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Risk-Adjusted Returns Still Top Fund Selection Criteria for BD Advisors

By Rita Raagas De Ramos March 29, 2018

Risk-adjusted returns remain the most important factor considered by this year’s Financial Times 400 Top Financial Advisors when choosing a fund to recommend to their clients, just as it has been since the elite list started in 2013. Even if many advisors say the Department of Labor’s fiduciary rule has placed a spotlight on fees, fund cost hasn’t crept up in the fund selection priorities of the top advisors.

When FA-IQ sister publication Ignites Research asked these elite broker-dealer advisors to identify which fund characteristics are most influential in convincing them to invest their clients’ assets, their top three choices were risk-adjusted returns (cited by 79%), trust in the portfolio manager/team (55%) and low cost (45%). The FT 400 advisors, who were surveyed in October and November of last year, have an average of $1.4 billion in client assets.

Broker-dealer advisors who make it to the elite FT 400 list are assessed annually by Ignites Research based on six criteria: total assets, asset growth rates, years of experience, compliance records, industry certifications and online accessibility.

Risk-adjusted returns being consistently the top fund selection criteria for FT 400 advisors “makes sense,” according to Loren Fox, New York-based director of research at Ignites Research.

“The top advisors understand that while everyone wants higher returns, an investment cannot take on disproportionate risk in order to chase performance,” he says. “It’s especially important to remember the value of risk now, when the markets are high, and the investment outlook seems sunny.”

Fox says FT 400 advisors generally still see a huge role for actively managed products in their clients’ portfolios.

Among the mutual funds and other packaged products used by the FT 400 advisors, 70% of the assets are in active strategies, including a majority of U.S. equity products, according to Ignites Research data.

Raj Sharma, an advisor at Merrill Lynch and one of this year’s batch of FT 400 advisors, says he prefers investment strategies with a “risk-controlled approach” and avoids those that are “incredibly speculative.”

“I like strategies where the managers understand the downside risk. It’s not just the upside that’s important, but also how much money you can lose when things go wrong,” he says.

Sharma says he also likes funds that are managed by a team. “In a team-managed approach, a lot of minds get into it as opposed to just one individual. That appeals to me.”

The trust in the portfolio manager or team as well as low cost factors also contribute to the FT 400 advisors’ performance objectives.

Loren Fox

Fox says advisors are willing to bet on good portfolio managers, “which means betting on the philosophy and the process” of a portfolio manager or team.

“Trust in the portfolio management team is so vital,” he says. “Advisors are hoping to invest in funds for the long run, and so they need to know that they can rely on a consistent approach even through the ups and downs.”

Patricia Baum, an advisor at RBC Wealth Management and another of this year’s FT 400 advisors, says that one way managers can gain the trust of investors is if they or their firms are also invested in their own funds. “That tells me something,” he says.

She says she tends to stick to managers “for many years,” which gives her the confidence that they can manage through various investment cycles.

The clarity of the investment philosophy of a manager or a team is also important to Baum. “I need to make sure they stick to their knitting. If I’m hiring them to be small-cap value managers, that’s what they should be doing.”

“I like strategies where the managers understand the downside risk. It’s not just the upside that’s important, but also how much money you can lose when things go wrong.”
Raj Sharma
Merrill Lynch

Meanwhile, fund costs are important for the FT 400 advisors given how easily fees can erode investment returns, but that doesn’t mean they only want passive products, Fox says.

“Advisors want active management, but they want it at a reasonable cost,” he says. “They simply don’t want to pay Rolls Royce prices for a Lexus. As a result, we’ve seen not just tremendous growth in ETFs but also a reduction in fees among many actively managed products.”

Merrill Lynch’s Sharma understands why many advisors believe having low-cost products is an “easy way” to prove that they are working in their clients’ best interests, but he doesn’t believe that cost should drive fund selection.

Indeed, while there are advisors shifting to lower-cost investment products to help prove they have the best interest of their clients in mind, others believe that instead of giving in to the “cheaper is better” mentality, they should be educating investors about the merits of an investment product and why one may be more expensive than another.