How to use client sentiment to your advantage

By Matt Davison, Chuck Grace and Kedar Mhapsekar | September 9, 2016 | Last updated on September 9, 2016
6 min read

Financial advisors, with their privileged access to retail investors, offer a unique window into investor behaviour. And our research shows there are specific attributes of advisor confidence that provide a lead indicator for economic, capital market, asset management and risk management activity. We measure advisor confidence via the Financial Advisor Index (FAI; see “Methodology”).

The numbers in the index are relative. An upward trend line indicates a risk-on market where advisors and clients are optimistic and prepared to take some risk; conversely, a downward line points to pessimism and a more defensive stance.

What has the FAI told us so far?

Advisors reflect, and can influence, their client’s confidence­—but they can’t influence or anticipate the markets. So we’ve identified five specific areas where the FAI may provide useful insights:

  • Advisor confidence is a strong indicator of general economic conditions.
  • Advisor confidence is vulnerable to surprises.
  • Advisor confidence can be used to anticipate asset and product mix.
  • Advisors may perform a critical role in mitigating investor behaviours.
  • Advisors provide a unique lens into the challenges threatening their client’s financial well-being.

Let’s examine each in turn.

1. A strong indicator of general economic conditions

The FAI is strongly correlated to a number of economic indicators, and it could be used as another gauge for the general confidence in economic conditions. For example, we have determined:

  • the FAI is strongly correlated, and at times leads, the Conference Board of Canada consumer confidence index; and
  • the FAI is strongly correlated to the CAD.

Our findings suggest that advisor confidence could be a useful tool in helping policy makers, industry and other market participants determine, at a macro level, a risk-on or a risk-off market, and to take action accordingly. For example, as confidence transitions from risk-on to risk-off (or vice versa), dealers that support advisors could create collateral material to help support the advisor’s communication efforts with clients. Given the lead time typically required to produce those materials, dealers would have an opportunity to get ahead of the curve.

2. Confidence and surprises

The FAI has proven to be strongly correlated to market volatility. There is a very strong negative correlation between the FAI and the S&P/TSX 60 VIX index (VIXC). The VIXC estimates the volatility of the stock market that is implied by the options on the S&P/TSX 60 index. The VIXC has historically proven to be a useful tool to hedge the potential downturn (risk) of the broad equity market.

Using the index, the industry can encourage disciplined practices critical during periods of unusual volatility. The FAI could be used to anticipate these periods and focus communication efforts. The classic example is encouraging clients to stay invested during dramatic market corrections, when overreaction can lead to less-than-ideal decisions.

3. Asset and product mix

The FAI is modestly correlated to shifts in asset and product mix. As confidence erodes, assets begin to shift towards less risky products, such as balanced funds and insurance solutions. In a risk-on market, assets shift to international or sector-specific equities.

With the S&P/TSX composite down 20% from its highs of last year, investors have taken a risk-off approach that saw assets being allocated to balanced funds and insurance solutions. These changes prompted advisors to take a more pessimistic view of their client’s probability of meeting their long-term financial objectives.

Advisors generally don’t undertake wholesale shifts from equities to cash, for example, but rather gradually move to more balanced asset mixes. We observed that the shifts are usually subtle, although we also observed occasional tipping points where subtlety is abandoned for a more urgent flight to safety. We observed one such tipping point in the period between late December 2015 and early January 2016, when there was a significant shift to no-risk assets before a return back to the established trend lines in February and March.

Using the index, industry players may be able to anticipate product and asset shifts more quickly. This anticipation would allow them to more effectively respond to shifts through their product and communication strategies which, again, require lead time.

TABLE 1: “Based on your experience over the last month, please identify the three most critical threats to the financial well being of your clients.”

Rank since inception Rank pre- Nov. 2014 Rank post- Nov. 2014
Undisciplined client behaviours 1 1 1
Personal debt loads 2 3 2
Negative or misleading news 3 2 3
Market volatility & risk 4 4 4
Market performance/interest rates 5 5 5
Regulatory burdens 6 7 6
Client’s physical and mental health or disability 7 6 8
Economic growth, unemployment 8 8 7
Inflation 9 9 9
Mistrust or skepticism with the financial services industry 10 10 10
Eroding real estate values 11 11 11

4. Mitigating behaviour

As advisors move from optimistic to pessimistic outlooks, we anticipate their expectation for investment returns to shift as well. With the FAI, we have observed that advisors are conservative in their predictions and that any change to their outlook tends to be cautious. With equities, for example, advisor predictions have followed a narrow band between approximately 5% and 6% during the year ended December 31, 2014, when actual returns for Canadian equities ranged from -3.4% to 23.1% with a median of 9.9%, according to Globe Investor.

Advisors also appear to be inherently optimistic. They don’t appear to make wholesale changes in their outlook from one extreme to another. Instead, they will shift from optimism to neutral rather than optimism to pessimism. This thoughtful or more cautious change leads to subtle shifts in their advice.

Using the index, industry participants can help reinforce best practices around asset/product allocation versus the folly of market timing. Similarly, the index can be used to reinforce best practices around periodic rebalancing and staying invested.

Several firms already have analysis and materials on this topic, including Dalbar’s ongoing research into the gap between investor and market returns. Reviewing the index could remind advisors to use these materials.

5. Challenges and threats

An important insight provided by the FAI is the advisor’s assessment of market risks and threats. Advisors are asked to rank the threats they believe will impede client progress towards their goals. The question is important because advisors generally work with hundreds of clients. Their perspectives on consumer behaviour are current, with access to actual behaviour and buying habits as opposed to intentions.

Since the inception of the Index in 2013, advisors have identified client behaviour and debt loads as two of the most critical threats to clients achieving their goals (see Table 1). With the exception of debt, their conclusions would appear to contradict popular press and regulatory agendas. Undisciplined client behaviour has been the number one threat each month since the inception of the index.

Recently, advisors have signalled that certain threats may start to trend in the near future. During December 2015, advisors from Alberta and Nova Scotia ranked unemployment as a top threat. Eroding real-estate prices was another threat that has gained attention over the last few months.

Using the index, dealers, MGAs, industry groups and regulators may wish to focus more of their coaching and training efforts on client behaviour and debt management. Examples would be the current nervousness around Canadian real estate markets and the behavioural finance concept of over-confidence.

Canary in the coal mine?

Economic indicators such as unemployment, interest rates, and growth rates are known to influence financial markets, yet the effects of how the average investor reacts to these forces is still unclear. As seen during the financial crisis, market participants were irrational during times of high volatility, increasing their exposure during a downturn or rapidly exiting while in upturn. Advisors saw these same choices: when Canadian equities started to fall, clients quickly moved their investments into safer asset classes, even if that meant compromising their long-term financial goals.

Being highly correlated with many key economic factors, the FAI serves as a litmus test for firms and advisors to anticipate their clients’ current state of mind and to then adjust their communications, product shelves and processes accordingly.


In 2013, a group of Advocis participants were asked to complete one of two short surveys, known as the Advocis Financial Advisor Index (FAI), each month.

Approximately 140 to 150 people participate each month and, of those, about one-third answer a specific survey each month. By February 2016, we had accumulated 34 months of data and about 125,000 data points across 12 variables. The research is ongoing and is conducted independently from Advocis. Future FAI data can be found here.

Matt Davison is Canada Research Chair in quantitative finance at Western University; Chuck Grace is lecturer in finance at the Richard Ivey School of Business, Western University; and Kedar Mhapsekar has an MSc from the Department of Statistics, Western University.

Matt Davison, Chuck Grace and Kedar Mhapsekar