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Advisors’ Dilemma: Investor Expectations vs. Market Reality

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Financial advisors today find it harder to satisfy clients, comply with new regulations and manage a thriving practice on their own, prompting some to reinvent themselves and others to exit the business entirely.

A study released Thursday by Natixis Global Asset Management found that advisors felt cost and regulatory pressure to yield to the demand for lower-cost passive investments, but 75% worried that investors were unaware of or did not appreciate the associated risks. A significant majority thought volatility lent itself to active management.

Twenty-seven percent of financial advisors polled said they were planning a dramatic change within three years by selling their book of business, merging with another firm, leaving the financial industry altogether or retiring. More than a third said they would disengage with smaller clients because of new regulations.

And 86% acknowledged that meeting strict regulatory and disclosure requirements were among the biggest challenges they faced in growing their business.

(Related: Finke: Keys to Retirement Planning in a Low-Yield World)

Natixis conducted its research in July with 300 U.S.-based financial advisors. The survey is part of a larger global study of 2,550 advisors in 15 countries and territories in Asia, Europe, Latin America, the U.K. and the Americas.

Managing Expectations

Managing investors’ expectations was advisors’ chief priority, the research found, which is not surprising considering investors in a February poll told Natixis that unmet performance expectations was their number-one reason to leave their advisor.

This is a big problem for advisors because investors in that poll expected an average annual return of 8.5% above inflation, which is 44% higher than advisors say is realistic in the current market.

Natixis noted that dialogue between clients and their advisors has been disproportionally focused on market performance, and not enough on risk management and investor goals and behavior. In fact, 85% of advisors said their success depended on obtaining a more accurate picture of their clients’ risk tolerance.

“The challenges facing financial advisors are tougher than ever, as they are asked to do more with less in an environment that seems to put low fees ahead of all other considerations, including risk management,” said John Hailer, chief executive of Natixis Global Asset Management for the Americas and Asia.

Advisors in the new survey agreed active investments were a stronger choice than passive ones for generating alpha, providing risk-adjusted returns, taking advantage of short-term market movements and gaining access to alternatives and exposure to uncorrelated assets. Still, advisors reported that they often used passive investments because clients preferred them and because they were less costly. In addition, 43% of advisors said they used passive investments because many active managers were really “closet indexing.”

Natixis said advisors are faced with striking the right balance between clients’ interest in passive investments and the best way to help them achieve their investment goals.

Beyond Asset Allocation

For 87% of advisors in the study, success depends on their ability to demonstrate value beyond asset allocation and portfolio construction. Natixis said this may be because clients can undermine progress toward goals by mistakes they continue to make, including:

• Letting emotions drive investment decisions.

•  Setting unrealistic return expectations.

•  Focusing too much on short-term market movements.

Fifty-one percent of advisors said clients had asked for help managing volatility over the past year. In response, 80% of advisors said active strategies would be important in addressing increased market volatility.

Many advisors are using a diverse mix of non-correlated investments to help protect their portfolios, according to the research. Sixty-six percent said that, for most investors, a traditional 60/40 portfolio allocation was no longer the best way to pursue return and manage investment risk. Seventy-five percent said they were using liquid alternatives.

The vast majority of advisors reported incorporating goals-based planning into their practice and client conversations. Natixis said this shifts the focus from market performance to better understanding clients’ risks, financial goals and personal values as the basis for investing decisions, behavior and return expectations.

Thirty percent of advisors said clients wanted goals-based planning. However, 61% said it was hard to manage clients’ performance expectations when it comes to integrating goals-based planning into their businesses.

Meanwhile, advisors or their teams are managing two-thirds of their clients’ discretionary assets themselves. A third of their clients’ assets are either in their firm’s model portfolios or managed by external consultants. Because of new regulations, 9% of advisors said they planned to outsource investment decisions.

The study found that time spent on asset allocation and increased client communication left advisors with little time to focus on building their practice. They expect their assets under management to change by 12%, on average, over the next year.

However, 91% saw that growth coming from their ability to acquire new clients, while 79% expect more assets to come from existing clients.

Automated Advice

Financial advisors in the poll believed robo-advisors could address a potential advice gap, particularly among younger and low- or middle-income investors. Advisors generally saw the automation of professional advice for certain segments as a positive development:

•  84% believed the automated advisory model provided greater access for low balance investors.

•  51% thought a front-end automated advice platform could improve the efficiency of their own business.

•  86% did not worry that automated advice would render the traditional, high-touch advisory model obsolete—they did not think robo-advisors could deliver the tactical asset allocation needed, particularly in down markets.

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