Fixed income attribution week

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I just learned that the Spaulding Group, which I wrote about in “Fixed income attribution falls short,” will run a week-long series of webinars on fixed income attribution from July 13-July 17, 2009.


If you remember the Campisi model that popped up in my earlier blog post, “Fixed income attribution falls short,” you may enjoy hearing the model explained by Steve Campisi himself in one of the Spaulding webinars. If you attend, please comment on my blog to tell me what you learn!

Behavioral finance can deepen your client relationships

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Understanding behavioral finance can improve your client relationships. That’s the lesson I took away from “Behavioral Finance: So What?”, a June 15 presentation by Gayle H. Buff, president of Buff Capital Management, to the Boston Security Analysts Society (BSAS). Buff has 20 years of experience working with  individual investors and is a past president of the BSAS.

Like financial advisors, clients of investment and wealth managers don’t act with complete rationality. They react with their emotional right brain in addition to their rational, reflective left brain. However, Buff said, to optimize our ability to make informed decisions, we need to use both sides of our brains. Advisors who understand this, can tailor their interactions with clients to take advantage of this. 

Behavioral finance experts have identified loss aversion, uncertainty aversion, and overconfidence as a few of the key investor tendencies that reflect the influence of the right brain. During the past year’s financial crisis, Buff observed many instances where fear of uncertainty trumped fear of loss. Some of her clients wanted to sell their investments, even if that potentially meant locking in losses.

Behavioral finance helped Buff respond effectively to her clients who wanted to sell. Understanding that clients’ “sell” requests were intensely emotional, “I don’t take it personally or as them telling me I’ve done something bad,” she said. Instead of arguing with them, Buff listened to her clients’ fears. “Talking about what makes us afraid makes us less fearful,” she said.

It isn’t easy for most advisors to follow Buff’s strategy. “We often want to rush in with facts,” she said. However, advisors need first to acknowledge their clients’ feelings. Only after doing that does it make sense to give clients an alternative perspective on the issues. The advisor who takes this two-step approach will find their clients more receptive.

In fact, if advisors and clients can work through a financial crisis, they may end up with a much deeper relationship. One of the big advantages may be enhancing clients’ understanding of risk. Prior to the past year’s financial crisis, most clients overestimated their risk tolerance said Buff.

Buff listed five areas that advisors should explore with their clients, including clients’
1. Capacity to tolerate market volatility and economic risk
2. Characteristic defensive posture in the face of anxiety and uncertainty;
3. Vulnerabilities, passions, strengths, weaknesses, and dreams
4. Ability to process, integrate, and adapt to new information a new experience
5. Commitment to working collaboratively and synergistically as one-half of the advisor–client relationship

This blog post only touches on a tiny portion of Buff’s material, which included a bibliography on complexity theory and adaptive systems, behavioral finance and investor psychology, and the intersection of theory and practice. However, she speaks on behavioral finance to CFA societies around the world, so she may come to your area.

By the way, it has been my pleasure to get to know Gayle through volunteering with her on the BSAS’ Private Wealth Management committee. I’ve seen her dedication to financial education.

Is the efficient market hypothesis dead?

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The efficient market hypothesis is taking a lot of heat. It’s getting slammed in opinion pieces such as George Soros’ “The three steps to financial reform” and articles such as Joe Nocera’s “Poking Holes in a Theory on Markets.”


What do YOU think? Did the efficient market hypothesis contribute to the current financial crisis? Answer the poll in this blog’s right-hand column.


Financial writer’s clinic: Great title, lousy intro

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“When Will Housing Recover?” This title reeled me in. I flipped directly to the article, bypassing two others. But what I found disappointed me. I’ll use this article’s mistakes to suggest rules you can follow in your article introductions.

The writing problem: Boring introduction
Then article’s first paragraph stopped me cold. It held a long-winded description of a home price index’s composition. It’s information that I might exile to a footnote if I wrote a white paper on this topic.

Here’s the first sentence of the article: “The S&P/Case–Shiller Home Price indices measure the growth in value of residential real estate in various regions of the United States.”  The first paragraph devotes 247 words to the details of the markets tracked by these 23 indices.

Three rules for an interesting introduction
1. Answer the key question. That’s “What’s in it for your readers, if they slog through your article?” The authors nailed this question perfectly with their title. But they forgot about it when they wrote their introduction.
2. Keep it short. Direct marketers have discovered that readers start to lose interest once a paragraph runs longer than 42 words. Sure, investment professionals have more patience than folks opening junk mail. Still, the authors’ 247 words–almost six paragraphs of words according to direct marketers’ standards–is way too long.
3. Don’t save the good stuff for your conclusion. If you’re like me, you learned in school that you should build your argument logically to a conclusion. Throw that habit away, if you want people to read what you write. At a minimum, hint at your conclusion in the introduction to your article.

