How to win wealthy clients

Advisors in the proprietary and HNW segments often tell us they need more than just the research and marketing support their in-house analysts provide. They’re looking for approaches that will give them a leg up.

Many advisors put client service first, and understand that in the eyes of their customers, reassurance and validation of their process are just as important as results. This is not to say advisors are not ensuring investments are researched thoroughly and responsibly. They just know the value of vetting third parties who can perform some of the heavy lifting on the analysis side while they maximize client contact.

Many top advisors who serve the HNW segment always look for increased touch-counts with their clients. They want ways to remind their most valued clients they are delivering leading results, as well as keeping on top of new risks and opportunities in the market.

Advisors have also told us their use of outside research is strengthened when they take steps to validate it in the eyes of clients. This might mean providing performance updates for any model portfolios they might use, as well as from articles that address specific risks that are not well covered in the market.

Some advisors also use sales sheets that highlight their investment process and how they incorporate external research and ideas, especially when those ideas can be tied to topics in the news.

The feedback we get suggests this approach works well because the use of complementary third-party strategies addresses head-on the criticism advisors often have of their home institutions; namely, that they skew their in-house research to shine a flattering light on current product offerings and equity issues. HNW clients are no fools; many are just as aware as advisors of this shortcoming of home institution research.

We also validate our expertise, while addressing top-of-mind issues, sectors, ideas and opportunities. For example, we highlight that over the past decade we were the first to advise against the risks inherent in several waves of new financial reporting, including the pro-forma, adjusted-earnings results that helped create the tech bubble as well as the business income trust mania.

We then tie that expertise into emerging issues. As we roll into 2011, we think the newest risk to investors is the switch to International Financial Reporting Standards (IFRS). Most companies made the switch effective January 1 and have reported their first quarter under the new rules. There is no shortage of commentary on the impact these changes are having on companies and target prices.

Unfortunately for advisors, the surprising fact is most home institution research is not focusing on these new risks and opportunities. A lack of expertise with accounting and financial reporting issues leads many sell-side analysts to adopt a merely reactive — if not indifferent — attitude towards significant IFRS changes.

As a recent example, many sell-side analysts have been downplaying the impact of IFRS on cash flows following the release of first- quarter results. It is not surprising the analysts are not picking up on the issues. For the most part, they are simply mimicking what they have heard from management on the conference calls without making further efforts to investigate the substance of what the companies are saying. In the most recent Talisman Energy conference call, for instance, management remarked that “underlying cash flows” do not change under IFRS.

Most analysts misinterpret such statements. What management meant is that total cash flows in and out of the firm do not change. Accounting rules do not change the substance of transactions. However, they do impact how cash flows are measured, and more specifically, how they are categorized.

IFRS definitely has an impact on the classification of cash flows as operating versus investing cash flows. And because analysts do not value companies based on total cash flows, they can make mistakes. They might focus mostly on operating cash flows to set their target prices, and by not understanding how the measurement of those cash flows can change, misjudge the value of the company.

To put the issue into perspective, under IFRS, Talisman’s operating cash flows in 2010 were $384 million (or 8%) lower than they were under the old accounting rules. Same year, same company, two very different ways of measuring cash flows — and one big gap when it comes to putting a value on the company.

Nevertheless, IFRS is only the most recent wave of accounting issues that have an impact on target prices and values. Despite accounting issues that present themselves in waves, like IFRS, income trust reporting, or tech bubble adjusted results, there continues to be much standard fare, so to speak, when it comes to financial reporting adjustments that need to be made to target prices.

One example is multi-employer pension plans, which are defined-benefit plans to which employees of several different companies belong, and which are funded by contributions from multiple employers. The accounting disclosure requirements of these plans are so bad that the majority of investors are likely unaware of their existence, let alone their impact on target prices.

This situation is specifically relevant to Metro Inc., which barely mentions the existence of its multi-employer plan in its annual report – never mind disclosing any figures on the size of the deficit for which the company is responsible. Only by pulling disclosures from sources outside of the company are we able to adjust Metro’s target price for the material impact of the financial reporting deficiency.

In another financial reporting adjustment that falls outside the scope of IFRS, we make material adjustments to our target price for Suncor Energy because the company does not disclose as much detail as its Canadian peers do on the value of its reserves.

Suncor provides net present value estimates of proven and probable reserves using average commodity prices and constant costs. However, this is not particularly useful since a more accurate way of determining net asset value is to use forecast commodity prices and costs, similar to the way Canadian Natural Resources Ltd. does.

Yet none of this means much to some HNW prospects and clients without solid performance numbers. Some clients will not want the details of how target prices and portfolio performance are impacted by accounting and financial reporting risks. They just want the bottom-line impact – how much it can add to their portfolio. That’s why so many advisors appreciate regular model portfolio performance updates.

The key to serving HNW clients and prospects is to have at your disposal as much or as little information as needed to satisfy the specific client’s taste. Some investors will just want performance results, while others want a one-page sell sheet covering the unique investment process.

Likewise, some clients enjoy articles that explain the under-covered risks and opportunities, while others are interested in the research reports themselves. Having a full arsenal at your disposal will make your job easier, and your clients that much happier.

Dr. Al Rosen, FCA, FCMA, CIP, CFE, CPA and Mark Rosen, MBA, CFA run Accountability Research Corp., providing independent research to investment advisors across Canada.