The term “financial advisory service” relates to the most general description of client-FSP interaction and may include a wide range of different services, ranging from retail products (such as payment and account facilities, mortgages etc.) and investment-related services (e.g., brokering and maintaining exchange-traded products like stocks and mutual funds) to individualized wealth management services (e.g., fiscal advice). In private banking – i.e., an FSP’s division reserved to wealthy clients (such as, increasingly, “affluent” clients) – such services are often combined [Molyneux and Omarini 2005:2], e.g., by providing basic retail services of accounting with investment advisory services. In the literature, especially the latter have received much attention because of their exposition to the complexity and volatility of financial markets. In contrast to retail-only services, these services are typically conducted on a one-to-one basis via a financial advisor or relationship manager, creating a link between the client and the FSP [Driga et al. 2009:232]. This role constitutes the main client interface to the FSP, offering “its professional financial expertise to individuals who seek assistance or want to completely delegate their investment decisions” [Fischer and Gerhardt 2007:9]. In this essay, we will mainly refer to investment advisory services that focus on supporting the client’s decision-making regarding her financial investments, regardless
whether they are performed “stand alone” or embedded in comprehensive
“holistic” advice (i.e., combined with retail products and services).
In general, sales-oriented advisory services like investment advice may be delimited from other professional counseling and advice, e.g., in socio-psychology; these strive to provide decision guidance for a client and her specific problems by means of brokering information and practice of capabilities [Schwarzer and Posse 1986], with the ultimate goal of helping the client in helping herself. Financial advice may also be delimited from
“everyday advice”, i.e., the information exchange between co-workers, friends and family, which constitutes seventy percent of all “advisory encounters” [Warschburger 2009:4].
Today, the notion of advice is exceedingly used in contexts of service provision, such as management consultancy, travel counseling or financial advisory services [Schmidt-Rauch and Nussbaumer 2011]. Indeed, in such settings clients seek to be enabled and supported to solve a problem (e.g., make-or-buy decisions, planning holiday trips or optimizing personal financial investments) – however, the advisory and consulting services are sales-oriented and potentially strained by the providers’ self-interest to provide recommendations that are geared towards revenues rather than the clients’ needs. For financial (investment) advisory services, a considerable amount of research has pointed to such inherent problems of information and interest asymmetry and their implications on quality and regulations [Buhl and Kaiser 2008; Evers et al. 2000; Jungermann 1999; Oehler and Kohlert 2009].
Much literature has investigated advisory services from the perspective of their underlying processes of client-provider interaction, e.g., especially in the domains of management consultation [Elfgen and Klaie 1987; König and Volmer 1996; Lippitt and Lippitt 1984] and financial service and insurance provision [Bechmann 2002; Haller and Ackermann 1995; Howald 2007;
Mutter 2003]. Such processes have also found their pendants in marketing practice, where FSPs increasingly promote their advisory approaches as a means of differentiation (e.g., UBS3, CS4), mostly targeting wealthier, at least “affluent” clients. Though they differ in their number of advisory phases and activities as well as their naming, virtually all advisory processes
3 https://www.ubs.com/ch/en/swissbank/wealth_management/relationship/
advisory_approach.html (last retrieved on 2012-02-05)
4 https://www.credit-suisse.com/ch/privatebanking/beratung/en/beratungsprozess.jsp (last retrieved on 2012-02-05)
from literature and practice share four generic phases (see also exemplary illustration in Figure 6-1). In the contact or initiation phase, the client approaches the advisor (or vice versa) because of an investment problem (e.g., investing savings in stocks or mutual funds). Advice will then be provided and discussed in the succeeding phase (advice), usually in (multiple) face-to-face encounters of client and advisor. In these encounters, the advisor will try to identify the client’s situation and needs, structure her problems and define the investment goals [Elfgen and Klaie 1987]. In investment advisory services, the solution generated in the advice phase is typically composed of a generic investment strategy based on the client’s risk profile as well as its specific mapping to a product portfolio. This portfolio is implemented in the next phase of the advisory process (implementation) and continuously monitored and adapted by the advisor and the client in the support phase; in this phase, further initiations of the advisory process may occur, activated for example by changes in the client’s financial situation or needs.
Figure 6-1: Generic advisory process, compared to processes from practice and literature
Advisory processes can be seen as the generic representation of the client-FSP interface, allowing each interaction to be subsumed into a respective advisory phase, independent from service channels (e.g., online, over the telephone, face-to-face). As such, advisory processes may also be conceptualized as the main interface between clients and their FSPs. As discussed above, this interface is increasingly important for FSPs as a means of differentiation against competitors [Buhl and Kaiser 2008]. However, they are also increasingly challenged by demanding clients as well as regulatory frameworks, both intensifying cost pressure [Birchler et al. 2011; Crosby et al. 2011].
