This Research in Practice piece gives a practitioner's perspective on the article "Client Involvement in Expert Advice -Antibiotics in Finance?" by Andreas Hackethal, Christine Laudenbach, Steffen Meyer, and Annika Weber. A Sustainable Architecture for Finance in Europe (SAFE) Working Paper (No. 219).
The Investment Issue
A number of studies in the medical sciences report that a significant share of doctors’ antibiotics prescriptions to patients are inappropriate. This exposes the patients to harmful side effects and ultimately contribute to drug resistances. One of the reasons for such inappropriate prescription according to doctors, is patients’ insistence on such prescriptions. In many cases, these patients, after receiving diagnoses from “Dr Google” show up to their doctors armed with the knowledge of "exactly" what they need.
Similar to doctors in the medical sciences, financial planners face clients who come to meetings armed with advice from the internet and may insist on specific investment prescriptions even if they are detrimental to their overall portfolio and not in line with their investment policy statements (IPS). Considering the remuneration structure, the financial planner may end up pandering to a client’s unsound request simply to “close the deal” which can reduce the quality of advice.
The Authors’ Approach in this Research
The authors studied the role of client involvement in the financial advice process and outcome by analysing how advisors who generally follow a highly standardised advisory approach react when clients approach them with investment ideas of their own. They also reported the implications on portfolio performance and client satisfaction.
Since January 2010, financial advisors in Germany are mandated by law to keep written minutes of all advisory sessions. The researchers analysed minutes of about 16 933 interactions between 6 204 clients and their 429 advisors at a large branch of a German bank between 2010 and 2013. The minutes include a documentation of financial products that are discussed during the meeting together with the final recommendations and a stated justification by the advisor for recommending a particular product to the client.
The internal guidelines of this bank require advisors to match their clients to portfolios designed by the bank’s fund management arm or other pre-selected actively managed funds of other providers. The advisor is however free to discuss other investment ideas or proposals from the client. This means the final recommendation of the advisor may include inputs from the advisor and the client. The minutes in such case, should then include instances of active inputs from the client in the advisory process. Using a double-rater process, the researchers used manual text analysis and searched for explicit client investment ideas and requests that came up during the meeting.
Overall, 8% of the clients approached their advisors with their own ideas at least once and clients’ ideas accounted for a little over 2% of the 25 200 buy recommendations over the period of the study. "Involved clients" who approach their advisors with their own ideas tend to be male, more risk-tolerant and had relatively large investment portfolios. These clients are more often comfortable to receive advice over the phone, more independent, and more often approached their advisors on their own initiative. Apart from analysing explicit ideas from clients, the researchers also examined other variables that point to client involvement in the advisory process. These variables include the number of securities the client purchased without receiving any recommendation from the advisor – this measures client independence.
The client’s gender is also used as a proxy for (perceived) confidence. The study finds that part of the variation in the recommendations of the advisors were due to explicit requests from clients as well as implicit investment priors, controlling for the risk preference of clients and unobserved advisor heterogeneity. This confirmed the assumption that advisors read the implicit investment preferences of clients from their existing portfolio allocations before the meeting. The researchers found that the bank’s standard products, available in different risk categories had little appeal to involved clients who tend to ask for and receive recommendations for more idiosyncratic products like single stocks or single-sector funds even if these products worsened an already under-diversified portfolio. Recommendations to involved clients deviated significantly from the ready-made approach of the bank.
Although client involvement did not have a significant influence on the returns of their portfolios, such portfolios, after controlling for risk preferences, had higher return volatility and ultimately inferior risk-adjusted returns compared to peers who went solely with the recommendations of their advisors. In general, the researchers found that higher client involvement negatively affected portfolio outcomes by reducing portfolio diversification. Interestingly, clients did not come with their own ideas with the aim of minimising advisor fees. The researchers did not find any significant difference in client satisfaction between highly involved clients and passive clients who simply went with advisor recommendations.
Implications for Financial Advisors
Although the internet facilitates increased access to information, financial advisors should be aware that such access can aggravate existing client behavioural biases such as over-confidence in their investment skills and confirmation bias on prior investment convictions. Financial advisors dealing with highly involved clients should reiterate the benefits of holding properly diversified portfolios, the need to focus on the overall investment objectives stated in the policy statement and ensure that all subsequent investment decisions are in line with the investment objectives.
You can read the full paper here: