The Rational Reminder Podcast

Episode 278: Juhani Linnainmaa: Financial Advisors, and the Cross-Section of Returns

Nov 9, 2023

58:20

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The podcast discusses the impact of financial advisors' portfolios on their clients' portfolios, the factors that determine variation in investment portfolios, the role of financial advisors in influencing equity market participation, the impact of increasing regulation on consumers and the positive effect of charlatans, the influence of data quality on investment factors, and the implications of pursuing momentum as a strategy.

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Quick takeaways

Financial advisors' own portfolios influence their clients' portfolios, leading to biased investment strategies.

Many financial advisors make portfolio recommendations based on misguided beliefs and lack of customization.

Accounting-based anomalies in investment performance may be the result of data mining or research bias.

Deep dives

Advisor Portfolios Influence Client Portfolios

Research shows that financial advisors' own portfolios have a significant impact on their clients' portfolios. If an advisor has a certain investment bias, such as a home bias or an equity-heavy strategy, clients are more likely to adopt similar biases, even if it may not align with their own financial goals or needs.

Introduction

3min

Financial Advisors' Investment Patterns and Influence on Client Portfolios

8min

Analyzing the Factors that Determine Variation in Investment Portfolios

7min

The Impact of Financial Advisors on Equity Market Participation

18min

Regulating Charlatans and the History of Accounting-Based Anomalies

2min

Analyzing the Impact of Data Quality on Investment Factors

13min

The Role of Factor Momentum in Driving Returns

6min

If you dive deep into financial advisor fixed effects, you’ll begin to understand that an advisor's own portfolio has a bigger impact on the portfolios of their clients than the characteristics of the clients themselves. To help us make sense of this and to further explain financial values and the cross-section of returns, we are joined by the influential and notorious Professor of Finance, Juhani Linnainmaa. Our conversation begins with a comprehensive analysis of financial values, including a comparison between the trading patterns of advisors and those of their clients, a disquisition of misguided beliefs, an examination of client characteristics, and the ins and outs of portfolio variation and customizations. Canada recently adopted regulations from the Mutual Fund Dealers Association (MFDA), and we discuss how this has affected the use of financial advice in the country before comparing the benefit of increased equity share to the cost of advice, what hiring a new advisor before a financial crisis may mean for clients, and the role of regulation in the industry. We end with the cross-section of returns by examining accounting-based anomalies pre-1963, how profitability and investment relate to data mining, why a financial firm would switch between growth and value, and finally, Professor Juhani Linnainmaa’s definition of success.

Key Points From This Episode:

(0:00:42) A very warm welcome to the influential Professor of Finance, Juhani Linnainmaa.

(0:03:52) Comparing the trading patterns of advisors to those of their clients.

(0:08:45) How regulators can go about addressing misguided beliefs.

(0:11:08) Client characteristics that advisors base portfolio customizations on.

(0:13:22) Whether the variation in a client’s portfolio can be explained by their characteristics.

(0:14:49) Explaining the remaining variation in portfolios.

(0:19:38) Other reasons for the high cost of advising, aside from portfolio customization.

(0:22:03) How the adoption of the MFDA affected the use of financial advice in Canada.

(0:26:03) Comparing the benefit of increased equity share to the cost of advice.

(0:31:45) How getting a new advisor before the financial crisis affects ongoing investments.

(0:35:46) The role of regulation.