The Model Portfolios Journey to Managed Investments 2.0

 

A sneak preview on a paper that I am writing about the journey that the industry is on kicked off by the use of model portfolios….

 

 Below is a slide that I am using quite a bit to highlight that model portfolios are not the end game, but just the start of what I call the transition from ‘Managed Investments 1.0’ (the ‘old’ product distribution based industry model) to ‘Managed Investments 2.0’ (an industry architecture that is in line with recent regulatory changes and consumer engagement models).

 

 

 

 Some key points from this slide:

 

That the use of model portfolios is just the start of this transition. The journey starts off with the use of model portfolios often being a solution to compliance and practice efficiency to help advisers choose products (in the early days they were perhaps called ‘preferred’ lists).  This evolves into the use of model portfolios to be an improved way to support the systemised implementation of asset allocation, product selection and the basis for a level of operational efficiency. We are seeing that in Australia and the UK, some 80% of new business is being implemented using ‘model portfolios’ and not surprisingly there are questions being asked by regulators as whether this is good practice, or just ‘show horning’ clients into a new method with a new way to justify fees from clients. Systems and technology to support this first use of model portfolios are generally based around automating some administrative processes about the allocation of monies to funds on a periodic basis.

 

 Then there is a distinct phase that follows when the initial use of model portfolios  moves into broad based adoption. Beyond the use of model portfolios in the first phase, industry participants become under pressure to deal with:

• The regulatory issues in the form of ensuring client portfolios and adjustments to them are in the best interests of the client, for example it is no good just rebalancing a set of funds if for example the rebalance results in an event that could not be in the clients interests such as a capital gains tax event, and that it perhaps need to be clear and agreed with the client when portfolios will be rebalanced, by who, when and to what service levels
• Consumer pressures, often in the form of investors throwing spanners in the works of instructing their adviser to not sell a specific fund, or not buy one from fund manager XXX because they don’t like them. The impact of these real instructions on the systemised operating model is now starting to be fully understood. In short it makes what started being a simple solution and problem to solve to one that gets rather difficult and complicated
• Competitive pressures, where 2 things start to happen, firstly that as consumers see the same model portfolio trend across an industry, differentiation becomes less and price pressure start to form placing operational efficiency pressures on providers of model portfolios, but also that consumer direct platforms start to offer model portfolios also directly at very low costs (look at nutmeg, marketriders etc). Naturally as consumers and their advisers start to examine overall fees more closely, model portfolios of lower cost passive funds such as ETFs and securities start to emerge to displace the value that active asset managers may have filled in the past.

It is in this second phase which we are entering now that we are starting to see tremendous amounts of innovation in both what the investment proposition actually is (yes it has to be more about the client in order to sell, yes it has to be lower costs (there is research that suggests that consumers move only when something is 20% cheaper than the incumbent), and it has to be slick), but also the need for fully systemised, automated (yet highly controlled) processes for the rebalancing and operation of portfolios. The key fundamental issue at this stage is how to resolve delivering a client centric (or client coach supporting) proposition with scale and efficiency, and with such complexity in solving this problem, the answer pretty well only is achievable with very specific technology for such a purpose, which is quite different from the technologies of where model portfolios started the journey on. At Financial Simplicity we have lived and breathed this for over 10 years already and appreciate the challenges that anyone would experience in taking this challenge on....

 

Please send me an email if you have any comments stuart@financialsimplicity.com.au

 

 

 

 

 

 

 

The Growing World of Customer Experience Management

Folks, we head into a new world, and one that we are seeing is quite a challenge in financial services. This world is about 'Customer Experience Management'. With the advent of transparency and the need to deliver demonstrable value to consumers in order to receive fees, there is now the immediate and present challenge as to how to deliver value to consumers where value is in their minds, not what was sold to them.

Because the feeling of value is so different for so many different consumers, the industry is evolving to understanding that the consumer 'experience' is actually as important, if not more important than other parts of service delivery. Move over 'products', it is now about 'experience'. In an on-line world, products are often available everywhere, purchased on-line and often at razor thin margins. In the world of 'experiences', anything goes, and consumers will vote with their feet if they don't think your experience is up to it. Difficult to predict, yet perhaps a goldmine for those who can get a lead and jump into a new way of consumer engagement ahead of the competition.

