People invest to make money, and always will. But getting the biggest returns is not the top concern for investors in choosing whom they want to handle their money, says a new survey from the CFA Institute. The new bottom line? Trust.
The growing emphasis on integrity over absolute returns follows a series of cases in which customers lost large sums from supposedly reputable firms getting outstanding results for clients.
In the two most noteworthy cases, smart, wealthy investors lost billions in ripoffs by Bernie Madoff and Allen Sanford. Former New Jersey governor and Goldman Sachs investing whiz, John Corzine, has shocked investors by allegedly taking $1 billion out of client funds to pay for his MF Global firm's trading losses in a case still being probed by regulators. Even mainstream firms are not immune; Record fines were levied this year against Main Street wealth manager LPL Financial for violating securities rules related to email, on top of recent fines related to selling real-estate investment trusts and fraud charges for a former LPL advisor.
Those cases, and a string of others involving investment firms from hedge funds to local financial advisors, have eroded trust in the entire investment community. The CFA Investor Trust Survey of more than 2,000 clients around the world showed that only about half could trust their money managers "to do what is right."
The investors say that having trusting relationship with a money manager is twice as important as getting the best possible financial result and five times as important as getting the lowest fee, says Kurt Schacht, CFA Institute managing director of the standards and financial market integrity division. "That was really the thing that surprised us the most was that it mattered more to investors than how much the money manager made for them," he says.
The findings show a pervasive view among global investors that "they want a culture shift - a renewed focus on ethical behavior," Schacht says. That means the industry needs to shift from telling people they have the hottest investing strategies to saying they have the cleanest ones, he says. So far clients are not convinced, even after years of government-mandated reforms, regulatory actions and industry shakeups.
A broker for a major wealth management firm in suburban New Jersey, who spoke about the CFA survey on condition of anonymity, says that in Madoff's case "he was showing 12 percent returns year after year. And those were audited results - or at least they were sanctioned by an auditor. You have to look beyond that."
For individual investors, the New Jersey financial advisor says, finding the right broker is really "a word of mouth process. You really have to find out what other clients says about the advisor." The problem, he concedes, is that it's hard to get good factual information about past practices and performance.
The CFA Institute says investment houses should do more to show clients and potential clients how they operate. "Individual investment managers need to be transparent, demonstrate integrity, and communicate clearly to strengthen client relationships," says the Schacht, a former compliance officer. "The retail investment firms' pitch has always been about price and performance," says CFA Institute's Bob Dannhauser, head of standards of practice and outreach, "They have to extend that conversation."
But how? Schacht says it's "a step-by-step examination of integrity measures" that smart investors are starting to use. Institutional investors, whose jobs involve picking money managers, rate the integrity measure far higher than retail investors do. Individuals can learn from these steps the pros are starting to use, he says.
-Ask what risk management infrastructure in place.
-Make sure they are charging fair commissions and fees.
-Be able to verify where customer money is held.
-Know the experience level of the firm's professionals.
-Avoid managers who push costly proprietary products over lower fees.
-Check SEC records on any past industry sanctions.
-Ask for specific, concrete examples of a firm's ethical practices.
-Find as much as possible about client-appropriate, risk-adjusted performance.
Institutional investors shopping for an investment manager can get those answers more easily than individual investors, to be sure. Asking friends for their recommendations or asking for references from other clients is one way average investors can get information in picking an investment professional. And even if they have little knowledge in advance, once they become clients they should keep watching the guidelines listed above. If advisors are failing on one or more, it might be time to shop around. Don't wait for a bad situation to turn into financial disaster.
Experts say one of the biggest signals of problems is an investment professional who cannot clearly communicate to a client about what decisions are made and why. "It's about the relationship," says the New Jersey financial advisor. "Performance matters but that really depends on people's risk levels. It's got to be appropriate. And it needs to be talked about openly."
The CFA Investor Trust Survey is the first ever so there are no prior year comparisons. But it was done in partnership with Edelman, whose 13 years of survey data from its Edelman Trust Barometer across industries shows rising "emphasis placed on individuals to behave in ways that build trust and protect reputation." Edelman says this holds true for the investment management industry as well."
None of the results show that money does not matter, of course. "Getting good results is entry level. Nobody wants to pay someone who gets crappy results," says Schacht. But 35 percent said the most important trait of an investment manager is making their clients' interests the top priority, and only 17 percent put maximizing return as the most critical requirement. Surprisingly the integrity issue was five times as important as fees, a top issue for only 7 percent of those in the survey, which included 1,600 retail an 500 institutional investors.
Does it mean people will pay for integrity and risk management? "It's definitely an opportunity for the industry if they can address the issue of character convincingly," says Schacht. "Everybody is looking for an honest broker."
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