The emotional impact of the recent financial crisis has finally surfaced. Despite signs of economic recovery and stock market rebounds, investor confidence — across multiple wealth bands — remains tenuous at best.
This is forcing many wealth management firms to incorporate elements of behavioural science into their practice, according to the latest Capgemini/Merrill Lynch World Wealth Report 2010.
The extension of behavioural finance to the broader HNWI population will the young science into the mainstream. But the shift is fraught with its own challenges and could result in fundamental changes to the wealth management service delivery model.
At a time when the level of distrust among HNWI is high, wealth management firms and advisors will find it particularly challenging to suggest the type of investing that is needed to recover losses. Investor hesitation and caution are emotional reactions that continue to inspire acute risk aversion.
This year’s World Wealth Report also looks at how wealth management firms are adapting to behaviour-driven investing by clients.
Most firms are focusing first on integrating behavioral finance by building room for emotional triggers in risk scenario analysis and comprehensive asset allocation models.
The report points to increased client involvement in managing their investment choices. They are demanding more specialized advice, full product disclosure and transparency, and are more educated about investing and their own needs.
“HNWIs understand they now need to view their portfolios through the dimensions of risk, versus just a diversified sector asset allocation or performance lens,” points the study.
Firms and financial advisors are approaching it with two different game plans; a short-term response to the demand and a long-term strategy that incorporates behavioral finance more deeply into their business model.
The short-term approach involves generally responding to increased client demands for transparency by bringing more products and risk specialists to the client meetings. The strategy aims to address emotional triggers that cause clients to remain cautious about making an investment decision.
Some wealth management firms are investing in more specialized advisor training to integrate tenets of behavioural finance into their asset allocation models.
On the product side, manufacturers are spending more time educating advisors and clients about detailed risks and rewards of their products and details of the disclosure statements.
The longer term strategy will closely examine the advisory process against the backdrop of clients’ emotional biases. The focus here is to capture information that can drive a deeper, goal-oriented conversation with clients, and as a result create investment strategies that inspire long-term trust and confidence.
Firms are embedding behavioral finance frameworks more deeply into their advisory service models and their risk-analysis assessment. The way in which they execute and enable transformation, though, may vary depending on the firm’s strategy and positioning.
In the end, every firm now knows investor demands and behaviours have changed, but their obligation to address a client’s investment objectives, desire for principal protection, and overall risk tolerance hasn’t.
(07/19/10)