Only this week, I tried to set up a share trading account with a new service in the Australian market. The website looked great, big balance sheet backing, some nice looking screens, but after half an hour I had failed to set up one of the accounts. After many pages asking me questions, each with nice ticks beside them, at the last hurdle I got a message on the lines of 'unexpected error - please call the call centre'. As you can imagine I rated this a poor customer experience, and whilst I did ring the call centre, they only rubbed salt into the wound and asked me to repeat the whole process all over again - another half hour perhaps lost. Sorry, I have moved on.

The key things to think about in the world of customer experiences is what is it really like to be a customer ?, not what is it like to be you, not like your manager etc ? One thing is for sure, unless you are out there talking to them, understanding the new era of consumerism, consumer interactions and consumer tolerances and alternatives, you have little chance of success.

In our business at Financial Simplicity, we have invested over 15 years already in working with consumers and those that service them, understanding what our clients and their consumer clients are seeking about consumer centric investment products and services. Whilst we are proud of this, we still suspect that we are only part way down the journey and have more to learn, and given the ever changing pace of social innovation, suspect it may never cease either.

Changes In Industry Architecture

I have been speaking a lot recently about how the industry architecture is changing, changing in line with regulatory change from being a product lead and product distribution architecture to a more consumer centric architecture.

 

So what is the difference ?

 

• Does the new architecture still involve platforms ? Yes (but they move from being menu driven supermarkets to back office outsourcers)
• Does the new architecture still involve those who deal with investors ? Yes (although the justification of their value may be a little more transparent)
• Does the new architecture still involve those who manage investments ? Yes … although....
• Does the new architecture leave the same environment for the commercialising of investment products ? NO !

 

So what does this last point mean ? Well it means that a lot of the behaviour that has developed over the last few decades in incenting layers of the industry between product provider towards the investor are undergoing change, as this is no longer to be permitted. Combined with the fact that if anyone was taking the risk for recommendation of products in less than a ‘perfect’ way, will now have a duty of care to choose the best product (or solution) for the investor.

 

The combination of these two points fundamentally iron out  the industry architecture and ‘supply chain’ from being one where each layer has it’s own clients, relationships, management of such, metrics, focus, culture to one where the whole supply chain has to focus on in delivering transparent and more tangible value to the end investor who can see what they are paying for. It means that every participant has to stand up and focus on the rising sun of the new regulatory and consumer driven regime. All participants must fundamentally consider the value that they are providing, and for what costs, and as many others write about, at what risk.

 

The systemic impact of this need for alignment in focus of all areas of the industry towards this new world is now being starting to be understood, and a large part of this is the positioning of the value add of investment management.  There is no doubt in my mind that this discipline adds consumer value, but what is happening is that this activity is moving closer to the client where, unlike in a ‘product’ where everyone is treated the same (remember how can it be right that the investments for a 20 year old be in the same fund as a 70 year old), by moving the process to the client can facilitate a high degree of personalisation and value creating ‘context’ for each investor.

 

With this we are seeing professionals with investment management skill sets popping up elsewhere in the supply chain, in boutique portfolio managers, in financial advisory firms, even in investment platforms where they can operate with perhaps a higher level of efficiency as they are closer to the registry of assets.

 

The next chapter which we are also seeing is that now product manufacturers are starting to respond to this and having to re-invent their proposition to compete. Productised ‘funds’ move over, it’s now about portfolios, portfolios about investors. The questions for many is ‘what value are you adding ?, how do you fit into this new era of proposition ?, what relationships do you need to change or develop ?, how do you get paid ?’.

 

Little doubt that some of  you may be thinking about this already…..

 

 

 

 

 

 

 

 

The FCA's approach to supervising wealth management and private banking firms

I saw a transcript of a speech by Clive Adamson, Director of Supervision, the FCA, at the APCIMS Compliance Conference, London, and noted some key points that the FCA suggest firms focus on. For those reading I thought I would add some commentary (in bold) as to how a number of themes are inherent (or at least my reading of such) within Financial Simplicity’s technologies…

•             Firms should consider their oversight arrangements to ensure they are suitable for the nature, size and complexity of the firms in question.

 

(My Comment : We think that the need for oversight is spot on and the need for firms to be equipped with a new era of management information about their portfolio operations. This is not just about providing clients with some oversight and perspective at portfolio review time, but continual oversight in their businesses about the relative status of client portfolios to their prescribed or assigned investment mandates. At Financial Simplicity we have pioneered this new era of oversight so that regardless of the size of a firm, anyone and everyone in the firm is equipped with the portfolio management information to get the perspective and oversight of the service they are delivering)

•             Firms should record and keep up-to-date consumer information in order to ensure their individual portfolios continue to be suitable for them. We expect firms to make every effort to keep this information current and relevant.

