Morningstar Magazine - February/March 2018 - 18

Dispatches

What's Our
Real Impact? We think
our products and
services help investors,
but do they?
BEHAVIORAL INSIGHTS

Stephen Wendel

In the financial-services industry, rarely
do we rigorously assess whether our products and
services actually help investors in practice.
We know what drives our businesses, and whether
a particular product could, theoretically, help
investors. But our data on actual impact in practice
is sorely limited, usually because we don't
have a clear vision of the rubber hitting the road:
investor behavior after our products are bought or
our advice is heard. That should change-
to the benefit of investors and our industry.
Why Does It Matter?

Through my research career, I've been
repeatedly amazed by the unintended and
negative consequences of seemingly
well-designed and well-intentioned systems.
One of the most profound books on the
topic is Dean Karlan and Jacob Appel's More Than
Good Intentions (2011). The authors detail
how many of the world's seemingly helpful
international development efforts, like
microfinance, were found to be ineffective
or even detrimental once rigorous measurement
was put in place.
Financial services provide many examples
of a significant gap between what people in the
industry intend and what actually happens-
especially for the end investor. For the many
companies that claim to serve the investor,
Morningstar included, this gap matters because
it's part of our mission to close it. Even for
companies that don't have an investor-centric
mission, it matters because if they aren't materially

18

Morningstar February/March 2018

and measurably helping investors, eventually their
business crumbles.
One example of such a gap is what numerous
studies call the "behavior gap." On average,
investors receive far less from their investments
than they should, because of common
behavioral mistakes (e.g., Kinnel 2017). A
well-structured investment plan can falter because
of these behavioral biases, or even exacerbate
them (Wendel forthcoming). Even passive
investing falls prey to the same problems. For
example, in a recent interview with Morningstar's
Christine Benz, Vanguard senior investment
analyst Jim Rowley discussed how investors
in passive vehicles make market-timing mistakes
at the level of asset allocation, instead of
investment selection (Benz 2017).
My own house is made of glass, too: Some
powerful research in the behavioral
science community shows how well-meaning
efforts to overcome behavioral biases can backfire.
Research by Beshears et al. (2015), for example,
shows how encouraging plan participants
to increase contributions via comparisons to
their peers can cause them to actually contribute
less-even though behavioral researchers
like myself had promoted such peer comparisons
for years as a tool to increase contributions.
The overall lesson is this: Wanting to help
investors isn't enough. Over the past few decades,
great strides have been made in helping
investors reach their goals, including lower fees,
more transparency, and better-aligned incentives.
To drive impact more effectively moving
forward, though, we can significantly tighten the
link between intentions and impact.
What would happen in our industry if we put
impact front and center-if we considered
practical, measured impact for investors as our
North Star and created a feedback loop to
facilitate improvement over time? It would mean
new internal business processes and
significant changes in how our industry works
overall. Let's delve into each of those two areas.
A New Impact-Focused Business Process

To understand the impact of our products and

services, we obviously need to know what
"impact" means and how to measure it.
While there is no universal definition of what it
means to help an investor (and, therefore,
what it means to have impact in doing so), I like
the simple, straightforward definition embedded in
Morningstar's mission: helping investors reach
their goals. I'll use that definition here, but in your
company, you may have a different definition.
How do we know we've achieved an impact?
Because investor success depends on the
actual behavior of individuals, especially investors
and their advisors, measurement must be
done in practice-with real investors in real
situations-and not in a theoretical model
or an Excel spreadsheet. It requires a significant
shift in mindset, though not necessarily
a large operational shift.
The research community has developed a
rigorous and effective way to measure impact
despite the vagaries of individual behavior. It's
called the randomized control trial. It is the
gold-standard approach and involves randomly
selecting some people to receive the new product
or service, and others not to. It is the same
approach used to test the efficacy of medicines,
in fact. In practice, companies can measure impact
in this manner by making a small change to an
existing standard practice: running pilot programs.
If instead of a "normal" pilot program the
recipients of the pilot are randomly assigned, it
enables this rigorous measurement of impact.
Both internal research staff and academic partners
can help with the mechanics of the process.
There are implications for the upstream process
of delivering products and services, as well.
First, a business should determine what
the product is supposed to do for investors, before
it is built. Second, it must identify a way to
quantify that benefit. For example, a provider of a
new smart-beta fund that says the fund "tracks the
S&P 500 but tilts toward growth" isn't saying
enough. How concretely does that help an investor
reach his or her goals? And how would the
company quantify that benefit?
These pieces allow a company not only to
measure impact (and verify the value of its work),



Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2018

Contents
Morningstar Magazine - February/March 2018 - Cover1
Morningstar Magazine - February/March 2018 - Cover2
Morningstar Magazine - February/March 2018 - 1
Morningstar Magazine - February/March 2018 - 2
Morningstar Magazine - February/March 2018 - Contents
Morningstar Magazine - February/March 2018 - 4
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