My rewrite of the article’s introduction

Everybody wants to know when housing will recover. But you can’t make a meaningful estimate until you understand the data. It seems to us that the severity of the decline has been overstated because of problems with the S&P/Case–Shiller Home Price indices. Once we understand the data better, we can make a case for housing getting on the road to recovery by the second quarter of 2010.

The indices are dominated by states, such as California and Nevada, that have experienced a housing boom followed by a bust. In fact, price increases and declines vary greatly by state. The price of housing in roughly two-thirds of our 50 states have risen–or fallen by no more than 5%–during the two years since the fourth quarter of 2006.

My rewrite isn’t perfect. Some of the sentences are awfully long. But I feel confident that it’s more engaging than the original. What do you think?

 


What’s a good elevator pitch for this blog?

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Whether you’re marketing your company, job hunting, or just networking, everybody needs an elevator pitch that succinctly conveys how they add value.

Even a blog needs an elevator pitch, says Darren Rowse of ProBlogger in “Write an Elevator Pitch for Your Blog.“

Here’s my elevator pitch for this blog:
The Investment Writing blog helps investment and wealth management professionals to communicate more effectively with their clients and prospects. The blog provides helpful communications tips and timely articles about industry topics.

How did I do with my elevator pitch? Do you have suggestions on how to improve it?

Also, if you’re a blogger, please share your blog’s elevator pitch along with a link to your blog..


 

Fidelity expert: "CMBS Challenges & Opportunity: Are CMBS Securities Mispriced?"

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By some measures, commercial mortage-backed securities (CMBS) are in good shape, according to Mark Snyderman, portfolio manager and CMBS group leader, Fidelity Investments, who presented on “CMBS Challenges & Opportunity: Are CMBS Securities Mispriced?” to the Boston Security Analysts Society on May 5. Still, he answered “No” to the big question posed by his title.


Good news: New construction and cash flow growth
Commercial property is not overbuilt, said Snyderman. In fact, in recent years, new construction has lagged the 2% growth rate needed to keep up with population growth and replacement of obsolete buildings. So, commercial property rents and occupancy should fare relatively well.


Commercial property growth has fallen from its peak. But even in 2009, Snyderman expects it will be flat or perhaps down by single digits. So, cash flow isn’t much of a problem.


Problem: Lack of debt financing to squeeze mortgage borrowers
CMBS delinquency rates could rise to roughly 20 times their current level, which is below 2%, said Snyderman. Commercial real estate is suffering as debt financing becomes less available for highly leveraged properties purchased at historically high valuations. The disappearance of cheap debt financing and concerns about cash flow growth suggest that CMBS delinquencies will increase dramatically.


Pessimism will create opportunities
Investors must approach CMBS cautiously, said Snyderman. They can’t rely on ratings because the ratings agencies haven’t adequately reformed themselves. Instead, investors must do old-fashioned, bottom-up credit analysis on a property-by-property basis. It’s also helpful to consider the “vintage” of a CMBS deal, even though there are deal-by-deal differences. 


Right now, we’re in a wave of market optimism, said Snyderman. But, he predicted, a wave of pessimism will bring attractive opportunities in CMBS.


Financial services: An industry at odds with its clients

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“Toward transparency and sustainability: Building a new financial order,” a newly released study by the IBM Institute for Business Value raises some provocative questions about the relationship between financial services firms and their clients. 

Two big questions
1. Do financial services firms really put their clients’ best interests first?
2.  Do financial services firms understand what their clients want?

Clients’ best interests lose to financial services providers’ 
“…providers offer products that serve their own best interests, rather than those of their clients,” according to more than 60% of the institutional and retail investors and intermediaries surveyed by IBM.  

Almost half of the American industry executives surveyed–and about 40% of executives worldwide–agreed that providers’ best interests get top priority. You can view graphs of the survey results on p. 10.

What do clients want? Financial services firms don’t get it. 
Financial services firms think they know what clients want. Clients’ top priorities are “best-in-class offerings” and “one-stop-shop,” according to their survey results. They reckon that most clients would pay a 5%-15% premium for these characteristics.

But neither of these items cracks the top two in client survey results. In fact, in the IBM survey, clients rate “Unbiased quality advice/client service excellence” and “convenience” as their top priorities. Best-in-class offerings rank third and one-stop shopping comes in eighth. I do wonder if some survey participants may confuse “convenience” and “one-stop shop.” I’m also curious about the make-up of the clients whom IBM surveyed.

You can view the providers’ and clients’ top 10 answers at the top of page 10. 

The survey results also lead IBM to suggest that financial services providers must segment their products accordng to how clients behave. “The ability to serve specific client clusters represents a major–and largely ignored–opportunity for the industry to make money,” says the report.

