The whole tooth, and nothing but the truth

Back in March, I introduced you to Dr Steinig, my endodontist, who had just performed some root canal surgery on me. I related that I’d recommend Dr Steinig to anyone, but that my judgment was really only based on how he made me feel, not on how good a job he did technically – something I was in no position to judge.

I then drew a comparison with financial planning clients – who are making an assessment of someone’s competence in a field in which they have little or no expertise (which of course is why they’re there in the first place).

At my recent six-month check-up, Dr Steinig was quite amused to hear that he had become fodder for my column. “How can you tell whether I did a good job?” he demanded, rhetorically. “This is how!” he exclaimed, thrusting a pair of X-rays into my hands.

The X-rays, Dr Steinig explained, clearly showed that the root damage had healed nicely over the previous six months. Certainly the black hole on the pre-operation X-ray, which apparently represented the infection, had been replaced by a more pleasant image of what he explained was healthy looking bone.

So it seems pretty clear that I’ve had a favourable outcome, despite my lack of expertise and discrimination. I’m still basing my judgments on a framework and on expectations that Dr Steinig set when I first saw him, however. A cynic might worry about the old “promise low, deliver high” trick.

The original question still stands in relation to financial planning, though: In a complex field within a dynamic world, how can a client judge the proficiency of their own planner?

Should clients set down benchmarks for their planners? Is that appropriate? Should these be market-related? If so, over what period should they be measured?

These are crucial questions and many of the answers will come down to a personal choice by clients. I’ve made my case for a more philosophical (as opposed to quantitative) approach in previous columns and I’d like to illustrate it with a real-life case study.

Fund manager Maple-Brown Abbott was an industry pioneer back in the 1980s. It remains a highly respected firm and I suspect most planners wouldn’t hesitate to recommend its products to their clients.

So let’s examine some results from the Maple- Brown Abbott Australian Equity Trust, established on December 31, 1992. As at August 31 this year, the trust had underperformed its benchmark over three, four and seven years (by 1.4 per cent, 2.4 per cent and 0.3 per cent per annum, respectively). The figures are better over one, 10 and 15 years, so a client might reasonably enquire of their planner about an appropriate timeframe for judging its performance.

As you might have guessed, I don’t believe this is the right question. Managed funds are not bank accounts. Unlike term deposit rates, for example, fund returns are not a “run rate” which can be compared across different products. They are a simple statement of historical figures.

The documentation always admonishes that past performance is not a reliable guide to future returns. Nevertheless, most people find it irresistible to use it as a basis for comparison.

My recommendation is that planners and clients focus on the fund manager’s core approach and philosophy, and determine whether or not it’s likely to be successful and whether or not the client is likely to be comfortable with it. This involves practical thought, as opposed to a simplistic comparison of historical numbers.

Straight numerical comparisons can lead to huge mistakes. Some fund managers (like the now departed Basis Capital) engage in strategies which author Nassim Taleb has described as “collecting pennies in front of a steamroller”.

This breed of fund manager can outperform for a time, perhaps quite a few years, before finally being flattened by an unexpected event that wipes out all of the previous years’ gains (perhaps with hindsight, some such fund managers even feel a pang of guilt for the millions in “performance fees” they pocketed in the good times).

The bottom line is that the figures alone rarely tell the whole story. And, while the easy option is to select products “on the numbers”, planners owe it to their clients to provide a deeper level of guidance and service. That’s a more difficult row to hoe but, like root canal surgery, no one said that providing good financial advice was easy.

Back in March, I introduced you to Dr Steinig, my endodontist, who had just performed some root canal surgery on me. I related that I’d recommend Dr Steinig to anyone, but that my judgment was really only based on how he made me feel, not on how good a job he did technically – something I was in no position to judge.

I then drew a comparison with financial planning clients – who are making an assessment of someone’s competence in a field in which they have little or no expertise (which of course is why they’re there in the first place).

At my recent six-month check-up, Dr Steinig was quite amused to hear that he had become fodder for my column. “How can you tell whether I did a good job?” he demanded, rhetorically. “This is how!” he exclaimed, thrusting a pair of X-rays into my hands.

The X-rays, Dr Steinig explained, clearly showed that the root damage had healed nicely over the previous six months. Certainly the black hole on the pre-operation X-ray, which apparently represented the infection, had been replaced by a more pleasant image of what he explained was healthy looking bone.

So it seems pretty clear that I’ve had a favourable outcome, despite my lack of expertise and discrimination. I’m still basing my judgments on a framework and on expectations that Dr Steinig set when I first saw him, however. A cynic might worry about the old “promise low, deliver high” trick.

The original question still stands in relation to financial planning, though: In a complex field within a dynamic world, how can a client judge the proficiency of their own planner?

Should clients set down benchmarks for their planners? Is that appropriate? Should these be market-related? If so, over what period should they be measured?

These are crucial questions and many of the answers will come down to a personal choice by clients. I’ve made my case for a more philosophical (as opposed to quantitative) approach in previous columns and I’d like to illustrate it with a real-life case study.

Fund manager Maple-Brown Abbott was an industry pioneer back in the 1980s. It remains a highly respected firm and I suspect most planners wouldn’t hesitate to recommend its products to their clients.

So let’s examine some results from the Maple- Brown Abbott Australian Equity Trust, established on December 31, 1992. As at August 31 this year, the trust had underperformed its benchmark over three, four and seven years (by 1.4 per cent, 2.4 per cent and 0.3 per cent per annum, respectively). The figures are better over one, 10 and 15 years, so a client might reasonably enquire of their planner about an appropriate timeframe for judging its performance.

As you might have guessed, I don’t believe this is the right question. Managed funds are not bank accounts. Unlike term deposit rates, for example, fund returns are not a “run rate” which can be compared across different products. They are a simple statement of historical figures.

The documentation always admonishes that past performance is not a reliable guide to future returns. Nevertheless, most people find it irresistible to use it as a basis for comparison.

My recommendation is that planners and clients focus on the fund manager’s core approach and philosophy, and determine whether or not it’s likely to be successful and whether or not the client is likely to be comfortable with it. This involves practical thought, as opposed to a simplistic comparison of historical numbers.

Straight numerical comparisons can lead to huge mistakes. Some fund managers (like the now departed Basis Capital) engage in strategies which author Nassim Taleb has described as “collecting pennies in front of a steamroller”.

This breed of fund manager can outperform for a time, perhaps quite a few years, before finally being flattened by an unexpected event that wipes out all of the previous years’ gains (perhaps with hindsight, some such fund managers even feel a pang of guilt for the millions in “performance fees” they pocketed in the good times).

The bottom line is that the figures alone rarely tell the whole story. And, while the easy option is to select products “on the numbers”, planners owe it to their clients to provide a deeper level of guidance and service. That’s a more difficult row to hoe but, like root canal surgery, no one said that providing good financial advice was easy.