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..

Tinder Understands its Users Better than Most Robo Advisors

I just read this article here at http://www.financial-planning.com/blogs/idea-exchange/tinder-understands-it-users-better-than-most-robo-advisors-2696001-1.html

I guess really opens a can of worms in terms of people personalities (or multiple of), and what is really the best way to ascertain some key aspects of people's financial profiles, attitudes to risk etc.

I do agree however that the phraseology and understanding of short sentences is open somewhat to interpretation, and that a perhaps more interactive approach, based on actions and larger amounts of data, could lead to better understanding of people's financial profiles, and suspect that we will see considerable innovation in this space as current methods get tested.

It reminds me some discussions with some telcos where they point out that often that the data on mobile phones and the analysis of such helps in some ways to enable them to know the phone user better than their partners..

The Digital Revolution and whats coming in 2016

That time of year again, where in this part of the world (Sydney), most people are heading back to work after a solid break. I find that each year after such a break, the thinking in the industry advances considerably as people have had time to clear their heads and absorb what has being going on around them last year. This often leads to new energies and directions, and this year I am already experiencing no different.

 
You may have been also reading about what many in Davos have been calling the ‘4^th industrial revolution’ which others have called the ‘digital revolution’, and I suspect there are a number of other names also for it. My key observation is that this ‘revolution’ is about the highly connected society that we now live in, where the power of the highly connected consumer (through smart phones primarily today) is having amazing effects on industries, businesses, society and individuals. Wealth management is no different and many in the industry are realizing that there is perhaps some profound trends and changes that are upon us, and this is driving the new energies for 2016.

 

Whilst sheer power of communication between individuals and businesses has clearly been evident in the use of smart phones, what is now being realised that this doesn’t just mean we communicate like we did before must more efficiently, but there is now new ways to communicate that mean that some communications of old are now redundant, and other types of communication are becoming more relevant. In wealth management, this is stuff like not just understanding valuation of portfolios with associated research, but introducing consensus on investments and sectors, dynamics of the markets with new metrics, and even ‘social’ overlays associated with companies etc. This also applies to what regulators are expecting to be reported to them.

 

We are also however seeing that some of the conflicts and shortfalls of the prior industry model as it has developed becoming increasingly exposed and industry participants finding themselves under increased scrutiny both from their clients who are demanding more information, but also the regulators, who are having to respond to the increased amount of data and information appropriately, which is in many cases creating new regulations, codes of conduct or even laws. I suspect in 2016 that will see this accelerate and like in many industries or other parts of life, that the ‘social regulator’ may in many cases have more of an impact than the one that comes through the door.

 

Back to people coming back from their Christmas breaks….well we are already number of enquiries around ‘how do I deliver to my clients better ?’, ‘how can I stop using product based platforms ?’, ‘how can I put in a model that allows me to scale the business easier than hiring people ?’. Well a lot of this happened last year, so what is different this year ? This year the difference is firms are recognising that rather than looking at each of these issues individually with point solutions, there is clear recognition that to manage such different initiatives separately, often with different technologies, is both expensive, and often leads to increased overhead rather than improved overall business performance. I suspect that is why many are telling me that so many wealth management firms around the world last year were struggling to improve profits, or in many cases even make a profit. The new year realization for 2016 that people are coming to is that just ‘putting more lipstick on the pig’ is not a recipe for success and that a more integrated coordinated approach, requiring broad enterprise review and modeling is required.

In the UK we saw a number of mergers of wealth management firms that I suspect will get efficiencies of scale in delivering the model with less duplicated overhead, but the question I ask is whether that is just short term fixing but avoiding the real issue of that a new engagement model is required in the digital revolution.

 

I still think we are at the start of this ‘digital revolution’ and some rules of thumb that I think will emerge from such are:

-          Be very clear on your value proposition to your client

-          Be very clear that your clients understand the value (to them) of everything that is put in front of them

-          Expect regulators to start wanting to look at more ‘data’, and ask for more definition of what your business is doing to add value to such data

-          Take it for granted that you cannot hide from the social regulator, and ensure practices and conduct reflect such

-          Often your uniqueness is your value

-          If you are in a value chain, expect your suppliers and partners to ‘pirate’ the value chain, ie move around you

-          Expect new forms of digital communications to be requested by, and valued by, your clients

Thankfully at Financial Simplicity, we have been helping wealth and investment management firms with much of this for some time, preparing them to survive and thrive in the digital revolution. If you are wondering what the digital revolution may mean for you or your firm, drop me a line. Its more than a web page.

