Archive for June, 2010

How to Think Smarter About Risk

Tuesday, June 29th, 2010

There was an interesing article in the WSJ recently entitled How to Think Smarter About Risk. Many of the ideas are worth thinking about and incorporating into your business if you are an advisor, although I have to admit that there were a few things in the article that I disagreed with.

The primary point of the article is that while many advisors consider how clients feel about risk and how they feel about the market overall (bullish v. bearish sentiment) when devising an asset allocation strategy, they often neglect to take into account the client’s human capital – their personal balance sheet.

Human capital is essentially a measure of future earnings. For example, if you work in the financial services industry, even if you are very optimistic about the market and willing to take a lot of risk, since your job might be at risk in another market downturn, this risk factor should be incorporated into your asset allocation (in essence resulting in a more conservative approach). The article contrasts this to a professor with tenure, where their job is relatively safe. Human capital can be quantified in terms of beta – is your beta higher or lower than the market? Thought of another way, are you more like a bond (risk-averse) or a stock?

I agree that human capital should be considered when an investor and their advisor devise an asset allocation. Part of the value-added of hiring an advisor is that he/she is able to incorporate the many facets of your life into your investment plan. A good advisor will take the time to really get to know clients and not simply base the investment plan on the answers to a 10-question risk assessment. I also agree with the article that decisions to buy insurance should also take human capital into account. The more stable the value of your human capital, the more insurance you should have to protect it, and vice versa.

One point that I don’t agree in the article, however, is its contention that high beta investors – investors whose human capital tends to fluctuate with the market and who should therefore be somewhat more conservative in their investments – should have little invested in the market during the first decade or two of their working lives, and more than conventional wisdom recommends during the later years. This idea, in my opinion, fails to take into account the powerful value of compounding. Factor your human capital in – yes – let it dictate your investing – no.

I also disagree with the authors take on education. The premise that the decision of what degree should be pursued should be intertwined with a eye toward hedging your long-term human capital seems somewhat cynical. If my son wants to pursue an undergraduate degree in history on his way to law school or whatever else he does, I for one am not going to try and dissuade him.

My conclusion is that while the article takes the issue of human capital a little too far for my tastes, the concept itself is important and advisors that integrate this issue into their fact finding and asset allocation decision-making are not only doing their clients a great service, but perhaps distancing themselves from the competition at the same time.

Financial Reform Surprise – the “F” Word’s Revenge!

Friday, June 25th, 2010

Like many others, I am surprised at the improbable win for the fiduciary standard announced yesterday – although, I think there is still too much uncertainty for anyone on either side to get too excited. What is certain is that the debate around this issue will continue for at least the next six months – if not longer.

The compromise reached in the financial reform bill almost certain to be passed next week is that the SEC will conduct a six-month study and have the power to decide at that point whether or not broker-dealers will be held to the same fiduciary standards under The Investment Advisor Act of 1940 as investment advisors are today. Advisors at broker-dealers are currently held to a less-stringent standard of suitability. Advocates of imposing the fiduciary standard on broker-dealers feel that it offers clients better protection, while the broker-dealer world is concerned over the costs of implementing and overseeing such a far-reaching change.

From an advisors point of view – the issue should be purely about semantics; I have always argued that advisors should hold themselves to the highest of standards regardless of where they work. It just makes good sense.

The ultimate outcome is far from certain, and there are some important carve-outs in the proposed legislation. For broker-dealers, the standard would only cover retail clients, not institutional clients; it also does not call for an on-going standard, of particular importance to discount brokers who offer do not have long-term relationships with clients (once intial advice is given).

Most importantly, however, is that the SEC does not have to act after the study; and given the SEC’s track record, it could very well be that this is a short-lived victory for those in favor of extending the standard to the broker-dealer world. Industry lobbyists are sure to be very busy over the next six months – so while even though many of us were surprised that the issue is living on at this point, the outcome is far from certain.

Keep watching!

Stop Putting the Squeeze on Investors

Thursday, June 24th, 2010

There was an interesting article in the WSJ recently – Hey, Money Managers, Stop Putting the Squeeze on Investors – focusing on how while the stock market overall has done poorly over the past decade, the net margins of the 10 major publicly traded fund managment companies is still running at an astonishing 25.5%.

The author suggests that unless some changes are made, many investors may abandon the markets like they did in the 1930s and 1970s. He suggests that top money managers consider 1) cutting fees (only 175 out of 6,732 mutual funds have cut their fees so far in 2010 and only by an average of 0.07%; 2) help slash tax bills by investing more tax efficiently; 3) close when they get too big; 4) leave the herd mentally behind; and 5) be more upfront about not only how they performed, but how investors would have done had they done nothing – in other words – did the money manager really add value?

