The challenges of appealing to millennial investors
Asset managers are developing new methods to help millennials overcome significant mistrust of the markets.
After experiencing two major bear markets — the tech bubble in 2000 and the global financial crisis in '08 — younger investors have little reason to trust the markets, said Kostya Etus, a portfolio manager at CLS Investments. As a result, they are demanding products that are easy to understand and offer transparency, he said.
"The millennial generation is getting married a little bit later, having kids a little bit later, building houses a little bit later, and all of these things have happened for most millennials in the last five years or so," Etus said in an interview with Money Management Executive. "Part of it is education and a part of it is just the natural evolution that you're going to start seeing, where more and more millennials begin to save for retirement because they need to think about their family and their futures."
As flows have continued to move to ETFs over the past decade — growing as much as 20% to 30% per year, according to Etus — socially responsible strategies have become one place managers have looked to drive interest. With boomers now entering their decumulation phases, the time to bring millennials up to speed is now, he said.
"Explaining to millennials that there are investments like this and giving options for ESG investments would really be a great way to help them get invested," he said. "Showing how much impact you have is actually bringing to the world something really impactful."
An edited version of the conversation follows.
How are the next generation's demands altering back offices?
The technological evolution is happening everywhere, and the millennials are always busy, they're always tired, they're always working, they're just starting their families, they don't really have as much time to go visit with a financial advisor. But they want access to everything at their fingertips, which is, of course, very possible with the evolution of the cellphone market. We all have a supercomputer in our pocket.
Now, how easy would it be to pull up your cellphone and pull up all of your accounts and all your information? Let's say you have a question about something or are unhappy about something — instead of taking time to do a phone call, which is really kind of relationship building, a lot of millennials simply don't have the time to do it, and they'd rather send a text message or get text message notifications. I think that's where this type of evolution is going.
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One key area where we're already seeing the more impersonal feel to financial advice is through the robo advisor market. There you can sign on to a website and have an account created in a matter of minutes, and have everything ready at your fingertips through an online interaction.
What do you see as the biggest impact from this shift?
It's certainly changing the way advisors need to think about interactions with their clients. Advisors need to think about how they can evolve their technology offerings and think to the future.
At CLS we are the money managers that provide third-party asset management for advisors, but we actually have a sister company, Orion, that provides the back office. They are consistently trying to find ways to help advisors with this evolution. They're always coming up with new apps and gadgets and widgets to help streamline what the client really needs.
Does this shift impact the way products are being developed?
As far as product evolution, I think all signs are pointing to ETFs — there's a ton of competition happening everywhere, and the focus has shifted toward low cost. Millennials are very cost-centric, and they are also very skeptical. I like to sometimes call it the know-it-all generation, because we perceive ourselves as experts on everything, no matter what question you ask. You simply Google it and you find out the answer right away.
Having that ability to look things up quickly is actually a great benefit to ETFs, which are highly transparent and simple. They're very easy to understand, they're index-based and they're transparent. You can look up the underlying holdings every day, you know exactly what companies you're holding, and I think millennials can really grasp that and appreciate that. If you told me you could have something very simple at a low cost, it's a no brainer.
Millennials have not saved the way previous generations have for retirement. What kind of challenges does that create?
I think the most important thing there is education. We can only do so much by promoting education through social media and through websites, but it falls on the employer when millennials get new jobs and start through their orientation. Employers should be focusing on saving for retirement and 401(k) education and, really, they should start making 401(k)s mandatory. That will get millennials more involved.
The millennial generation is getting married a little bit later, having kids a little bit later, building houses a little bit later, and all of these things have happened for most millennials in the last five years or so. So part of it is education and a part of it is just the natural evolution that you're going to start seeing, where more and more millennials begin to save for retirement because they need to think about their family and their futures.
How are managers addressing the phenomena of fewer investors taking part in the market compared to previous generations?
That is a huge issue. The older generation that has been a lot more focused on their future and saving is really getting to that age where they're already in retirement — the baby boomers — and they're starting to take distributions. Advisors are going to see that their large cash-cow accounts are going to start distribution, and the new crop of millennials coming in aren't saving as much.