 

 

 

EY Report - The $500 Trillion Consumer Centic Prize

Just read the recent report from EY about the $500 Trillion Consumer Centric Retirement Prize at www.ey.com/pensionsreport2015. Great report with some really pertinent observations in there. Some I specifically noted (sorry rather long but it is a long report !):

·         There is broad recognition that the industry has a long way to go, which I suspect needs to happen in line with the changes to public policy, regulation and societal sustainability and the role of money. The question raised about who underwrites the wellbeing risk of people I suspect is one of the biggest issues of our time.

·         There is a major point raised around that in the shift in the attitude from ‘paternalistic’ to ‘client centric’ means different skill sets in both subject matter and management. At Financial Simplicity we have seen this for 10 years now, where firms making such a shift to a customer centric model need some very different ingredients. We notice that there are just different characteristics of the CEO’s right through the organsiation. It is difficult to pinpoint it, but some critical ingredients appear to include high degrees of knowledge and competency, a business owner mentality and passion (in more ways than just equity), and a higher appetite for ‘participation’ over ‘position’

·         the question of who pays for innovating and developing the new infrastructure required for a consumer centric industry and operating model is a really big one. My view is that this infrastructure will have quite a different form from the last ‘generation’ and will be far more ‘intertwined’ rather than ‘standalone’ product / organisations. I suspect that amongst this infrastructure will be some very key components that will almost be regulated to be used to support a consistent theme of consumer centric outcomes. I aspire that Financial Simplicity or the techniques we have developed around consumer centric investment management will be one of such

·         I think Figure 4 is great and believe (as practiced) that 'Simplicity' (or rationalising complexity into..) is very much a key tenant of the future in a consumer centric world

·         I really like the mention of the ‘all stakeholder’ code of conduct and believe that this will underpin a form of regulation. I suspect it also will closely align with the attributes of organisations that successfully transition from ‘paternalistic’ to ‘client centric’

·          the issue of consumers’ understanding the relevance and roles of all those involved with their ‘wellbeing’ will be critical to create, and sustain,  a new era of trust. One could argue that this extends beyond financial wellbeing also, but limiting it to such, I suspect every organisation will need to how it is positioned in the eyes of the consumers it ultimately deals with an what is it’s value proposition and cost base

·         The point about wellbeing being the driver, but how is it measured and monitored ? I think is quite interesting and also can extend well beyond financial issues. I suspect we will see an increased focus from the industry on broader issues than financial affordability and see it extend into education beyond consumerism and hype

·         The point about the need for clarity for alignment of interests is a key one, and always difficult to implement in a world where there are stakeholders that one could argue have different motivations than that of the consumer, such as shareholders in the companies’ that serve them. This is closely linked to the question about the funding of new era infrastructure as clearly those who invest in such will be seeking some form of return

·         There is a mention which I like about all stakeholders to increase understanding of behavioral finance to increase confidence. I suspect it moves beyond impacting consumer confidence also, but a necessity for behavioral finance understanding in order to improve organizational culture and ability to lead. Over the years I have become well aware of the conflicts of staff in companies who are doing one thing in terms of investing for their clients vs the way they would invest their own monies due to the difference in managing to 'mandate' vs personal outcomes.

·         In relation to the ‘digital’ advances, there is welcome highlighting of the need for the encouraging of participation for consumers and empowering to make decisions, ultimately implying involvement in the decisions and outcomes that effect them. At Financial Simplicity we have noticed that our client firms that practice this ultimately end up with much higher client satisfaction levels and I suspect are helping their clients with their ‘wellbeing’ beyond just managing monies.

·         There is a really pertinent point about what is the purpose of the financial ‘wellbeing’ of consumers which spins out plenty of thoughts as to what is the purpose of the pension / investments industry also. I suspect that governments are going to really have to think this through, especially globally now given the global flight of monies, and position financial and economic wellbeing in the context of sustainable and healthy societies.

·         In the governance section there is a reference to the need for ‘an integrated and adequately empowered fiduciary framework that covers the entire value chain and it’s key stakeholders to maximise alignment and support confidence’. This lies very closely to the point about consumers understanding all the roles of people involved with their financial wellbeing and the shift from paternalistic to client centric propositions and cultures of running such businesses. My view is that this will ultimately come down to a more formulaic value chain model with some very common components that define the fiduciary framework. Many suggest that Financial Simplicity could be one such component

·         I was amazed on Figure 19 as to how few rate themselves as being ‘easy to deal with’. I also liked the framework in Figure 18 that hits with some of the core issues at the heart about avoiding negative emotions and building on positive ones, a stark contrast to the paternalistic model. This is something that we have had at the core of Financial Simplicity for over 10 years as we are reminded by our clients that making investment (or other financial) decisions is quite statistical in it’s outcome, but very emotional at the point of decision.

