Portfolio Management : Advisory vs Discretionary, The Pros and Cons are Changing

In many of the groups that I visit around the world, we find that they have a portfolio proposition that is either advisory, discretionary, or perhaps have both. What I find interesting though is why their propositions are such and whether they are open minded to the alternatives.

In the advisory proposition camp, we often find that the key drivers on the positive side are that it supports a highly client engaging and interacting proposition and supports relationships, and in other ways is regarded as often with a lower business risk as each adjustment to the portfolio is done with the client’s approval. The downsides of this proposition for the adviser and possible also the client is that it requires for the adviser to establish contact with the client, for the client to approve the portfolio adjustments which may have challenges if the client is not in the same time zone as the adviser, may not be contactable, or just doesn’t want to think about any portfolio adjustments at that time.

In the discretionary camp, the clear benefits are that the adviser or portfolio manager can take advantage of short living market opportunities, perhaps can get leverage of the whole book size (or many portfolios at the same time),  and reduce or eliminate the workflows for client communications and confirmations when adjusting portfolios. Also this model is inherently more scalable as less ‘workflows’ to involve external people (ie clients) are required. The downside however is that in many countries the regulatory overheads and approvals to offer a discretionary service to investors is sometimes quite challenging in terms of license approvals, education and experience requirements and often firm capital adequacy requirements.

 

What I find interesting is that in some countries the discretionary service is regarded as the premium service for more valuable clients, and advisory for the broader client range, whereas in other countries it is the other way around. Clearly this is historical in it’s positioning.

 Now enter the world of new technologies over the last 10 or so years, like smartphones, interactive web sites and global internet connectivity. A combination of these essentially help overcome some of the challenges of the advisory portfolio proposition as it can be easier to communicate with clients and get their approvals. Compounding this with the ability to produce high quality personalized portfolio reviews with massive scale and efficiency though Financial Simplicity, and we have now sufficient enough ingredients and removal of the frictions of the advisory model to make it a lot more efficient, and more scalable also.

 Whilst clearly the advisory model will not suit the client that expressed strong preference or instruction that they just doesn’t want to be contacted (which may come with additional costs to support the regulatory increases to deliver such),  some of the business and operating barriers and considerations can be ironed out and / or be removed.

Picture this:

a)      Each adviser can use portfolio intelligence capabilities from Financial Simplicity to monitor all their client portfolios (could be thousands) for required portfolio adjustments. Within seconds they can identify which client portfolios need adjustment.

b)      Then for those client portfolios that warrant adjustments, the adviser can use Financial Simplicity’s personalized portfolio modelling / rebalancing in seconds again to produce personalized portfolio reviews for such clients. With the automation in Financial Simplicity to support this, they may do this for dozens of even hundreds of client portfolios within minutes

c)       Assuming the clients have phones or email. the adviser can then use their email / CRM / SMS or whatever ways of communication they desire to communicate with their clients electronically

d)      The clients can read the portfolio review documents and can then either speak to the adviser or use on-line methods to approve the portfolio adjustments for the adviser

e)      The adviser then implements the portfolio adjustments according to their workflows and methods which could involve methods to efficiently make trades for clients en-masse

In the same way that discretionary managers may only make smaller adjustments to portfolios in a day, should the above process be sufficiently efficient, then it may be that each client portfolio review will just be smaller adjustments, requiring less contemplation or time to consider by each client, improving overall end to end efficiency.

 When faced with the decision of advisory vs discretionary portfolio propositions (or both), the above operating model raises a number of questions:

i)                    What is the client engagement model  that each client prefers, to ensure to deliver a service to their requirements ?

ii)                   What the different economics of the different operating models ? Are now the costs of monitoring , reviewing / rebalancing portfolios and communicating with clients now down to a cost level that makes it more appealing than a discretionary offer (with associated regulatory overheads perhaps) ?

iii)                 What are the set up and establishment costs (ie licensing, capital adequacy, resourcing, compliance  etc) for the different proposition types ?

iv)                 Where are the technology trends likely to move in the future ?

v)                  What pricing levels,  premiums or discounts can the firm provide for each type of proposition compared to the other – which is cheaper or more expensive to operate ? what is the relative value in the eyes of the different client types ?

vi)                 Now do I segment my clients more around how they want to be engaged rather than how much monies they have for investing ?

