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Morningstar – most people have heard of the company.  They provide various tools and services for investors and advisors, many of them valuable.  Good company with good products that has done an incredible job of ingraining itself into the web that is financial services.    I like Morningstar.  We are even hoping to go to their ETF conference in Chicago.  Now, that’s out of the way, let me cut to the chase.  Morningstar has a particular tool (I guess that’s what you’d call it) that’s in their suite of services for advisors – the Morningstar Hypothetical.

In short, this tool should be banned.  It’s too easy to manipulate and abuse in a way that communicates a reality that just isn’t real. We don’t have a problem with the tool itself, just how it’s used.  Here’s what it is and why we feel this way:

The Mornginstar Hypothetical allows advisors to build a portfolio with multiple funds and generate all types of reports.  They show basic portfolio details such as cost and allocation, but can also go into great depth on historical performance over time, risk metrics, etc.  Valuable tool, no doubt.  Especially, if it’s being used to understand how certain funds or managers interact with each other, or to investigate style drift, or this, or that, and so on.  The list of potential things this tool could help with is long.  What it should never be used for, is to show a potential client “how they would have performed if they had been invested with you 10 years ago.”

Valuable wealth management is a combination of other things (be sure to read Justin’s take on what those are) along with sound portfolio management.  The other things can be boring to discuss – the portfolio management is way more interesting and, in many times, the main topic associated with an advisor from the potential client’s perspective.  That’s a known fact which increases the importance of having something compelling to show to a prospect from a portfolio management stand point.  This is where a Morningstar Hypothetical gets dangerous.

Positioning a hypothetical as how a client would have performed if they’d been your client for the last 10 years is just not true.  When you put a hypothetical in front of a potential client, no matter how it’s positioned, that’s being insinuated.

I’m aware that my opinion of banning the Hypothetical Illustrator tool is not realistic.  With that in mind, I wanted to offer up a few disclaimers that may be helpful to more accurately communicate to potential clients:

  • This Hypotheical Illustrator was put together with the immense help of knowing exactly how the last 10 years have unfolded.
  • ZERO, yes zero…that’s the number of my clients whose portfolios looked like this 10 years ago and have earned the return illustrated in this report
  • 80%, but could easily be 100%, of these funds I’m using now have been recently added because of good performance and have earned my firm’s or Morningstar’s approval for recommendation  (as a disclaimer for this disclaimer – that approval may have more to do with the revenue share arrangement than the manager’s ability but that’s an entirely different topic for another day)
  • In essence, this is the portfolio I would have put all my clients in 10 years ago if I had a Delorean and rode back in time with Doc Brown while holding my Morningstar return scorecard in my pocket.

The disclaimers should help communicate the reality of what’s actually being illustrated.

The goal is enhancing investor outcomes.  Not properly setting expectations on the front end leads to just the opposite.  Investors are warned all the time that past performance does not indicate good performance moving forward.  That idea seems to get lost within these illustrations.  The emphasis is placed on finding the best past performers rather than understanding exposure and process.  If your advisor’s value proposition is the ability to find the best performing funds…stop wasting your time.  I just don’t want to see or hear about investors making decisions based on an illusion of reality.  In this moment, the last 10 years are far less important than the next.  Don’t rely on your advisors ability to find the last decade’s best performers…rely on their ability to understand process and exposures, be disciplined and consistent in action, and bringing the other things to the relationship.

To all investors, ask more questions and demand transparency.