There are some important points here for investors and advisors. Fees should always be a consideration when investing and it is fair to question whether a particular manager, fund or fund family has reduced their fees. While there may be a legitimate reason why fees are where they are, it is incumbent upon the investor and advisor to determine those reasons. Part of the intial investment decision should take taxes into account – any advisor that has not done this is not doing clients any favors. Investors who invest on their own need to be aware of taxes – or perhaps they should consider getting some advice.

As managers or funds get larger, especially if they are investing in anything other than large-cap stocks, they should consider closing. Many managers and funds have closed in the past. In conducting due diligence, the question of when and if the manager or fund will close is definitely important. While the answer to one of these questions might not change your investment decision, taken as a whole, these questions, if answered in a way that does not add comfort, should make you think twice before making an investment.

One value of having an advisor or firm that conducts due diligence is to find a manager or fund that does not follow the herd, especially if it impacts their turnover as discussed in this article. Finally, managers and funds and their performance should be evaluated in multiple ways and no one should rely only on the manager or fund to tell you how they did.

The article raises valid points from a number of perspectives. Investment managers and fund companies should evaluate their policies in all of these areas and provide answers – not only when asked, but proactively. Advisors should outline their criteria for making investments to their clients, and all of these points are important ones to include. And investors should either develop their own due diligence methodologies to address these issues, or seriously consider working with an expert who can!

More Potential Bad News For The Wirehouses

Monday, June 21st, 2010

In FundFire’s recent survey of industry participants, the highest percentage of respondents indicated that they felt that revenue-sharing agreements – or the amount of money that fund companies pay to sponsors for promotion and support – were the most important determinant of whether or not a fund company gets on that sponsors platform. In other words – pay for play.

Investment philosophy came in as the second most popular answer, followed by the wholesaler’s relationship with the gate keepers. Why might this answer be bad for wirehouses?

The answer is that it indicates that the perception is that money speaks louder than anything; if true, this phenomenon hurts smaller mutual fund companies that don’t have the financial resources to compete. It would also limit client and advisor choice.

I say perception because while I agree this might have been the best answer a few years ago, I would agree with the management of wirehouses who would dispute this is still the case in today’s market. Especially following a large settlement a number of years ago against Edward Jones, the wirehouses have been reluctant to let revenue-sharing dictate their actions.

But since perception is reality, this type of issue, if publicized further, would be another black eye for the wirehouses. In the midst of the continued debate over the fiduciary standard, perceptions such as this become reality if used by RIAs and others who compete with the wirehouses; these competitors would argue that not only are wirehouse advisors not held to the fiduciary standard, but their firms limit their product offerings due to monetary issues, with the loser being the client.

My advice to the wirehouses is that this issue should be added to the list of perceptions that need to be proactively addressed head-on so that their advisors can compete.

Today, the financial services industry is losing the external public relations war (wall street v. main street). The wirehouses are losing the internal war to the independents. The war is far from over and the wirehouses will survive. But the sooner they start getting their case heard, the better off they will be.

Cutting Advisor Sales Assistants is Bad Business

Thursday, June 17th, 2010

Published on June  17, 2010 – FUNDfire – An Information Service of Money-Media, a Financial Times Company- written by Andrew Klausner, Founder and Principal of AK Advisory Partners LLC.

The continuing cuts by wirehouses of sales assistant positions have an amplified effect on how advisors run their practices and how clients perceive these advisors.

What was a trademark downsizing move circa fall 2008 is unfortunately showing no signs of abating. This was most recently witnessed by Morgan Stanley Smith Barney’s decision to cut sales assistants along with other support staff at the brokerage. An industry recruiter summed it up best by telling FundFirelast month that such cuts make it harder for advisors to be happy. “Sales support on the local branch level is very important…You will chip away at morale,” the observer remarked.

When firms eliminate the support sales assistants provide, the advisors must take time away from their most important business duties: client-facing activities and investment management. The cuts force advisors to take on tasks like processing trades, answering requests for account statements and other general administrative inquiries. In addition, these cuts also hurt the advisor’s ability to schedule client appointments that can build future business.

Consider, too, that the sales assistants at wirehouses today may be taking on other important duties, such as office receptionist work, due to previous support staff reductions. That means that it isn’t just the sales assistant’s work that may be piling up on the advisor’s desk.

The impact on client service quality is substantial. Remember that the more time advisors have to proactively call clients on investment issues, the better off their relationships are. If advisors must spend more time on administrative duties, they fall into a perpetual state of catch-up on client service matters. Their frustration increases while productivity decreases.

What makes the situation far more troubling is the fact that many advisors with sales assistants are not spending quality time with clients. Just look at the facts.

Wirehouse advisors reportedly spend only 27% of their time meeting with existing clients, according to a Cerulli Associates advisor time allocation study done in conjunction with the College for Financial Planning, the Financial Planning Association, IMCA and Morningstar. While this is more time than RIAs reported they spend with investors – about 22% – it is still much less time than most advisors would prefer. (Advisors actually say they have even less time to spend on investment management, which takes up 25% of wirehouse advisors’ time and 23% of RIAs’ time.)

