You and your clients are in a relationship of reciprocal commitment. At the outset of your relationship, they committed their assets to you and you committed to fulfill their investment mandate.
Over time, like in any long-term relationship, that commitment will be tested. If emergent issues are not constructively addressed, the relationship will deteriorate to the point of dissolution.
Your clients’ attention is being sought by competing managers, strategies, and products. And, of course, the relative attractiveness of these alternatives only increases when you are going through an inevitable period of underperformance.
Your clients are also fallible. Like all participants in securities markets, their decision-making is subject to multiple sources of noise, such as price volatility. Less obvious, maybe, is that any perceived dissonance in your communications can be a source of noise that negatively impacts your clients’ thinking and commitment.
Even if this doesn’t lead directly to your clients withdrawing their assets from your firm, any noise that your clients experience is likely to reverberate back to you. Their noise can become your noise in a number of ways, three of which are:
- Emotional Contagion. Their hopes and fears subtly infect your thinking. When this happens it can drive you either to take consensus views or to abandon your process. Neither of those two is going to delight your clients in the long run.
- Resource Diversion. You spend more time hand-holding and reassuring. The first-order consequence is that you are forced to misallocate your precious cognitive resources. The second-order is that it will make you more prone to emotional contagion (see above) or more wedded to your positions through repetition of your views.
- Fund Flows. Clients tend to invest and redeem at the worst times because they’re human. This will force you to buy high and sell low, which damages your performance track record, and which will prompt other clients to consider withdrawing.
Your commitment to your clients is also being tested because of the changes that you inevitably experience, some environmental and some personal.
The underlying structure of the market changes over time, sometimes abruptly, and makes it more difficult for you to generate alpha. Other factors are also in flux: your team changes, or your assets grow, or your firm merges. And you personally change: your baseline risk aversion changes as you accumulate battle scars, and your confidence waxes and wanes over time.
It can become a lot more difficult to fulfill the promises you made at the beginning of your relationship, through no real fault of your own, but just because things have changed. This is not to excuse any professional or ethical lapses, but to recognise an inescapable reality: things change.
So what’s to be done? I believe you can hedge a decent chunk of this risk by taking care over the quantity and quality of your communication. If you and your clients are not talking to one another about the changes that each of you is undergoing, someone is in for a nasty surprise. At the very least, you need to communicate material changes quickly and clearly. If you lose a key member of your team, you need to pick up the phone and tell your clients so that they are not surprised or embarrassed.
But I believe that there is much more to be gained from good communication. By communicating well you allow your clients to get to know you better, which allows you to get to know them better.
Knowing each other is a massive competitive advantage.
When a client’s investment committee meets to decide which of their managers should be fired and which ones should receive additional allocations, you need someone in the room to risk some of their personal political capital on you. Whether they take that risk or not will depend in some large part on how well they feel that they know you. And that will depend on the quality of your previous communications.
- What changes at your firm have not been adequately communicated to your clients?
- What might be the impact of better communication?
- What might be the shape of this communication? What, how, when, who?
- Justin Newdigate: Noise (2019)