RIA Reads: The Cruelty of Financial Education Advocacy and a Questionable Argument for Active Management

An easy solution to a difficult problem

If you are poor you must be stupid.

Advisor Rick Kahler doesn’t say that, but it is the clear implication of his recent contribution to Advisor Perspectives, “The Harmful Power of Mistaken Money Beliefs.”

Kahler begins with the catchy statement that “What you don’t know about money … has the potential to literally kill you and those you love.” He explains:

A comprehensive research project conducted by Columbia University in 2011 on the impact of social factors on mortality found that 4.5% of deaths in the United States could be attributed to poverty. Research overwhelmingly supports a huge correlation between financial illiteracy and lack of money.

Kahler cites no evidence for the latter claim that there is a “huge correlation” between financial illiteracy and poverty, but builds his argument around the supposed connection. He keeps on:

[A] A FINRA study found that 71% of Americans report being financially literate. Yet, at age 40, 66% cannot correctly answer five questions about basic money concepts …How do you know if your strong beliefs about money are putting you and your family at risk? How do you know if you are among the 71% of Americans who think they are financially literate, but are not? One indicator that you may have a loophole in your financial belief system that isn’t serving you well is if you’re among the seven in 10 Americans who have less than $ 1,000 in a savings account. Other red flags include the accumulation of credit card debt for daily expenses.

But again, does such a connection exist? Is there really a strong connection between the ability to respond accurately questions like “If interest rates go up, what will usually happen to bond prices?” And the possibility of saving money? If there really is such a correlation, is it really likely that the lack of knowledge of money leads to poverty (rather than the other way around)?

It is deeply comforting to answer yes to such questions. If ignoring the answers to five questions is the immediate cause of a low bank account balance, then we can improve the lives of 70% of Americans just by adding a few clauses to the oath of allegiance. And think how far financial education will go in countries like Ethiopia, Uganda and Afghanistan, where the adjusted national net rate per capita Income is less than $ 1,000.

Such a revelation also has a massive impact on our solutions to poverty. Since Kahler’s framework makes us believe that money is meritocratic – if you run out of it you’re probably ignorant – then any concerns about lack of equality of opportunity or structural forces such as racism evaporate. . The only solution to poverty is more education.

But is it? We can agree that many Americans could probably make better decisions about their money. But is more education really the answer? Leaving aside Kahler’s unrequited “overwhelming” evidence, a meta-study published in the International Journal of Consumer Studies found “limited empirical support which in fact demonstrates that if an individual is financially literate, he / she will exhibit better financial behaviors.” The researcher, Liezel Alsemgeest, continues:

The only real answer that might help solve this problem might be one-on-one counseling sessions that might address the individual’s current financial situation …The people best suited to provide these services would probably be financial advisers for their clients and debt counselors for people with unmanageable debts …The problem here is that these service providers might not be willing to provide this type of service, considering that the people who might need these services may not be able to pay for them.

Instead of blaming the poor for their problems, perhaps the financial advisor community should turn in on itself.

Active imagination

We all know how difficult it is to successfully select stocks, select asset managers, or time the market. So figuring out the right time for active managers to pick stocks for you should be a snap.

Well, the apparent challenge didn’t slow down C. Thomas Howard and Jason Voss, who took to the CFA Institute’s Enterprising Investor blog for just do that.

Using four complex variables typically related to volatility and dispersion of returns, Howard and Voss propose an “active action opportunity” (AEO) score. Their calculation indicates that the score is very high at the moment. They also provide a table:

Obviously, the index tends to rise during times of great market turmoil – no big surprise, given that one component of the equation is the CBOE Volatility Index (VIX).

They can be on to something. Consider the reverse situation, in which there is no volatility and no dispersion of returns. It’s hard to see how a skillful manager could outperform in such an environment.

However, even admitting that their methodology has descriptive merit, its predictive value is much less certain. The problem is, predicting future volatility and dispersion ratios isn’t exactly a snap (for proof, consider that if we could predict them, we probably have everything we need to perform on our own. very profitable transactions). And unless they are able to make those kinds of predictions, Howard and Voss seem unable to make any valid predictions about what the future of active performance will be.

Yet predict – and urge – they do:

Since the end of 2019, market conditions have become favorable for active equity funds. The dispersion of individual stocks and the positive asymmetry, market volatility and premium of small companies have all increased in recent months. The stage is set for stock pickers to demonstrate their skills …This new golden era of stock picking could stretch over several months. Professional managers and investors should seize this opportunity for as long as it lasts.

Reading the conclusion of this article – which gives off a slight whiff of done – I found myself wondering if this analysis is ultimately scientific, or if it is rather written in the cynical language of sales.

Although we cannot answer this question without knowing the mental state of the authors, a comparison between the April 15 post (‘Active Actions: “Reports of my death are greatly exaggerated”’) And an article with the same title (‘Is active management dead? Not even close‘) published in July 2016 on the same blog can be instructive.

Granted, Howard is much less enthusiastic about the overall active management category in the 2016 article, which was written by Voss. But his complaints revolve around the apparent obstacles to “real” active management, such as the tendency of their managers to “over-diversify” and follow the “constraints” imposed by ethical organizations such as the CFA Institute. himself. Howard said in 2016:

In a recent comprehensive study, I found that up to 90% of active equity managers are senior stock pickers, a finding that goes against most popular belief …If they had the option of managing portfolios according to their preferences, the vast majority of fund managers would offer superior performance to investors.

But take another look at the table above. If Howard then used the same metrics he uses now, he would have been forced to conclude that July 2016 was a terrible time to pick stocks, and investors would have been better off switching from active funds to passive managers. Now does he wish he could go back in time and hand his five-year-old the above painting? ‘Please! Before recommending the most active of the active managers, consider the current score of active equity opportunities! ‘

Is it really the right time to invest in active funds? Perhaps. But it’s worth remembering that for some reason investors seem to get such a message over and over again.

These déjà vu-inducing deliveries are certainly unrelated to the fact that many passive funds are almost free, while active funds continue to incur the fees that keep the world of investment management afloat.

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