I think education is key. Having the products, the differentiated product offerings through ETFs is important — and having the technology in place so they have everything at their fingertips. You need to make it easy for millennials. If it's easy and it doesn't take a lot of time, they'll do it.
Do you see socially responsible investing as a solution for the lack of interest in investing?
Absolutely. We've already seen the tremendous flows into ETFs over the last decade or so, upwards of 20% to 30% growth per year. The ESG movement is in the infancy stages, and over the last year it's really the first time that it's starting to peek its head.
There has also been evolution within the ESG space itself. If you think about more of the traditional values-based investing, we call it SRI, that dates back decades and the clients always associate it with screening out negative companies, screening out tobacco, screening out weapons manufacturers and perhaps energy companies. This new evolution of ESG — instead of negative screening, this new-school approach is only investing and not taking out companies one by one out of a flat index.
Higher-quality companies have done well over the last year on a global basis, and ESG companies have followed suit. So that's a very interesting dynamic and something that particularly resonates well with millennials, because, although other older generations were also focused on some social issues, millennials are more focused on global climate change [and] gender equality, and they're really more interested in companies that are helping the world get better.
This gets us to the topic of impact and which companies are really helping to drive global change. Explaining to millennials that there are investments like this and giving options for ESG investments would really be a great way to help them get invested. Imagine if you look up your account and you look in your cellphone app, and let's say your account will say 0% of your investments are in tobacco stocks, or you're saving this many pounds of carbon emissions. Just showing these things, showing how much impact you have is actually bringing to the world something really impactful.
What types of tools are being created today to address risk?
For millennials — we're still fairly young, but we've been through two major bear markets. We had the tech bubble in 2000, and then we had the financial crisis in '08. Both of these events have made us untrustworthy of the markets. There's a little bit of fear there that may have something to do with the lack of amount of money millennials are investing. I think it's important to highlight to millennials the importance of risk management; that's really what millennials are mostly worried about. When I talk with some of my colleagues; it's really about how do we manage risk in our accounts.
What the financial crisis has really taught us is the traditional view of risk management, which would be a stocks and bonds approach, really isn't the best way to do it. There are a lot of factors that it doesn't capture, mainly the different risks within asset classes. Large-cap stocks have different risks than small-cap stocks. And high-yield bonds or corporate bonds have very different risk than Treasuries, which are very much a safe-haven asset issued by the U.S. government. So it's really important to assign specific risk at the individual asset-class level before aggregating it up to a risk target.
“It’s important to highlight to millennials the importance of risk management; that’s really what millennials are mostly worried about.”
At CLS, this is how we manage money. We call it risk budgeting, and it works very well with new clients. Let's say a new client comes in, and this can be a millennial simply working through a website. We have a calculator on our website, and you answer a series of questions and they evaluate both your ability and willingness.
Ability would be: When do you plan to retire — how much money do you make? Willingness is: What's your comfort level for taking risk? You fill out a questionnaire and it results in a risk-target number from 0 to 100. We would match you up for that specific risk target with a model portfolio that is targeting that specific risk.
Let's say another market crash happens, or let's say a pullback, or the markets go up; the key thing is for the investor to be comfortable with the return that they're going to get.
What does the future look like in this space?
As a complement to risk budgeting, you can also break down a portfolio into those risk factors that I talked about earlier. The value, momentum, size, quality, and breaking down your portfolio into those key factors allows you to see where your risk is actually coming from. So in an '08 type of event, you might have thought that you were allocated in a particular way, but it turns out you weren't. You didn't have the specific exposure you wanted, and it hurt your overall results.
Now this factor risk decomposition is actually quite complex in nature. It's an expensive [and complex] analytics tool, but we believe that in the future it's going to be very integral to break down their portfolio and monitor risk at that microscopic level to ensure that those surprises don't happen, and to ensure that you always know exactly what you're allocated to.
It might seem simple to sell a fund that you don't believe is going to outperform. But what it could have an effect on is the total aggregated risk of the portfolio when you factor in all the correlation. Understanding every single interaction between this new position with every single other position currently in the portfolio is of utmost importance.