·         The point about the importance of digital in making this transformation from paternalistic to customer centric I think cannot be underestimated, and was amazed (ie on the low side) at the chart about participants perspective on such. Customer engagement and customer experience is THE future for satisfying the new consumer and will iterate the advances that need to be made here, for which without I believe that firms will just be left behind.

·         There is a point about the cost of regulation being high and how this impacts the ability to innovate. This is undoubtedly a major factor deterring progress and in Australia we are seeing some really welcome initiatives being taken in an attempt to unlock this barrier, such as the ASIC Start Up Innovation Hub. My guess a lot of the issue here is that regulation has to be designed quite broadly for good reason, however the lions’ share of servicing consumer with wealth accumulation strategies can be quite simple to regulate if they stay ‘on piste’. I suspect over time we will see some ‘slim down’ regulation to support consumer centric initiatives come into the market easier as long as they ‘fit in the box’, and for those propositions that deviate considerably (such as highly leveraged complex products) will have more regulatory overhead to deal with. It will be interesting if such strategies and products then are attractive with such overheads compared to the more simpler ones

At Financial Simplicity, we have been both thinking and developing techniques and technologies for over 10 years to help firms with the shift from ‘paternalistic’ to ‘customer centric’, and this report from EY I think highlights much of the issues associated with achieving such. Ultimately I am of the view that this shift will not be achieved alone, firm by firm, but will take a coordinated approach across all stakeholder groups with tight consultation with consumers in a very ‘agile’ fashion. If you are interested, we will be happy to talk about it.

Managed Accounts and Practices vs Businesses

There are some increasingly clear lines being drawn in the rapidly growing world of managed accounts. One of them relates to whether wealth managers are practices or businesses. "What ?" you may ask, or "Why does it matter ?". Let me try and explain:

 

First of all distinction between a practice and a business. For this article, lets call a 'practice' as a group of people (perhaps in partnership), who invariably are in work of servicing their clients, perhaps joining together to help each other out and form a larger footprint than they would themselves. Practices often are named after their principals and may be 'partnerships' of some form.  Lets call a 'business' as something that is usually incorporated, usually creates a 'product' and is often about creating an operating model that can grow, scale, and possibly ultimately be sold as an operating entity irrespective of the owners of the business.

 

Some key differences here:

• Practices are often charcterised by their principals and often have 'succession' issues as often a lot of the value is lost when the principals leave (who would go to Smith and Partners if Mr Smith may no longer be there ?). Because of this, they often trade at values or multiples of profit / revenue that are lower than businesses.
   
   
• Businesses are often characterized by brand and their product, which can be passed on from owner to owner. Businesses are often less 'personal' but fulfil an important utility value to their customers. Because of such, they trade at larger values in terms of multiples of profit and revenue. They have broken often the link between owner and management.

 

What has this to do with Managed Accounts ? Well in some cases quite a lot, especially in terms of valuations of the firms that are providing or using such. The key point is that the firms that are using other firms managed account offers are more like 'practices' and those creating and operating their own managed account offers are more like 'businesses'. Clearly (and often) there are hybrids also, which in many cases have, or are considering, splitting such operations between portfolio manufacturing operations (ie a business) and dealing with clients (ie a practice).

 

We have noticed this with some of our clients recently who are reporting that as they transition from  being a 'practice' to having a 'business' with a managed account portfolio 'product' that can be promoted by both themselves and sometimes others, that they are being viewed with higher valuations.

 

So if you are involved with the creating or selling of managed account portfolio offers, perhaps ask yourself whether you are in a practice or a business, and ask yourself is what you are doing currently the best way to maximize the value of your skills and assets, and if appropriate how to turn your capabilities into a 'business' that may have considerably more value than just the servicing of clients.

 

At Financial Simplicity, we would like to think that we very much recognize the differences between 'practice' and 'business', and continue to help firms make the transition to create value for their owners.

 

In summary:

• Practice - often promoters of other providers' managed account offers, or service clients on a 1 to 1 basis
• Business - often operators of a managed account offer that can be promoted via client attraction and servicing channels, or other firms (often practices)

Just think how valuable a business would be if it could manufacture a managed account portfolio product that was tailored to each investing client ? That's practice level service with business level value, that's Financial Simplicity ! 

Thankyou to my friends Creel Price and Matt Church for some of the background around practices and businesses.