 

(My Comment : We believe that this is a mandatory, and not only in terms of contact details, and records about risk profiles from a compliance point of view, but to absolutely inclide the very specific instructions and feelings from clients about the way they want their investment  portfolio managed for them). Our feedback from many consumers (and advisers) is that in the past much focus has been about theory of investment management with less focussed on the client’s specific feelings about investments in their portfolios). With a highly competitive environment upon us, we feel that systems that can accommodate individual client specific rules, preferences and constraints will be critical not only form a compliance perspective but also from a client relationship management and client retention perspective)

•             Firms should identify and manage conflicts of interest. We want to see that you have thoroughly considered any potential conflicts of interest and will look, for example, at how many in-house products or products manufactured by an associate of the firm are held within individual portfolios – questioning whether this is right for the customer.

 

(My Comment  Whilst I don’t see it a role of technology to drive the choice of investments used by a firm, clearly with focus on conflicted remuneration now upon us, the real issue here is that what is the most appropriate, efficient and to some extent cost effective way of delivering value for investment clients. With the massive growth of passive investment funds in the last few years, there is strong argument to indicate that the value add to clients has moved from the choice of products, to the active monitoring and management of portfolios, requiring the oversight and decision support technologies to achieve such)

 

•             Firms must deliver the services customers have signed up for, agreeing upfront the exact nature of the service they will provide and how the customer will pay for this – ensuring it is recorded in the client agreement signed at the start of the business relationship.

 

(My Comment : For some time the question of ‘delivery vs promise’ has been around in relation to investment services. With increased focus in this area from both a regulatory, but also consumer perspective, both the demonstration of value and it’s delivery and articulation of such will be increasingly important. From a technological perspective this is all about providing the capabilities for constant oversight and monitoring, pro-active rather than scheduled client interaction, and such interaction being focussed on each specific investor rather than an ‘across the board’ approach. We designed Financial Simplicity for this.

•             Firms should ensure that their customers’ wealth is legitimately acquired. It is important firms have a culture based on integrity and ethical values, combined with effective anti-money laundering controls and anti-bribery and corruption processes to prevent their businesses from being used for the purposes of financial crime.

 

(My Comment : Absolutely !)

•             Firms should ensure portfolios are consistent with customer objectives. It is important to explore and record your customer’s attitude to risk and fully understand how they want to invest their money. Where we find that your records are unclear, we will question why.

 

(My Comment : We think that there will be growing emphasis on technology to support this point, and the need for a new era of relationship managers who can adapt and interpret this from investing clients). The monitoring of portfolios to these objectives and goals will move to become a hygene factor over time)

•             And finally, firms should clearly set out their periodic reports. These provide vital information to customers with discretionary accounts and without them, they cannot judge how well their investments are being managed, whether they are performing in line with their expectations, or if they getting value for money. So we expect reports to be clear, use appropriate benchmarks and adequately disclose relevant fees.

 

(My Comment : In a new era of smart phone empowered consumerism, we are of the view that access to information about consumer assets has jumped to a new level where the baseline is moving to a level where the consumer seea everything about their investments on-line 24x7, on any device, and with the information comes perspective and context. Technologies such as Financial Simplicity have a huge role in this and our latest portfolio ‘presentation’ module we hope will define the new standard for consumer interactions by wealth firms)

 

 

 

Enabler vs Protector

With industry change well under way, I am seeing two distinct behaviours in the firms that we are working with,  and there is a high level of struggle between them that is proving to be a considerable management challenge.

ENABLERS VS PROTECTORS

‘Enablers’ are ones that are extremely aware of the impact of regulatory change in terms of what this means in terms of the supply chain. I hear lines like ‘servant leadership’, they question really what does ‘client centric’ mean, and they fundamentally are prepared to air their views about they would like to receive as a client of an investment firm. Words like ‘proposition’, ‘service’, ‘value’, ‘trends’, method of engagement are common.

‘Protectors’ are the ones that appear to display the characteristics of seeking to retain much of the current industry model and structure and seem to be trapped in some lines of thought and practice that is perhaps becoming redundant. Words and phrases like ‘product’, ‘distribution’, ‘segment’ are used heavily, often in the context that these things are fixed.

 Are you an ‘enabler’ or a ‘protector’ ?

