Broker Check

The Straw Man Advisor

| April 28, 2015
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I’m not sure if any of the following situations have actually occurred in my life personally (convenient hedge) or if I’ve just seen each of them on television fifty thousand times.  That being said, you know the cliché scenario where someone asks a question for someone else, like a ‘friend’?  Or what about a person having a convenient circumstance that gives them an out from doing something?  Need an example?   I thought you’d never ask.  How about someone calling into a dating/romance show to get some advice for ‘a friend’?  Or someone at a cocktail party asking a physician about a weird rash that their ‘cousin’ has?  How about the middle school kid who won’t ask that girl to dance because he has a girlfriend?  Where is this girlfriend exactly?  He met her at summer camp and she lives out of state. Unnecessary Newsflash: you are the friend, you are the cousin with the rash, and the girlfriend does not exist.  These people are withholding information, not sharing the whole story, however you want to phrase it.  Why? They’re hedging or they’re embarrassed.  In social environments this behavior is usually obvious and harmless.  How does all of this relate to my business and why am I writing about it?  While the examples above can make for stale, yet semi-amusing sitcom moments, proper disclosures between financial advisors and clients make for healthy relationships and better advice given and received.  When material information is not disclosed by either party, it can lead to legal/compliance disputes at worst and incomplete and sub-par advice at best.

Advisors are required by law to provide proper disclosures about fees, conflicts of interest, portfolio risk, and any strings that may be attached to a given investment such as lock-up periods or redemption fees.  It’s pretty simple, if the advisor doesn’t disclose, they get in big trouble.  Do all advisors provide all of these disclosures all of the time?  They should, but that is what compliance departments are for.  Bottom line, the rules for advisor disclosures are quite clear and must be followed.  But what about the other side of this coin?  What about the clients?  There really aren’t many ‘rules’ about what they must disclose to their advisor beyond basic identification information (social security numbers, date of birth, etc.).  I’m not here to suggest that there should be disclosure rules for clients per se, but I know from experience that it is in a client’s best interest to provide as much pertinent information as possible to their advisor(s).  As an example, I’ll recount a client experience from the past which I’ve coined ‘The Straw Man Advisor’.

I had a client back in the day who had their portfolio split between my firm and another.  They showed me the statements from the other firm and there was indeed another advisor’s name on the documents.  The client spoke highly of the other advisor and talked about how they had worked together for years.  The client asked me for my opinion of their portfolio at the other firm and I was happy to oblige.  Issues that I saw included allocation vs. risk tolerance asymmetry, over-concentration of individual security positions, portfolio overlap, fee structure inefficiency (taxes), amongst others.  Need an example?  Stick with me here……….but how about owning an actively managed portfolio, a passively managed portfolio that the previously-mentioned actively managed portfolio competes against, and several individual passively managed sector portfolio positions, each (sector) of which are already encompassed within the two previously mentioned investments?  To me, this spells redundancy, unnecessary transaction costs, and all-around wheel-spinning.  I shared my concerns with the client and began asking questions to discern how he actually got to this place with his assets at the other firm.  I wasn’t getting straight answers.  I suggested that the client have a conversation with their advisor about these issues and even included a list of questions to ask the advisor, but the client was not willing to do that.  I made suggestions on how things could be streamlined and simplified with their other account and the suggestions were never implemented.  These conversations went on for a few years, and then I simply gave up trying, caring, take your pick. 

As a New England Patriots fan I have fond memories of Bill Parcells coaching the team.  He left because he was butting heads with the team owner, Bob Kraft, over personnel decisions.  Parcells wanted to pick his players and Kraft wouldn’t relinquish control.  In the press conference to announce Parcells’ departure, the coach was asked why he was leaving.  Parcells’ responded with what was, and still is, one of my favorite quotes of all time.  Parcells said “sometimes you need to get hit in the face three or four times with a skunk before you can smell it.” One word: Genius.   With this client that we’re discussing, I kept giving advice, solid advice, to no avail.  So what changed with me?  Why did I give up on them?  I realized after the fourth or fifth iteration of this conversation/skunk slap-to-the-face that the other advisor was likely (in my opinion) a place holder, a straw man.  How did I reach this conclusion?  I don’t believe that any competent advisor would build the portfolio that this client held.  This other advisor was likely a nice guy who the client could bounce ideas off of and who could execute/trade said ideas.  The advisor was likely okay being paid to be this client’s ‘yes man’.  I finally concluded that in critiquing the other advisor’s advice, I was actually critiquing the client himself.  The client was the one managing the portfolio and causing the problems that I was attempting to fix.  The client never disclosed any of this to me, but I believe it to be true as it’s the only explanation that makes sense.  The other advisor being involved and on the client’s statement provided a shield, or ground cover for the client.  It enabled the client to explain away their mistakes or mismanagement when their own investment ideas weren’t working out or didn’t make sense.  Weird, huh?  You bet, welcome to my world!

So why didn’t the client just make my suggested changes to improve his portfolio?  Pride, I guess.  Had I known from the beginning who I was really critiquing, I would’ve softened my message and framed my critique differently.  This likely would’ve led to a better portfolio result for the client. How so?  Legitimate diversification could’ve been achieved by removing holding overlap which was causing redundancy.  This would’ve properly aligned his portfolio with his stated risk tolerance.  Significant cost savings could’ve been realized by eliminating the expensive and unnecessary actively managed investments within his portfolio that were so highly correlated with his low cost, passively managed holdings.  Tax savings could’ve been achieved by revamping the structure of his portfolio to increase the deductibility of the client’s advisory fees.  So let’s see, lower risk, lower costs, higher tax efficiency…………what’s the problem with that?  Unnecessary News Flash #2: There isn’t one.  We were just too far down a false path to turn around and do what made sense.  Why?  Lack of disclosure on the client’s part.  Do you remember those old commercials for the Mormon Church back in the 80’s?  They were on all the time when I was a kid.  Remember the one where the kid wants to lie to his mom about going to the movies instead of doing his chores?  The next thing you know he’s in a dark room surrounded by guys dressed like burglars holding flashlights up to their faces singing the ‘one lie leads to another’ song?  Why do I hear crickets chirping?  Anyway, I remember the commercial all too well and this situation was pretty similar!

To be fair, maybe the client didn’t fully trust my advice or didn’t trust me.  That’s possible, and obviously, okay.  On the other hand, maybe the client should’ve taken the time to more carefully select an advisor that they fully trusted.  Doing that would’ve saved us a lot of time and benefited their portfolio greatly.  Here’s the point………..this example of the unhealthy client-advisor dynamic of incomplete disclosure of information wasn’t the first of my career and it won’t be the last.  For the client’s sake, they should know that I’ve never seen a client benefit from this dynamic.  It always leads to sub-par results, at least in my experience.   At the most basic level, this all could’ve been prevented by the client telling the truth about how their other assets were actually being managed and by whom.  I guess those Mormons were really on to something!

 An advisor-client relationship is really no different than a romantic one.  Trust must be present and lines of communication must be open from the beginning.  In a relationship, you can’t have one foot in the door and one foot out.  You need to put it all out there and walk across the threshold of love………  What’s that?  This sounds like a romance call in show?  I wouldn’t know anything about that, I have a ‘friend’ who listens to one and he told me all about it.

By: Andrew Gonski

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Some of the opinions expressed in this material do not necessarily reflect the views of LPL Financial.

No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.  LPL Tracking #:


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