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.

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)