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Regaining Investor Confidence

by Eric

Investors' primary concerns these days are twofold: (1) is my money safe? and (2) does investing still even make sense? Asset managers and advisors used to have to prove the superiority of their products and services. Since the market meltdown and abuses of investor trust, though, the importance of stacking up versus the competition fades to a distant third after the two questions above. If asset managers are to grow and thrive post-recession, they need to face these two questions head-on.

The first of these questions is fairly straight-forward. Investors have heard enough about Madoff and Stanford to be very wary of turning over their money to just anyone. Discerning the real good guys requires some diligence. Ultimately, reputation, track record, social media, feedback loops and ratings, client loyalty scores, and redemption rates will all signal to investors who is trustworthy and who is not.

The second question for the industry is far tougher. Many investors regret having invested their savings over the last ten years (the "lost decade"). Investing in the markets, once taken for granted as a smart thing to do, has yielded poor returns for many investors. However, there are two ways for investors to react to the results, and the difference between these two viewpoints is vital for asset managers.

Some investors infer that they made a bad decision to invest at all. Others see the results as bad outcomes of good decisions, which happen from time to time. This is not just an academic distinction, because it has implications for future decision making. To hammer home the point, offer me an even-money bet based on the roll of a fair die: I win if it comes up 1, 2, 3, 4, 5; you win if it comes up 6. We roll the die, it comes up 6, and you win. Did I make a bad bet? No! I took a risk and made a rational decision that did not work out, one that I would take again as many times as you offered it.

One cannot always infer the quality of the decision merely from the nature of the outcome. Investing in the markets the last ten years did not work out too well, but that does not mean the decision to do so was poor. Inferring that they made a mistake may cause investors not to invest going forward, and this would be a mistake. Over the long haul, substantial evidence indicates that broadly diversified and regular investing in productive enterprises increases wealth. However, how one does so may change.

Some investors have learned that their risk-tolerance is not as high as they thought. For those clients, new products or services may be in order. Structured products with downside protection (e.g. principal protected notes), annuities, or portfolios including diversification beyond the standard long-only style box coverage may give some investors peace of mind and the courage to continue investing.

Asset managers and advisors recognize that investors are emotional. It is human nature to blame decision making for poor results; this minimizes the role that risk plays and leaves us feeling more in control of our destiny. But our rational mind knows that randomness plays a role in determining outcomes.

Therefore, if asset managers and advisors want to continue to thrive, they need to convince people with assets that investing still makes sense, and that investing the last ten years was a good decision with a bad outcome, not a bad decision. Only after making a strong case for their own trustworthiness and the sensibility of investing at all will asset managers and advisors be able to move on to discussing their particular products and services.