“We have lost sight of the client in our own striving for outsized returns. We must get back to basics and focus to a far greater extent on our clients.”–Global Head of Prime Brokerage, large U.S. bank

Related post: Research study: How financial services firms will make money in the future


Research study: How financial services firms will make money in the future

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The financial services industry can’t continue to make money the way it used to. So the IBM Institute for Business Value tackled the challenge of answering the following questions:
*  Which forces are disrupting the industry? 
*  What will clients be willing to pay for?
*  How will the basis for competition change? 
*  And what steps should financial services firms take to prosper over the next three years?




Recommendations for a “new financial order”


You can read the researchers’ answers in “Toward transparency and sustainability: Building a new financial order.” As I see it, their answers boil down to a need for financial services firms to

1. Work with regulators to develop a system that hits the right balance between protecting investors and fostering financial creativity

2. Deliver on their promises to clients, including their promise “to focus on the interests of their clients”

3. Become more specialized, with a division between “beta transactors” and “alpha seekers”

On #1, the need for the right regulation, the executives surveyed by IBM anticipate “greater transparency and higher capital requirements,”IBM’s analysis suggests seven elements for an appropriate solution (see p. 7).

As for #2 “… firms will need to become more cost-effective, manage risk more competently and move closer to their clients,” says the report (p. 9). 

The specialization called for in #3 may result from unbundling. Although the industry executives surveyed by IBM favor the universal banking model,”the vast majority (89 percent) anticipate that overcapacity will ultimately result in some sort of unbundling” (p. 12).





Provocative ideas

“Most providers do not even realize what their clients actually want,” says the report. So they’ll struggle to meet their clients’ needs.

Managing risk will require cutting costs because “the amount of risk [financial institutions] can underwrite relative to the capital they employ will be much lower…. Slashing headcount and closing business lines–the levers traditionally employed when the industry wants to save money–will not be enough” (p. 9). Companies must slash 20% beyond the savings they realize from divestitures and eliminating redundancies, according to IBM’s analysis. It sounds as if firms have a lot more cutting to do.


Ignore this advice–at least some of it

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“10 Words to Use in Your Website Copywriting” gives you some great advice. But some of author Eric Brantner’s suggestions need to be adjusted for investment management websites.

Eric lists 10 words that tug powerfully on human emotions. 
     You
     Free
     Guaranteed
     Easy
     New
     Proven
     Results
     Save
     Maximize
     Benefit

     
Can you guess which word I’d ban from your vocabulary? 


Yes, it’s “guaranteed.” Bandying about “guaranteed” can get you in trouble with the SEC.


I have my doubts about “new” when it comes to something as sensitive as your prospective client’s money. I think they may prefer “proven.”


As for “free,” it may seem tacky to offer something free on an investment management website. Sure, you can offer a free report, but don’t hype it like one of those late night TV commercials for a super duper chopping gadget.


“You” is my favorite word on Eric’s list. But I know some firms consider it undignified. They prefer to talk about “clients” or “investors.” What’s your preference?


"The Current Financial Crisis: Why did it happen and what is being done?"

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Look at a typical investment bank’s balance sheet and you can understand how the collapse of housing prices took down those banks. 

That’s the message I took away from “The Current Financial Crisis: Why did it happen and what is being done?”,  an April 16 presentation by John Haigh, executive dean of the Harvard Kennedy School, to the Boston Security Analysts Society. Haigh said it didn’t take much to explode the investment banks’ model of highly leveraged balance sheets with lots of short-term debt.

I liked his simple diagram of the progress of the financial crisis.
“Home prices fall –>mortgages reset –> delinquencies –> foreclosures –> prices fall further –> mortgage equity withdrawals decrease –> consumer spend falls –> job market erodes –> recession”

Haigh made several statements that stuck with me.
* People are wrong about the rating agencies. “These are such fundamentally new financial instruments tht they don’t know how to rate them.” That’s because ratings agencies typically rely on historical data–which didn’t exist for the new financial instruments–to build models for rating.
* There’s a “hot potato theory” that investment banks tossed the hot potatoes off to pension funds. But, in fact, pension funds that got AAA notes got the better assets. Investment banks were left holding the worst assets. They thought they had insured against losses in those assets through credit default swaps. That turned out to be wrong. “That why they went overnight from being investment banks to being commercial banks.” Given their exposure, they needed the liquidity and support of the federal government.
* People tell me credit default swaps are like Las Vegas, except Las Vegas is regulated and credit default swaps aren’t.
To fix the near-term crisis, Haigh said, we must
1. Recapitalize banks
2. Restart interbank lending
3. Absorb “toxic” assets
4. Prevent bank runs

More regulation of financial services is coming. Haigh is concerned that the pendulum may swing from too little regulation to too much. He referred to an April 6 presentation by Barney Frank at the Kennedy School that discussed regulation.  However, Haigh said, “You have very smart, thoughtful people in the Obama administration. I don’t think you’ll get insane regulation unless Congress gets out of control.” 

You can email John Haigh for a copy of his slides, if you’d like to learn more.