One risk clients might not consider

By DAVID MOON, Moon Capital Management, LLC
August 12, 2012

If you have an investment advisor, stockbroker or someone you pay to help you with your investments, there are multiple types of risks you expect him or her to help you assess and manage. There is one risk he is likely managing, however, about which you have no awareness – and it may be the one that most impacts your investment returns.

Client risk. That is, the risk that you fire him.

Years ago I worked for a large bank running the Knoxville office of the trust department. The influencing corporate philosophy of everything we did – including our investment process and stock selection – was “don’t lose clients.” That may sound logical on the surface. After all, the clients paid the bills and we were in the business of being in business.

Actually, however, we should have been in the business of serving clients. And serving your client is sometimes entirely different than placating him – especially in the short term.

Our trust department clients were concerned about things like risk, retirement, college planning and income. While the bank investment people shared those concerns, many were preoccupied with making decisions that reduced the likelihood of getting fired, not making decisions that increased the likelihood of meeting the clients’ goals within their risk tolerances.

That is, the advisers were more concerned about their own risk than those of their clients.

Sometimes the most appropriate investment decision for a client isn’t the obvious one. It isn’t the most popular one. It may be one that doesn't make obvious sense to a client. An attractive investment is often out-of-favor. Buying or recommending out-of-favor stocks is doubly risky for an adviser. There is a risk that any investment won’t work. But if an unpopular investment performs poorly, an adviser has increased his risk of being fired.

It is unlikely that a manager or adviser will be criticized for losing money owning stocks like Apple, Amazon or ExxonMobil if everyone else owns those stocks. Those are safe investments for an adviser, regardless of whether or not they are safe for the client. No one will fire his broker for recommending popular investments.

So a lot of people own Apple, Amazon and Exxon.

This is the same reason a lot of people owned Wal-Mart in late 1999. It was the largest company in the S&P 500. No one could criticize an adviser for buying the stock. Even though the stock declined 32 percent over the next 37 months, you couldn’t fire an adviser for owning it because almost anyone you might consider hiring probably also owned it.

Anyone who recommended Wal-Mart in 1999 was not capable of an independent thought. They weren’t concerned about the risk of the investment. They were concerned about the risk of being fired. What if Wal-Mart continued to go up and they didn’t own it? That was much riskier than owning the stock and seeing it decline - as long as everyone else owned it, too.

At least it was riskier to the adviser, not the client.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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