Continuous, Cost-Effective Compliance IS Possible

The emergence of a stricter, more onerous regulatory environment in a number of OECD countries, namely Australia, the UK, and Singapore to protect investors is excellent for the industry but it comes at a high price.  Or does it?

Certainly, an effective compliance regime (eg one in which client portfolios do not breach their guidelines but allows for imaginative investment latitude within defined boundaries) requires constant vigilance. This kind of attention requires a great deal of thought, reflection, and adjustment - generally performed over many hours by several staff. As a result, monitoring effective compliance can be one of the most significant costs to a wealth management business. 

Now, however, smart, flexible technology can ensure that the entire compliance process can be automated.  Every portfolio in a wealth management business, irrespective of individual and widely-varied compliance requirements can be adjusted simultaneously and in complete conformity. Beginning with the client’s own rules, preferences and constraints, compliance can now be vertically integrated throughout the entire investment process. 

The entire process is automatic and portfolios are monitored on an ongoing basis. The ability to scale portfolio adjustments easily and accurately makes it possible to provide a genuinely tailored investment service for the masses in a low-cost manner. 

Supply Chains vs Stacks

One of the key differences we are finding when helping firms put together their new era of ‘client centric’ propositions is that the design of the proposition and the components that form such are taking a very different form, in the form of ‘Stacks’ as opposed to ‘chains’. They are characterised by the fact that each layer of the ‘stack’ must add value to the overall client value proposition and work as part of it, rather than the value proposition be passed down a chain and just packaged up with layers of costs and overhead at each stage.

Whilst this may be obvious, it does have considerable impact on the design of systems and propositions from a technology perspective. What it generally means is that participants in the overall stack must work out ways to integrate into the last system that enables the investor proposition. It means that one needs to think about where in the stack a type of business sits, and what are the key integration points, authentication protocols and data related issues in order to nicely fit within the stack of your business partners.

 At Financial Simplicity we have taken this now to a new level, where we recognise that as a ‘proposition enabler’ that our technology must neatly and flexibly fit inside other systems, often our client’s web sites and client interaction layers. To do this we have broken down the overall user interface into ‘containers’ and ‘components’ where the components can be easily embedded in our client’s and partner’s web sites that deal with advisers and investors. We now fit nicely into their ‘stacks’.

 We generally see that the top level of the stack is the engagement layer, then there is the authentication layer, the  user navigation layer, the componentry layer, and then for each component, the permissioning layer, the business logic layer and the data access layers… and sometimes a few more.

 We have thought about this a lot recently and in my view the key to the better propositions moving forward will be how efficient and client centric and efficient their stacks become. Something to think about when choosing technology providers..

Connection is the new form of Distribution

AS the industry moves from the structure of ‘product’, ‘platform’ and ‘distribution’ to one of ‘proposition’, ‘site’ and ‘engagement’, we are seeing some distinct trends around how Financial Simplicity and our clients are doing things.

One of the key trends is about ‘connection’ – just connecting systems and working to common sets of data. Rocket science no, but straightforward in achieving such, no also. Naturally there are issues such as data privacy, data protection, timeliness, formats, protocols to deal with and most of these are quite easy to deal with alone, to achieve them all at the same time requires quite a change in thinking in terms of systems for many industry participants. Gone are the days where systems were built just for internal staff access, gone are the days where systems were designed as for staff who could see an entire client base….

The new era is about providing authenticated role based and data domain based permissioning, whole of supply chain access, separation of data vs presentation, and 24x7 uptime. These are becoming the tools to connect to industry participants and are becoming a significant factor in choice of suppliers. Connection is becoming the new form of distribution…. How connected are you to the industry participants that are going to be critical for your business ?

Practices or Business ?

I am spending quite a bit of time with advisory and investment boutiques (usually between 4 and 10 people) who are facing the reality of new regulation and forming intense competition. I guess this is the new normal.

Looking objectively at their businesses, many of them have sound financial performance to date, and developed a loyal supporting client base, but the issue is where do they go from here.

 Typically these businesses have been set up by principals who have had careers in major private banks, and have transported their skills to a smaller, more independent and flexible boutique. They have earned a decent living and enjoyed their jobs. They however know now that they need to make their businesses more efficient to achieve any form of exit, or even to survive, and this is requiring a considerably different skill set and thinking about what they do.