Also from a client’s perspective, improving advisory processes and their quality seems important. Clients seek financial advice for many reasons, e.g., because of their lack of knowledge regarding financial markets or their lack of interest or time [Financial Services Authority 2002:15–17]. Consequently, they find the greatest advantage of advisory services in advisors explaining relevant information, giving feedback on the client’s own investment ideas and giving “assurance of doing the right thing” [Cocca et al. 2009:33].
Similarly, Bluethgen et al. [2008] argue for the need of financial advice because of complexity (individuals making mistakes in complex situations which an advisor may be able to prevent) and the related high costs of information collection. The important function of advisors to reduce complexity of investment decisions is also mirrored in the low financial literacy of typical investors. Birchler et al. [2010:29], for example, found that only 32% percent of Swiss affluent investors (investments from 0.1 Mio to 0.5 Mio CHF) evaluate their investment-relevant knowledge as being
“good” or “very good”, whereas the majority (61%) states to have only basic knowledge.
While clients obviously seek help of investment advisors in order to achieve superior decision quality, research on the quality of advice brokered by FSPs is quite ambiguous. Hackethal et al. [2012] find that using professional investment advice lowers portfolio returns and has negative effects on risk-return profiles; advised clients exhibit increased account turnover and investment in mutual funds, which the authors find to be “consistent with incentives built into the commission structure” [p. 510] of financial advisors.
Likewise, Bergstresser et al. [2009] found few measurable advantages of customers that make use of brokers rather than buying mutual funds themselves; actually, brokered funds underperformed their counterparts purchased via direct channels (even without subtracting charges). The authors argue that their results may also reflect that brokers act in self-interest, given that fund flows were positively related to related fees. In the prevailing advisory business model of FSPs (in Switzerland and, incidentally, also in Germany and other European countries [Oehler and Kohlert 2009]), such fees – e.g., product distribution and transaction fees – are used to cross-subsidize the “free-of-charge” advisory services [Roth 2007]. Such cost considerations are problematic in terms of moral hazard as the advisor may be incentivized to optimize his or the FSPs benefits by recommending products that are more costly [Oehler and Kohlert 2009:105].
As such, lay investors relying on professional advice are potentially exposed to misselling, where – essentially enabled by information asymmetries
[Eisenhardt 1989] regarding the actual costs – advisors may sell products that do not match the client’s needs but his own interests [Inderst and Ottaviani 2011].
Even if not emphasizing on such detrimental effects of financial advice, similar research finds no evidence that advised investors significantly outperform or underperform their unadvised counterparts [Gerhardt and Hackethal 2009; Kramer 2009; Marsden et al. 2011]. Thus, regarding the potential advantages of professional investment advice, Marsden et al.
[2011] picture financial advisors as “clinical psychologists whose services are of value per se” [p. 641, emphasis in the original], in that they encourage clients to concern themselves with important investment-related tasks (like examining their needs and goals) and make them feel confident about their financial future.
Based on the above-mentioned issues, research on advisory quality [Evers et al. 2000; Oehler and Kohlert 2009] and consumer reports [e.g., Stiftung Warentest 2007; Stiftung Warentest 2008; Stiftung Warentest 2009; Stiftung Warentest 2010] alike tend to heavily criticize professional investment advice. The main critiques include the advisors’ insufficient incorporation of the client’s financial situation, risk profile and financial goals, lack of individualization and poor quality of information exchange, especially regarding the explanation of investment types and disclosure of their associated risks.
Legal frameworks have been developed to address such issues and to establish uniform regulations for consumer protection. For European markets, the most prominent example is the Markets in Financial Instruments Directive [MiFID; European Commission 2004]. Basic duties of allegiance, due diligence and information disclosure have also been defined for Swiss FSPs [FINMA, Eidgenössische Finanzmarktaufsicht 2008; Roth 2009]. Such legal duties require FSPs to establish basic transparency, e.g., that the advisor collects all relevant client information and in turn provides her with all relevant information for the potential investment decision [Oehler and Kohlert 2009:98]. However, research has frequently pointed to weaknesses and failures of the legal frameworks [Jungermann and Belting 2004; Kohlert 2009], arguing that they show little effect on advisory practice because of their generic nature, being neither comprehensive nor specific enough [Oehler and Kohlert 2009:98–99].
Despite these vast criticisms and despite their dissatisfaction [White and Yanamandram 2004], however, the majority of clients keeps turning to advisory services for their investment decisions – as reported by Cocca et al.
[2009], 69% of Swiss private banking clients use financial advice provided by their FSPs.