Peter Brooks of Barclays Wealth explains some of the practical techniques and tools for relationship managers and other advisers to help clients avoid falling into some of the common behavioural traps.
Date: Jun 2011
The industry needs to show clients that it is focused on understanding how and why they make their decisions, and how they try to cope with certain circumstances, he explained.
It is noteworthy that as individuals get wealthier, their circumstances don’t necessarily get any easier for them, said Brooks. As a result, he said that understanding the strategies people use to try to cope and the way they try to make things simpler for themselves can help wealth managers better appreciate the potential pitfalls for clients.
Avoiding common behavioural traps
According to Brooks, there are two things relationship managers (RMs) can do to help clients avoid common pitfalls in relation to their investment attitudes and behaviour.
They can try to guide the client towards strategies which other HNW individuals have used successfully – for example cooling-off periods, delegating control to other people, or asking for more opinions among family members. However, said Brooks, the ability for a wealth manager to influence a client in these ways is somewhat limited.
As a result, the other thing which RMs can look to do is change the portfolio to implement those strategies to help the client who gets particularly stressed or trades too much – by building a portfolio to protect that client against those instincts.
For example, for a client who gets stressed easily, Brooks said an RM could think about creating a portfolio which delegates control to somebody else for at least a portion of the assets. Or it might involve looking at options such as long/short hedge funds whose strategies should remove some of the market’s short-term volatility.
It’s all about building a portfolio that a client should be more comfortable holding for the long term, he added.
It’s not about getting the optimal portfolio – but instead telling the client a slightly different story. For example, that if they don’t try to protect themselves against some of the instincts they are likely to have along the way, then they will get less-than-optimal returns.
By controlling the experience of risk, clients will get more satisfaction and better financial results, said Brooks.
Classical finance plays a key role in building the optimal models, he explained. But if a client cannot hold these they won’t get the returns. So by building in an emotional layer, while it will cost a few basis points and might look like there is under-performance versus the optimal benchmark, actually the client is out-performing themselves.
Questions to ask clients
Brooks said RMs should add some specific questions to their advisory toolkit. Asking a client about their experiences during the recent financial crisis and how they felt can provide more information on which to base future conversations, and to determine their drivers in terms of emotional reactions.
This can then be followed up with further questions, he added. For example, for a client who exited the market during the crisis, RMs can ask them when they thought about getting back in.
Typically, Brooks said clients say they wouldn’t buy back into a market if they have seen it drop by 50%. Yet the biggest single-day returns tend to occur during periods of peak volatility at the bottom of the market when people are stressed and therefore panic. As a result, investors sit out of the market until they see an upward trend and want to get back in after having already missed 15% to 20% of the upside.
It is therefore possible by asking simple questions at the start to determine appropriate strategies in relation to taking on risk or buying some downside protection.