 

I would say many to date have been ‘practices’ where they have built clients, FUM and income, yet the foundation of this model is set in that a principal or staffer service a number of clients, they enjoy their jobs and juggle a variety of roles of client management, investment management and operations. These sort of businesses may command a multiple of earnings in valuation, or perhaps a FUM related valuation, but with change in regulation, these multiples are declining. To achieve an exit and with an exciting valuation, they have to turn themselves from ‘practices’ into ‘businesses’. This means the very challenging transformation of developing and implementing a set of processes and systems where they are no longer the lynch pin to the business. It means surrendering expertise in their minds and placing into processes and techniques that others can perform and scale.

Whilst some of our clients are well down this path and developing highly scalable portfolio based businesses that I suspect will be exit-able and valuable, the challenge many firms are facing is this transition from practice to business.

 In my view a key (and test) to this transition is the implementation of technology and surrounding processes that define what actually investing clients are receiving. If it is so special that only one of the key principals can deliver it then I suspect the firm will remain a ‘practice’ for some time and struggle to grow. However if the staff of the business can take a step back, really rationalise what they do for their clients and implement a systemised process for them, they then have the foundations of creating a scalable business operation.

 Next steps then are separation of roles, so instead of each staff member responsible for all aspects of client delivery, generally it is about separating out the client management and recruitment from the investment management. This critical step is often hard, but one that is critical for the development of a scalable business model. To achieve this with business management that can measure the performance of these roles and hold them accountable for their success, then becomes a key next stage.

If you are reading this, feel like a practice, and contemplating how to get to an exit, or how to achieve business growth and scale, feel free to give me a call.

Is the future of investments about people or products?

A fascinating week, and the flood gates appear to have opened up on conversations concerning the wealth management industry's future being more about understanding people than understanding investment products.

There are several different starting points to these discussions.  Generally, however, two key themes prevail: regulatory and marketing.

In the regulatory camp, the discussion is all about what is a survivable (as in not subject to appeal or litigation) method of mapping investment products to people, or perhaps the other way around. The debate here is expansive, but is fundamentally centred on what is a legitimate way of mapping the 'needs' of a person to suitable investment products. This is pretty challenging if the design or purpose of the product does not map to the 'needs' of the investor.

This, in itself, raises a number of questions: how does the product owner or operator actually know the needs of the investor? Have they spoken to them? Or, is it just assumed? And, if so, on what basis? In the past there has been an assumption of modern portfolio theory and asset allocation, but is this still valid today? Is this defensible? Clearly, there are some big questions here...

In the marketing camp, the discussion is more about 'how' does one promote a 'product' in a way that is suitable to an investor's needs. If there is an accepted theory that this mapping can be done from within, then there is a better chance of marketing success and investor acceptance.  However, if there is not, then the product manufacturer (or the person implying suitablility) must demonstrate some basis for mapping the product philosophy to the investors' 'needs'.

Again, the approach of modern portfolio theory comes up a number of times. But what does modern portfolio theory have to do with each and every individual person? Not a lot in the specific sense, but quite a lot in the generic sense.

Are financial consumers being held hostage?

Consumers are supposed to be the new royalty in any service industry. In the financial services world, plenty gets written about how important the consumer is, how powerful, how discerning but how many business models are really built around the consumer?

Far from being more free and able to exercise all those choices one sees dangled tantalizingly in front of the ravenous crowd, today’s consumers are sometimes little more than hostages to the current system.

The UK has a declining class system with perhaps dangerous erosion of order and predictability.  The extreme wealth of London is offset by the poverty and extreme uncertainty of the working classes.  This has been the price of freedom: consumers – individuals –  are now hostages to the very system that was supposed to liberate them in a financial sense.  

This situation is not, of course, unique to the UK.  In the US, for example, 47% of people currently are supported by the state.

If we are to liberate today's financial consumers, I suspect that there must be a genuine, fundamental shift in the very nature of the system that caters for them.  Most importantly, everyone - from financial services companies to governments - must act with empathy when considering the consumer and, more broadly, the electorate.  

All of us who operate within financial services must recognize, in a collective sense, that the system must give consumers what they really need as opposed to what we think they need.  Specifically, we must ensure that the system intended to build wealth in order to fund individual retirements can, in the first instance, actually support sustainable livelihoods for individuals.   

I suspec this is will be critical for rebuilding confidence in the financial services system.  More broadly, this could become a permanent election issue. I suspect people cannot build wealth meaningfully while they are held hostage within a system that may well threaten their survival.