As advisors, we appre-ciate great performance numbers. The S&P/TSX composite index has turned in stellar returns during the past four years. Even more impressive are the returns that Canadian energy stocks have produced.

But how many clients actually saw those returns filter down to their bottom lines? More important, if clients did not earn those returns, how many are unhappy with their portfolios — without really understanding why?

Such is the catch-22 of advisory relationships. We know our role is to help clients stay invested for the long term. However, we also know that clients constantly focus on the short term. The challenge is to bridge that gap. But we cannot do that without first understanding the cause and effect of their behaviour.

When clients hear about the great performance of specific stocks, sectors or markets, they tend to use that as a frame of reference to measure the performance of their own portfolios. Usually, a well-balanced portfolio has not kept pace — and that usually leads to disappointment.

For example, if we listen to the financial media, we hear that stocks are at record highs. Yet, portfolio returns are anything but. So, why the disconnect? For Canadians, the disconnect is directly related to the value of the Canadian dollar. Like it or not, we report results to our clients in C$. And in C$ terms, the S&P 500 is down some 8% since the beginning of the year, while the MSCI EAFE, which represents the broadest measure of international equities, is down approximately 4% in C$ terms.

The point is: we are forced to deal with clients trying to bridge the gap between what they hear on the news and what they see on their financial statements. Unless advisors deal with these disconnects effectively, they run the risk of alienating their clients. And, make no mistake, the C$’s move is roughly equivalent to a one in 100 occurrence.

One approach to dealing with the C$ issue is to talk to your clients about oil prices. Oil prices are at record highs, yet the price at the gas pump is 20% less than the highs that occurred when oil was trading at much lower prices. This is happening for the same reason: a weak U.S. dollar or a strong C$ — take your pick.

Oil prices are at record highs only in terms of the US$. The price for a barrel of oil in C$ is the same today as it was at the beginning of the year. It is the same disconnect that occurs in clients’ investment portfolios — but, in this case, the client is happy with the results.

Of course, it is one thing to deal with events that occur 1% of the time; it is quite another to deal with the month-to-month disconnect between the performance of a well-balanced portfolio and the returns associated with the flavour of the month — be it equities, bonds or GICs.

That takes us to a related issue: transparency. There’s no question that we want efficient markets, which means having the ability to access relevant information instantly and to act on that information quickly. The worst thing that could happen is a liquidity crunch such as the one recently witnessed in short-term asset-backed commercial paper.

The problem is that transparency also provides the investor with a graphic short-term evaluation of their net worth, which all too often causes angst. And it’s usually not the result of a flawed portfolio.

If the markets rise, clients frequently view their net equity statement — something that can be downloaded daily if they choose — and then evaluate that number within the context of the most recent market update. So, let’s assume the S&P/TSX composite index is up 2% and your client’s portfolio is up 1%. Will your client be happy?

Moreover, in a transparent market, there is no way to massage that number. Your securities are worth what the market values them at — and that value is transparent. That’s very different than what we see in, say, the real estate market.

Suppose a home on your street sold for $X. If that price seems low — meaning: less than your expectations — you simply estimate the value of your home at $X+1 or some other number that reflects what you believe to be an appropriate value.

@page_break@You can justify that value by establishing a set of parameters that distinguishes your house from the one that just sold. Perhaps you have a five-piece bathroom or a finished basement or a swimming pool. In the end, unless you are moving, it is nothing more than a mental feel-good exercise.

I cite real estate because it is an asset class that has created wealth for a lot of Canadians. In fact, ask any Canadian what they think of real estate and most will tell you it is a great investment.

Ask those same Canadians what they think of the stock market, and they will typically say it is a crapshoot. Yet, when you look at the long-term numbers, the average annual compound return of real estate is about 3% less than the average annual compound return on stocks. Stocks have outperformed — with about the same level of risk.

The point is, if we were able to hold our stock portfolio the way we do our real estate assets, it would do wonders for our bottom line. Average clients don’t do that because they perceive stocks to be risky.

So, why does that perception exist? And, more specifically, why — if we take away the fact we need a place to live — do clients look at two asset classes so differently?

The answer, in my opinion, is twofold: first, the transparency that accompanies liquidity establishes a hard price for financial assets, leaving no wiggle room for inves-tors to fudge the value; second, that transparency leads clients to review their investments more frequently, which dramatically increases the chance of being disappointed with the results. Whether the results are good or bad, behaviourists refer to the latter point as “myopic loss aversion.”

To get the most for your clients, you need to help them understand and manage those issues. One approach is to establish a frame of reference — a benchmark.

I am not here to tell you what kind of asset mix makes a reasonable portfolio. Only you and each client can define that. What I am saying is that you must define each portfolio and then establish a benchmark by which you can gauge how well it is doing.

If your client is invested 100% in Canadian equities, then the S&P/TSX composite index would be an appropriate benchmark.

If your client holds 100% energy stocks, then the S&P/TSX energy subindex would be an appropriate benchmark.

Of course, portfolios typically have a combination of safety/income and equity assets — and your benchmark should reflect that combination to allow for an apples-to-apples comparison.

Then, rather than looking at the financial news of the day for a point of reference, your client looks at how his or her portfolio is doing relative to the benchmark.

The second point is intertwined with the first, in the sense that having a reasonable frame of reference should reduce the review frequency.

That’s important, because myopic loss aversion is a behaviour trait with natural but often negative, consequences. It is, in fact, the same psychology that causes many weight-loss initiatives to fail.

Think about it: when you decide to lose weight, you have a point of reference: “I am going to lose 50 pounds.”

Now, let’s say, after Day 1, you get on the scale and it shows you have lost two pounds. That’s good; but, subconsciously, you will be comparing that number with your 50-pound point of reference. Disappointment ensues because the two pounds is such a small fraction of the point of reference.

Weight-loss clinics go to great lengths to remove that temptation by getting you to avoid stepping on the scales until you come in to the clinic for your periodic review. At that point, you step on the scales, with a counsellor in the weight-loss program overseeing the results. The counsellor’s job is to frame your expectations by putting context around the results on the scale. Whether you lost one pound or five, your counsellor will frame the weight loss as meeting or exceeding the expected result. That support goes a long way toward keeping you in the program and, ultimately, leads to a successful conclusion.

In the investment business, that’s what a good advisor should be doing. How well your clients trust and/or accept your advice goes a long way in determining what value you bring to the table.

In the end, the objective is to frame expectations with a point of reference — which, in this case, is an appropriate benchmark. If the benchmark provides comfort, it should lead to less frequent reviews. That will keep your client more focused on the longer term, which allows the portfolio to work its magic — in this case, that is producing the expected long-term rate of return. IE