment policy statement (IPS) into your process. The IPS needs to be owned by the clients. Therefore, it must be based on what they want and what they have agreed to. The IPS may include such components as risk tolerance, investment time horizon, liquidity needs, and selection criteria for investment managers.

Refer to it over and over again to gain back control of their financial plans during an emotional time in which they may be looking to jump into the latest investment fad.

Be a Custom Tailor

Tailor the review to each of your clients, keeping in mind their style of communicating, stage of their investment cycle, and behavioral biases, to ensure they are engaged in the discussion. You should think about what each of your clients needs and not only how their investments performed--or they may look elsewhere for personal service.

As we discussed in the June 2006 article, "Listening to Margaret Mead," it is beneficial to consider each of your clients' passion points and leverage this knowledge, incorporating it into your language, touch points, and ongoing service to further your efforts--and relationship--with them. Remember, to ensure success, you must deeply engage your clients' emotions in addition to, and even above, their intellects.

Keep in mind three things to help manage your clients' behavior:

Structure the review to be as consistent as possible;

Focus the on the clients' goals and the process, not performance;

Manage the clients' expectations throughout the review.

The secret is a repeatable, consistent process. In the words of Warren Buffett, "To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insight, or inside information. What's needed is a sound intellectual framework for decisions and the ability to keep emotions from corroding that framework."

Maintaining control over the meeting means the difference between one that has long-term value in strengthening relationships with clients in their asset-gathering process and one that is merely an unproductive session focusing on recent performance.

Small differences can mean a lot. Unlike the saying we've heard so often, each client review actually does give you a second chance to make a first impression. To build on your clients' success, and not coincidentally improve your chances of success, you'll want to take the right steps now to ensure that that impression is a good one.

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