When Less is More

This got me to thinking. What about the demands and needs of investment management clients generally, and Nexus’s clients in particular? With the benefit of 2-years’ experience with our own on-line reporting portal, are the design principles underpinning it still valid? They included:

• Security
• Ease of access and flexibility
• Reliability
• Consistency with Nexus’s existing (quarterly) reporting to clients
• Delivery of the custodian’s monthly account statements and annual tax reporting
• Suitability for clients and/or their professional service providers (e.g., tax preparers)

For now, the verdict is “all still valid”. But a pass/fail scale (or, in this case, a “still valid”/”no longer valid” scale) isn’t an especially tough standard to meet.

Financial services firms are in a technology arms race – with each other and against their clients’ rising expectations. With this as backdrop, it’s a legitimate question how a discretionary investment management firm like Nexus should be harnessing technology to provide more choice and convenience to clients.

One obvious – and tempting – answer is to capitalize on the ease of access principle noted above by providing more detailed and more frequent information. After all, banks provide fresh data daily, including customers’ most recent deposits, withdrawals and credit card transactions, along with up-to-date account balances. Discount brokers and other trading businesses provide up-to-the-minute securities prices and portfolio values. Surely more information is better, no?

When it comes to managing portfolios for long-term success, “not necessarily” is the answer. Indeed, paraphrasing the modernist architect, Ludwig Mies van der Rohe, “less may be more”.

Short-term fluctuations in securities prices are virtually random, depending on whether the news at any given moment is better or worse than it was a moment before. It follows, then, that a portfolio of stocks is equally likely to fall as to rise. Reproduced here is a chart from our November 2014 presentation showing the likelihood of an all-equities portfolio having increased in value after various periods of time.⁽¹⁾ Perhaps surprisingly, it’s a virtual toss-up for periods of a month or shorter, but an extraordinarily high probability for periods of 10 years or more.

The historical evidence suggests there is almost nothing to be gleaned from frequent checking of portfolio values. More importantly, however, there is a potential behavioural impact from the effect of the random fluctuations on an investor’s state of mind.

It’s not hard to imagine how owners react to fluctuations in the value of their portfolios. Most would regret a decline, and delight in an increase. Given the probabilities described above, a portfolio owner who checked his or her portfolio value more often than monthly would be nearly equally likely to experience regret as happiness.

Now introduce into the mix the well documented psychological phenomenon that human beings feel the pain of loss approximately twice as strongly as the joy of gain. You can see where this might lead. Doesn’t this combination – frequent portfolio checking, a 50/50 chance of loss, and a double-weighting of emotional impact – expose the portfolio owner to an avoidable risk of unwarranted overreaction to a decline in their portfolio? A risk that can be reduced simply by checking their portfolio value less frequently?

If this is true, it’s fair to question how well an investment manager is meeting client needs by using technology to sharply increase the frequency of portfolio valuation information. Perhaps more is not more. Maybe Mies van der Rohe was right. Maybe “less is more”.

“Hold on!”, you say. “That just sounds like an investment manager rationalizing how to avoid hand-holding clients when times are tough. Moreover, carried to its logical conclusion, doesn’t this line of reasoning justify no reporting of returns and portfolio values at all?” Unfettered, yes. But an investment manager, like any service provider, must serve clients – by delivering results, being accountable, and providing value for money.

So, it’s a balancing act: between doing right by clients and serving them. In our view, monthly or quarterly reporting strikes that balance.