As advisors stare down the end of 2020, they may begin to question if 2021 will bring a repeat of the 2008-2009 financial crisis in which we saw high-net-worth clients opting to change financial advisors, in our observation, in significant numbers.
Granted, 2020’s economic turmoil played out differently than it did last time. On March 23, as governments began imposing stringent lockdowns as the coronavirus pandemic took hold in the U.S., the S&P 500
As the markets continue to operate in uncharted and volatile ways, we predict that clients will be scrutinizing their advisors’ performance more closely than ever in the coming year, and expect many to find such performances wanting.
As a result, advisors should beware of losing clients for the following three reasons.
1. Simplistic portfolio solutions
The offerings of many advisors currently consist primarily of prebuilt investment vehicles, such as mutual funds and ETFs. While these products may democratize investing, clients who seek the professional help of an advisor should expect more for their fees.
Despite a growing range of strategies, prebuilt funds severely limit the ability of an investor to customize a portfolio with exposures or restrictions that they prefer, often holding entire categories and sectors despite pandemic-affected dislocations. We know full well, for example, that not all hospitality or retail companies have weathered the pandemic equally. While these products may perform well in a robust market, they are not well suited for environments characterized by extreme economic dislocation and a failure to capitalize on divergent trends.
2. Unnecessary tax liability
A sophisticated financial plan can be derailed by unsophisticated investment portfolio management. In the 2018 market cycle, many portfolios ended the year flat. But the outsized performance of a few stocks, like Microsoft and Nike, led to capital gains tax liabilities for holders of those vehicles.
For example, if a fund realized significant gains from selling shares of Apple, it created considerable tax exposure for investors, even if the rest of the fund performed poorly. The current market is similar to 2018’s, with tech shares performing well, but many other sectors underwater. Thus, an investor could face the double whammy of a large tax bill coupled with negative-to-flat returns. Advisors who do not adapt and fail to offer such an approach will be at risk.
3. Failing to adapt to changing markets
The post-COVID investing universe will be very different from the situation that prevailed pre- or even mid-COVID. Stocks that became investors’ darlings during the pandemic lockdown, such as Zoom, Netflix and Peloton
Over the past several weeks, stocks that will benefit from the economic reopening have outperformed those that benefitted from shutdowns. Since Nov. 1, Exxon Mobil (XOM), Simon Property Group (SPG) and Brinker International (EAT) are all up roughly 30%.
In this environment, clients may be quick to replace advisors who are slow to recognize the market’s propensity for rapid shifts, and fail to construct portfolios accordingly. The conventional wisdom of constructing portfolios with a 60% equity-40% bond split is one critical area where advisors may need to change their established notions. In the prevailing near-zero interest rate environment, the return on a traditional high-grade bond portfolio is essentially nil, which warrants a mix change towards more equities, if that’s within the risk tolerance of the investor.
Even a small rise in interest rates will easily swamp the meager yields now offered on bonds. Depending on the goals of the client, a financial advisor who is attuned to this market shift may recommend an allocation to preferred stock — or to other higher-yielding — but short maturity instruments.
Bad year to slack off
In the current market environment, offering a “lazy” portfolio constructed of mutual funds and ETFs combined with insufficient attention to portfolio customization, tax efficiency and portfolio transparency, does not serve investors well and may doom a number of ill-prepared advisors.
But those advisors who start with the always-valid premise, “If it’s important to you, it’s important to me,” will be better able to understand their clients’ needs, adapt to a volatile marketplace and create solutions that are relevant to investors in a changing market.
