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CFP Board Picks Best Research Papers of 2021

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The Certified Financial Planner Board of Standards’ Center for Financial Planning recently announced the winners of its Academic Research Colloquium for Financial Planning and Related Disciplines Best Paper Awards. Below are some of the papers that we thought were especially relevant to investment advisors.

1. Who Pays the Price for Bad Advice? The Role of Financial Vulnerability, Learning and Confirmation Bias By Julie Agnew, Hazel Bateman, Christine Eckert, Fedor Iskhakov, Jordan Louviere and Susan Thorp

Bernie Madoff committed a $17 billion fraud against 1,000 wealthy clients, but as this paper states, fraud isn’t limited to only wealthy clients. “Evidence of persistent misconduct by advisers, when combined with findings that cast doubt on whether advisers actually improve their clients’ portfolio outcomes, underscores the importance of choosing a high-quality financial adviser,” the researchers state.

This paper explores mechanisms that drive client choice of advisor and the willingness to pay for financial advice. As the authors state, “We show how consumers with certain characteristics can incur higher economic costs, and we find that predatory advisers can exacerbate these costs.”

What kinds of people will pay bad financial advisors? Younger, more trusting, more impulsive, less financially literate and less math-savvy participants were most vulnerable to paying a poor-quality advisor. Further, not only do these consumers seem to pay the higher price for bad advice, bad advisors will prey upon these groups.

“Poor financial advice can leave a lasting trail of destruction among unquestioning clients, as the Madoff case and numerous others show. This paper provides an explanation for why some clients are more likely to ignore bad signals about financial advisers and identifies those clients most vulnerable to manipulation by advisers.

“That is, they are more likely to follow a learning process that is consistent with confirmation bias,” the authors state in their conclusion, noting that combined with limited knowledge “can make a client too ready to follow an adviser of dubious quality and make them willing to pay more in fees.”

2. Measuring Financial Advice: Aligning Client Elicited and Revealed Risk By John Thompson, Longlong Feng, R. Mark Reesor, Chuck Grace and Adam Metzler

Financial advisors use questionnaires and discussions with clients to determine a suitable portfolio of assets that will allow clients to reach their investment objectives. This paper compares Know Your Client (KYC) profile risk allocations to their investment portfolio risk selections using a value-at-risk discrepancy methodology.

VaR is used to measure elicited and revealed risk to show whether clients are over-risked or under-risked, whether changes in KYC risk lead to changes in portfolio configuration and how cash flow affects a client’s portfolio risk.

The team demonstrated the effectiveness of VaR at measuring clients’ elicited and revealed risk on a dataset provided by a private Canadian financial dealership of over 50,000 accounts for over 27,000 clients and 300 advisors. By measuring both elicited and revealed risk using the same measure, they could determine how well a client’s portfolio aligns with their stated goals.

The study determined that using VaR to measure client risk provides valuable insight to advisors: to ensure that their practice is KYC compliant, to better tailor their client portfolios to stated goals, communicate advice to clients to either align their portfolios to stated goals or refresh their goals, and to monitor changes to the clients’ risk positions across their practice.

3. Racial Animosity and Black Financial Advisor Underrepresentation By Derek Tharp, Jeffrey A. DiBartolomeo, Michael G. Kothakota and Elizabeth Parks-Stamm.

Although Blacks represent 13.4% of U.S. population as of 2018, Black advisors represent only 1.6% of CFP professionals, according to CFP Board data from 2019. This number may be higher when the definition of financial advisors is expanded. However, representation of Black advisors is not consistent across the United States.

One aim of this study was to investigate whether racial animosity across metropolitan markets is associated with Black financial advisor underrepresentation. Using a dataset of all U.S. securities-licensed identified financial advisors (237,435), the team used racially charged Google search queries as a proxy for racial animosity.

They found that greater racial animosity is associated with greater Black advisor underrepresentation. There was lower underrepresentation of 0.9 percentage points when comparing markets with the highest and lowest levels of animosity. For the average market with an estimated 11.4% Black advisor representation, an increase of 0.9 percentage points would represent a 7.9% increase in Black advisor representation.

The study also concluded that one problem was that “attitudes of racial prejudice in areas may make it more difficult for stakeholders in the field to combat underrepresentation of Black advisors.”

4. What Do the Portfolios of Individual Investors Reveal About the Cross-Section of Equity Returns? By Sebastien Betermier, Laurent Calvet, Samuli Knupfer and Jens Kvaerner.

Researchers sought the answer to three questions: If one sorts stocks by the characteristics of the individual investors who own them, do these characteristics produce factors that price the cross-section of stock returns? If so, how do the new investor factors compare with traditional factors constructed from firm characteristics? Lastly, how do investor characteristics, risks, and biases relate to portfolio tilts toward the new factors?

Researchers constructed a “parsimonious” set of equity factors by sorting stocks according to the sociodemographic characteristics of the individual investors who own them using administrative data on the stockholdings of Norwegian investors in 1997-2018.

They showed, theoretically, that portfolios of stocks sorted by the age or wealth of their individual investors should produce powerful pricing factors. Using the Norwegian data, they verified empirically that a three-factor model consisting of a mature-minus-young factor, a high wealth-minus-low wealth factor, and the market factor performs well in pricing the cross-section of stock returns.

According to the researchers, “the tight connection between investor factors and investor portfolio decisions allows us to shed light on the underlying mechanisms at play. We document that investor wealth, indebtedness, macroeconomic exposure, age, gender, education, and investment experience explain investor portfolio tilts toward the new factors. Our findings support the view that hedging motives and sentiment jointly drive investor factor tilts. “

5. Are Millennials Wary of the Stock Market? A Cohort Analysis of Stock Holdings

By Zhujun Cheng and Tansel Yilmazer

Participation in the stock market dramatically dropped during the Great Recession. There have been concerns that certain demographic groups, especially millennials, have not since been back to the stock market, the paper states.

Using the Survey of Consumer Finances (SCF), the team created seven cohorts based on birth years and age and cohort effects on stock holdings outside and in retirement accounts. Results provided evidence for strong cohort effects for stocks outside of retirement accounts.

Controlling for age, not only millennials but all age groups had lower stock holdings outside retirement accounts in 2016 compared with 2007. The researchers did not detect any cohort effects for stocks in retirement accounts.

The CFP Board website includes a full list and abstracts of all the considered papers.


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