 With technologies such as Financial Simplicity that can enable very efficient and massively scalable advisory or discretionary portfolio propositions, there clearly are opportunities for firms to think hard about, and be creative with, the type of propositions they want to offer, and accommodate broader ranges of clients. The profitability of each proposition I suspect will be quite influenced by how regulators regulate the different proposition types, overlayed with the increasing ease of use of networked technologies to bring the adviser and the client closer together.

 I also am guessing that moving forward, wealth management firms may find themselves in a position where the client may have apps and technologies in their hands that will define how their service providers will interact with them if they want their business. The ever changing technological, regulatory and social landscape that we operate in I doubt will keep evolving and changing.

 

Digital Termites and Wealth Management

In the late 1990s, I used to work for an innovative company called 'Open Market' which pioneered both ideas and technologies about the commercial use of the Internet, much of which has evolved and become commonplace today.

One of the themes that the President Shikar Gosch introduced was the idea of 'Digital Termites' and 'Termiting' digital media. What he meant by this is that with broad access to information and data by anyone if a supply chain, there was the ability for industry participants to extract new data, re-purpose it, combine with other data and create new value propositions. He called this process 'digital termiting' and the organisations that did it 'digital termites'.

What has this got to do with wealth management ? Quite a lot !

We are in an unprecedented period in the investments and wealth management industry of the grab for consumer relationships and margin compression, and with this it is largely recognized that there are 'too many snouts in the trough'. There has been to date in many cases  multiple 'layers' of value (bringing together someone's opinion, market access and / or intellectual property) that over time have been synergistic, but the packaging of such has lead to an 'supply chain' that has become expensive and inefficient.

This is where the termites come in.

Organisations that may have relied on third parties to package up their value in some way, and combine their value on the top or bottom of such are now more able to considering 'termiting' the value propositions together in a more efficient manner and cutting layers of costs out. Examples may include

• where advisers are packaging up asset allocation information and investment model portfolios to replace investment product providers
• where investment platforms introduce model portfolios of investments to displace 'fund of fund' managers and / or investment products
• where asset managers seek to go directly to consumers and offer personalized investment portfolios with consumer data
• there are many more....

They key questions for wealth management industry participants are:

• what risks exist to your business of being digitally 'termited' by others
• what digital 'termiting' opportunities are there for your business to cut the snouts out of the trough and increase your business standing
• would you be disadvantaged if others could digitally 'termite' you proposition out from around you ?
• what data do you have that is important to your business to ensure that it is not 'termited' out ?

In an era where conflicted remuneration structures are being disbanded, and digital information is more readily accessible than ever before, I'd suggest that this trend is not going away...

If it means introducing an investment proposition into your business, we would love to help you understand how to achieve this and perhaps 'termite' some value elsewhere into your business.

The Wonders of Model Portfolios

So many firms are bringing in these things called 'Model Portfolios' and for some, they look like a new list of approved investments for clients, often in different proportions for different risk appetites. So what is the big deal ?

Well the big deal is that to be used properly, 2 key things must happen:

1) authors / publishers of model portfolios need to maintain them as their views on markets and investments change. To not do so could imply that there is perhaps some lack of duty of care, and it is a pretty public place to be seen here
2) those advisers that use the model portfolios need to continually check that their client portfolios are kept within whatever parameters associated with the model portfolio in order to demonstrate

• that they are delivering to promise of a portfolio in line with the model portfolio
• that they are demonstrating a continuous and comprehensive oversight of the clients portfolios bearing in mind the model portfolio

Whilst practices of the past may have deemed this to be sufficiently done once a quarter or once a year, regulators around the world are expressing that the onus for advisers and the firms that they work for, is to do this in line with the way fees are being charged, and if the advisers is to position themselves as a fiduciary, that this is pretty well a continuous process.

Perhaps look at it should an adviser not achieve this continuously......what risk does the adviser or business open itself to from clients if portfolios deviate from model portfolios ? What are acceptable tolerances ? Are they defined ? Also, what does an adviser need to do to justify their fees to regulators that are looking at this a lot more closely.

At Financial Simplicity, we believe best practice is that advisers and firms are best served to work together to both be able to monitor portfolios to model portfolios at the same time. If the advisers notices breaches first, it is a client servicing opportunity, if the firm / licensee does, it is a business risk reduction action.

Call us to find out how..