Legally speaking: Volatility, prepared clients and opportunity

As the market turmoil continues, advisors again have an opportunity to demonstrate their value. This opportunity should not be missed — volatile times are when clients look to their advisors for proactive advice. What’s more, advisors also have an opportunity to avoid the obvious, foreseeable negative result of actions made by clients who are spooked into crystallizing their losses.

The absence of proactive advice during times of volatility is a major complaint that comes up in advisor negligence regulatory complaints and legal actions. The common refrain, “if only my advisor had reviewed my financial plan when my portfolio value was dropping…” is the chorus playing during most complaints and actions. Client perception is that the advisor did not review the plan with them because the advisor knew he or she had failed. This lack of contact, sometimes combined with newsletter communication that contradicts the news they see (with advice or recommendations to invest more) seems insensitive and out of touch.

Most advisors, though, have prepared clients for the market risk and volatility we are witnessing. Admittedly, there are many market risks. Recently, two particular risks that have affected client holdings are currency risk and sector risk.

With swings in the comparative value of the Canadian dollar, the value of non-Canadian dollar investments has fluctuated significantly. For clients whose financial strategies are not based on market timing, this volatility can seem like a very significant risk.

As for sector risk, the massive swing in the commodity sector and financial investments is compounded in many cases by the high degree of similar sector holdings among certain mutual funds. This can result in significant market and sector concentration risk.

Advisors who have clients with currency or sector risk should or will have specifically canvassed clients with exposure to these risks and addressed them during the planning process. These advisors will also have warned their clients, specifically, in plain English and in writing, to anticipate significant market volatility. The risk and volatility that are now so predominant have long been anticipated.

All advisors know a bull market is defined, in no small part, by the contrast of bear markets that bookend each sustained growth period. All advisors also know that markets have cycles, complete with low and high points. The good advisors have prepared their clients for where we are today by establishing plans that anticipated this volatility.

Providing risk and volatility advice along with education are two key parts of the advisory role. Clients turn to advisors to ensure that the investments in their portfolios all have suitable risk and volatility parameters.

Advisors, in turn, do not guarantee results; they guarantee that a professional planning process occurs for each client. It is the “know your client,” due diligence, suitability and review planning cycle that are guaranteed. Thus, advisors who have done their jobs are in an excellent position to politely remind their clients, and reassure them, with an “I told you so,” if needed.

The “I told you so” comment is not a point of pride; it is a factual statement, intended to reassure the client. The advisor who can reassure clients with a timely, factual reference to an informed and implemented financial plan is the advisor who has proven his or her value. This sort of reassurance in good times is easily dismissed as pride and boasting. Factual, timely reassurance in harsh times, though, is appropriate and professional.

Why now? Because clients are reading the news — reporting that is often extremist. Clients have reason to be fearful. Some will receive monthly and quarterly statements that may cause deep concern. An advisor who proactively reaches out and explains that the risks and volatility were all planned for in the client’s portfolio helps to illustrate the importance of a professionally designed plan. Clients may even be reassured by the robustness of the planning exercises they went through, the investment portfolio they’re holding and their advisor’s professionalism.

Consider, in contrast, the known risks. It is axiomatic or evident that investors follow market trends, buying in rising markets and selling in falling markets. The institutional and sophisticated investors are ahead of this curve, while average individuals, left on their own, are behind the curve — clients who lack a professional plan and faith in their professional are investors who are reasonably likely to be spooked by the unavoidable evidence of risk and volatility. If not reassured, clients will likely act irrationally and blame the advisor for the circumstances. Regardless of client actions, it will seem like these circumstances destroyed the professional’s planning, exposing investment suitability problems.

Clients left on their own are the proverbial loaded shotguns. Advisors can disarm those shotguns by proactively reviewing their financial planning exercises and carefully setting objectives for foreseeable circumstances. “Staying the course” is a viable option but the last bear market clearly showed us that some clients will not accept this option; they will not face further losses.

Clients who can no longer accept the volatility in an investment should make a decision to either stop the losses or make a planned transition to less volatile investments.

If there is a lesson to be learned from this stage in the last bear market, it is that advisors should act now — this is when clients need you most. They need your wisdom, your counsel and your help in making significant financial decisions. If you’ve left them on their own, do not be surprised if they act irrationally and blame you. If reassured, though, do not be surprised if their trust in you grows.

Harold Geller is an expert on legal issues affecting financial intermediaries. Harold assists and represents dealers, MGAs, branch managers, compliance officers and advisors dealing with their compliance, regulatory and negligence issues. Harold also helps financial intermediaries with internal business and their clients’ legal issues. Harold is a well-known industry commentator, a CE provider and administrator with foradvisorsonly.com. Harold’s law firm, Doucet McBride LLP, also provides advice on tax issues, Succession Planning, Retirement Planning, Estate Planning and buying and selling books of business. Harold can be reached at hgeller@doucetmcbride.com.

(09/11/08)