Model Portfolios - Commonality in the Chaos

Professional fund managers employ significant intellectual resources and systems firepower in order that they can extract excess return from markets in a structured and consistent manner. Of utmost importance to the investors they represent, the ability to explain the sources of return and attribute them to a repeatable process is key in gaining investor confidence and attracting funds, and also retaining funds when returns aren’t the best. 

Similarly, high net worth investors that entrust their funds to professional wealth managers also seek the confidence of knowing the process - in which their life savings are being invested – is a robust and repeatable process that is managed in a structured manner, rather than choose services based on something opaque, such the ‘knowledge and experience’ of some guru stock picker. 

For most wealth management firms, model or guidance portfolios is the crystalisation of the firms’ research process and represents its best portfolio ideas at the time in a hypothetical sense (i.e. if a client portfolio was being implemented from scratch today).  Having a common research basis for portfolio recommendations across the entire client base is extremely useful from a scalability and compliance point of view (having a demonstrable basis of recommendations). It is also widely recognised that having structure and definition around a ‘best ideas’ portfolio in terms of security selection and weightings is an important aspect of risk management and ensuring appropriate diversifications across the client base.    

However, as a basis of portfolio recommendations, model portfolios introduce the paradox of scalability benefits, coupled with implementation inefficiencies.
The implementation efficiencies arise because of:
1)    Legacy positions in existing portfolios
2)    Customisations for each client related to tax positions, preferences, exclusions and other specific instructions not perfectly in line with the prevailing model

In most practices a significant proportion of adviser and paraplanning time is utilised to align the hypothetical model portfolio with client portfolios overlayed with client rules, tax management and instructions. And while model portfolios introduce a thread of commonality across client portfolios, the process of custom overlay creates chaos in the kitchen from an admin perspective and often the use of spreadsheets (that are often prone to error) and manual tasks is prolific. 

The modern day reality is that in order for a wealth business to scale (through alleviating the time required by client advisers to implement a model portfolio with client customisation) the overlay process needs to be become systemised, scalable, and repeatable. In a world of limited resources, the only alternatives are all negative (higher cost of delivery, less client engagement time, less customisation, less frequent reviews, more propensity for operational errors). 

This is why Financial Simplicity has researched and finessed over time the process of aligning model portfolios to client portfolios incorporating personal overlays for each client. This is also the reason why if you are operating a wealth management business and want to deliver  tailored portfolios to clients in an efficient manner that also adds value to their experience and your business, it may be worth your while to call Financial Simplicity today for a  confidential discussion about how we can scale the delivery of your firm’s best ideas across your client base. 

Australian Super Fee reports highlights poor outcomes of product distribution model

The Grattan Institute has recently been released a report alleging that Australians pay $10bill too much fees collectively per annum. The net effect this has to the average Australian is a cut in retirement income of up to 20 percent. 

Overpaying for the seemingly simple function of holding and investing assets is not news to most of us with a superannuation or pension fund in Australia. However, the fact that Grattan has come out with a specific figure of $10bill per annum, I would suggest is quite a revelation as to the extent of inflated margins being facilitated by the institutions that are entrusted with our retirement savings.

If anyone has doubts to the basis of these figures, perhaps you would rather listen the Treasury, who earlier this month described Australia's superannuation system is one of the world's least efficient and most expensive (http://www.smh.com.au/business/super-system-expensive-and-inefficient-says-treasury-20140406-366re.html#ixzz30FXZtVGP). Of the 15 OECD nations whose pension operating expenses it graphs, Australia's are exceeded only by those of Spain, Hungary, Mexico and the Czech Republic. 

It is not the entire Super system that is seemingly overcharging, as is highlighted in one of the charts extracted from the report which shows that public sector and corporate funds are a paying fees of a third to half what industry and retail funds pay.

It is clearly the Retail sector of funds that pass to their members the additional costs of sales and distribution needed to market their products to advisers and consumers. FOFA reforms should be a catalyst for fees to come down as costs of commissions payed to advisers is no longer allowed. This of course, does not reflect reality as fund managers attempt to recover costs in a more competitive market. Treasury also suggests that the separation of the ownership of funds from those who manage them ''opens up the risk that managers rationally maximise their own interests at the expense of fund members''.

Unfortunately, the truth is that without an overriding consumer disruption, retail funds and fund managers have had no incentive to lower fees. As such, the Grattan report declares “Fees in Australia are high for one main reason. The system relies on account-holders and employers to put pressure on fees, but many do not.”

They are referring to the extent of member disengagement which is another feature of our superannuation system. The vast majority of retail fund members are still in a retail fund because they have been put in there by an employer, are disengaged and uninterested in switching funds or even investment options.

For those who have read my previous papers, you will know that I have been arguing for years that the industry has too many fee and admin layers in delivering the basic function of holding and investing assets. In addition, super fund back office processes are still highly manual, leading to costs incurred in the deployment of expensive human resources, and the clean up of errors that human involvement leads to.

Excluded from these charts are SMSFs, who according to the report, average fees in the range of 0.85-1%. The fact that this has been the fastest growing segment of the super fund market for some time we believe reflects the fact that a large proportion of members with larger balances are attracted to the ability to have increased transparency, engagement, and lower fees than retail fund options.

Skills in going from professional sellers of investments to professiona buyers

With changing regulation around the world either in place, or moving to be in place quite soon, there is a fundamental shift occuring in the wealth management industry. This shift in many ways is that people who made their living from the selling of investment products (and were paid product commissions to do so), now are being forced to move to the other side of the table and make a living by charging their clients for buying investments on their behalf.

Simple..?

Those in the industry will be well aware on the substantial investment that has gone into systems, proceses, compliance changes etc in order to support this change. At a simplisitic level it could be that rather than the professionals being paid by the product providers, they are now paid by the client instead under methods some call 'adviser charging'. OK, now lets move on....

Whilst what could be seen as a small change, there is a very different reality as to the business model of that professional's business though in this transition in terms of a) exposure to change in revenues b) demonstration of the value to support revenues, c) the perceived value of those revenues to consumers in a world where access to investments on-line has never been easier (and more confusing some would argue !)

Fundamentally the value proposition of professionals has moved form being about access to investments for sale in 'regulated' way, to one to how much value do they add in the eyes of the clients. Some key points here:

a) value is now perceived by the client, not the product provider -requiring a considerable change in identity and context
b) with tightening consumer wallets, this value is more transparent and will undergo more scrutiny, especially in a world where there is vast amounts of consumer information and commentary on-line, often around low cost access to investments also

What does this mean in terms of skill sets for wealth advisory professionals ?

I'd suggest that it means about extending skills in understanding client context, demonstrating on going value with ongoing suggestions in terms of investments in a portfolio, and operating a business that absolutely maximises and optimises the value-time equation with clients, not just number of clients.

Whilst many are well equpped to deal with the client facing aspects of this, many are struggling with a componnt of this which is amounting to them essentially have to become portfolio managers / investment managers themselves, which is not suprising as it is probrally not their skill sets. This is a specialist area that is not for the faint hearted, is often multi-dimensional, and can have deep consequences for client portfolios if not properly operated, overseen and managed.

It is this latter aspect of portfolio management that Financial Simplicity helps our clients with, helping them use business intelligence and sysemised workflows to operate such a portfolio management funciton with lower costs and risks, allowing them to spend more time on the essentials... adding value to clients lives.