Nick Dignam from Fortitude Investment Partners shares insights with Lachlan Maddock from Fortitude Investment Partners on how a diversified portfolio in mid-market private equity is structured. The Inside Adviser
The world of alternative investments is at a crossroads. As markets defy expectations and liquidity concerns take centre stage, investors find themselves forced to rethink how they deploy capital in an increasingly complex environment.
Defusing the behaviour bomb that blows up client contentment: Jonathan Blau
The penny finally dropped for Jonathan Blau in 2008, during the market slump that followed the global financial crisis (GFC), which halved the value of the S&P 500 index in less than nine months.
Having built, with colleague Harvey Radler, New York-based wealth management practice the Blau Radler Group, and run it under the umbrella of first Morgan Stanley Smith Barney and then UBS Financial Services, Blau had seen “repeat iterations of the same thing” wash through his client book.
As an intern at Lehman Brothers in the summer of 1988, he saw the market winter that followed the 1987 crash; he saw the dot.com crash in 2000, working in wealth management at Sanford. C. Bernstein; the slump after the September 11 attacks in 2001; and now, the GFC crash, from the vantage point of UBS.
At that point, it hit him – the problem was not that the markets regularly threw these kinds of events at investors, it was how those investors reacted to them. And that realisation got him thinking.
“When I started at Bernstein in 1996 there was a six-month training program, and I remember we did two days on behavioural finance, which was a very nascent science back then. Daniel Kahneman (who won the Nobel Prize for his work in 2002) and Amos Tversky had been publishing their research for a while, so people knew about it, but even today, it’s still not widely used in real practice. But for some reason, it stuck in my mind,” he says.
[In 2016, Michael Lewis published The Undoing Project, chronicling the close academic collaboration and personal relationship between Israeli psychologists Amos Tversky and Daniel Kahneman. The duo found systematic errors in human judgment under uncertainty, with implications for models of decision-making in fields such as economics, medicine, and sports.]
The essence of behavioural finance is that emotion and psychology adversely influence investors’ financial decisions, causing individuals to behave in predictably irrational ways, which often reduce the probability of them achieving their financial goals.
All of that came back to him when the market tanked in 2008. “There we were again, walking the same clients back off the same cliff. They wanted to sell-out at precisely the wrong time. It hit me like a light had come on, we were wasting a lot of time trying to react to client behaviours. I realised that the only way we can really help people preserve and grow their wealth is to figure out a way to do the lifeboat drill before the bow of the boat hits the water. That’s when I really started to embrace behaviour.”
Blau went all-in.
“It wasn’t that we were sprinkling behaviour into financial planning and wealth management, we sprinkled wealth management into behaviour,” he says. “From our perspective, when it comes to succeeding or failing as an investor, it’s one per cent intellect, what we know, and 99 per cent temperament, what we do.”
At Fusion Family Wealth, the Long Island-based fee-only investment advisory firm that Blau established in 2013, the client onboarding process starts with the ‘discovery’ interview – so far, so typical – but it’s a different kind of meeting to most in the industry. “There’s nothing we do that is conventional in terms of what the broader wealth management usually does,” Blau says. “Our discovery interview is about discovering clients’ behaviours, not their assets.”
Why? The wealth management industry spends a lot of time and effort telling investors that past performance does not indicate or guarantee future performance; but Blau has a twist on this. “I always tell potential clients that past behaviours are almost certainly indicative of future behaviours,” he says. “If we can identify these, and cure them, we can help our clients succeed.”
Blau and his team are looking to identify clients’ goals, but also, find out their propensities to irrational biases such as recency bias, loss aversion and confirmation bias. “We want to put in place a process that helps insulate clients from continually feeling that they have to react to current events and short-term market movements,” he says.
The team asks prospective clients about their investment past: their best successes, biggest disappointments they’ve had, and why these might have happened. The point is mainly to find out their previous mistakes, and the behavioural biases that drive them. “If they’ve been investors for any length of time, they will have made mistakes, whether it was not buying something when they could have done, not selling something when they could have done, or selling something and not buying back into the recovery,” he says. “You get a feel for the way they think.”
Ultimately, Blau says, what an adviser owes a client is to build-in protection against risk; but he also holds an unconventional view of risk. “Harry Markowitz, in the 1950s, won the Nobel Prize for Economics for coming up with the idea that we need some risk measure in the comparisons of investment performance. He chose volatility, or fluctuations in market pricing, and so the whole industry adopted that as a definition of risk.”
But Fusion Family Wealth defines risk and safety differently. “Firstly, we think in terms of protecting the purchasing power of the clients’ capital from eroding. We think the ultimate risk is in building a risk-averse, or ‘safe’ strategy in industry terms, that decreases purchasing power. Equally, we want to protect clients against ‘sequence of return risk’ (what we in Australia call ‘sequencing risk’) as they near, and enter, retirement. Those considerations are what govern our asset allocation.”
It seems to work, he said: Fusion Family Wealth currently oversees more than US$1.3 billion ($2 billion) in assets between private individuals and families and 401(k) retirement plans, and much of that figure has been built through referrals and retention.
“Because we spend so much time on explaining behavioural finance concepts and how temperament is more important than intellect, our clients understand, and can articulate, how and why we’ve helped them,” Blau says.
“We’re continually reminded of this, when new clients tell us they have friends who are Fusion clients, and they told them how they lost money when the market fell – and their friends said, ‘you have to talk to Fusion.”