Additionally, FA Insight research found that advisors spend just 50% of their time on client servicing, including meetings with existing clients and other revenue-generating events. Smaller practices tend to get hit harder in this regard.

The harsh truth for the wirehouses is clear. Their advisors are at risk of losing clients if they become spread too thin and also have less time to prospect for new business. While other types of firms have cut support levels, wirehouses especially can’t afford to neglect their primary producers while they also weather a large number of defections. And the argument that these brokerages are cutting back because of integration efforts following mergers shouldn’t apply to the sales assistants if we’re not seeing advisors being let go in the same proportions.

I understand that wirehouses must be bottom-line conscious in light of current economic conditions. However, I particularly question the continued cutting of sales assistant support. This may very well be one of the quickest ways to negatively impact an advisor’s business and alienate clients all at once.

A Merger With an Interesting Twist

Friday, June 11th, 2010

There was an interesting merger announced last week between a private equity firm (Northern Lights Ventures) and a firm (Echelon Capital Partners) which has primarily provided distribution services to boutique asset managers (they also provided small amounts of capital as well).

What caught my eye was this unique value proposition – investing in an asset management firm with a minority stake but then providing help on the sales and marketing side to help them grow. The idea makes perfect sense – proactively helping the firm with its marketing efforts without taking a majority role serves the purposes of both paries.

From an investment point of view, the new firm is helping grow its investment. And from the prospective of their partner firm, they receive help in areas where they may not be experts without having to give up control of the business.

I have thought for a long time that the asset management area would see a lot of mergers, particularly among small- and mid-size managers. I still believe this will be the case. But this latest deal adds an interesting twist into the types of mergers that we may see move forward.

I had concentrated on mergers that would help two firms become more operationally efficient, especially in light of reduced AUM as a result of the markets over the past few years. This latest deals broadens the spectrum of deals that may indirectly affect the money management industry.

The deal on its surface makes perfect sense. The proof will of course be in the execution of the strategy. But I think a lot of people will be watching the new firm to see if it is successful; if it is, it may be the first of a number of similar types of hook-ups that add an interesting business line to private equity firms.

A Preview – Final Negotiations on Financial Reform

Monday, June 7th, 2010

The next month or so will be filled with uncertainty for our industry as the House and Senate negotiate away the differences between their versions of financial reform. As usual, and in a rush to judgement, a false deadline of getting the bill on the President’s desk by July 4th has been set as the goal by Barney Frank. As I have commented before, it would be nice if for once the politicians would settle for getting it done right rather than getting it done quickly.

Nevertheless, a few things seems apparent – there will probably not be a fiduciary standard imposed on all advisors in the financial services industry (meaning that this particular debate will rage on indefinitely), and the final bill, though large and significant, will probably not be as bad as feared by many industry participants and not as far-reaching as the financial reform of the 1930s.

The profitability of banks is sure to be negatively impacted; by how much is uncertain at this point. But this bill does not signal the end for the banking industry – as in the past, banks (as many other businesses) will find new business lines to enter into to replace lost profits.

The four main areas of negotiation to keep your eyes on include 1) derivatives – will banks be required to spin-off their derivatives units as currently is in the Senate bill; 2) proprietary trading – will the “Volcker Rule” be part of the final bill – a rule which bars banks from making trading bets with their own capital or from owning hedge funds or private equity firms; 3) consumer protection – the House bill calls for a new independent consumer financial protection agency while the Senate has it housed within the federal reserve; and 4) too big too fail. The likely final bill will probably have a diluted derivatives restriction, a water-downed version of the “Volcker Rule,” an independent consumer credit agency and some sort of bank tax to protect against too big too fail.

Importantly, however, and oft looked in today’s debate, is the fact that nothing in either bill on the table right now makes it mandatory that future homeowners need at least 20% down to buy a new home. Absent a change in this, which does not seem likely, and regardless of any other positives in this bill, the door has been left open to future housing problems not dissimilar to the one of the recent past. In a rush to punish Wall Street and appeal to voters, have our elected officials left us vunerable to another financial crisis?

To Go Independent or Not to Go Independent?

Tuesday, June 1st, 2010

This battle has been raging for a number of years now, and is apt to continue. An article in today’s RIABiz caught my eye, as it recaps a study which cited that the trend of wirehouse advisors going independent may slow as the recent mergers among the largest wirehouses start to show positive synergies. It also mentioned that many wirehouses are beginning to devise ways to allow advisors to operate more independently within their structures. All good points – but as important to this trend – and its future direction –  is not only the firms themselves, but the characteristics of the advisors.

It is natural that the trend toward advisors becoming independent will ebb and flow. Certainly the financial crisis hurt wirehouses, as the reputation of many – UBS for example – were tarnished. What has been the cache of working for a firm that was well known became a negative. The “shotgun” marriage of Bank of America and ML, and the subsequent fallout didn’t do much to help wirehouses either. And the Morgan Stanley/Citi partnership has been slow to develop.

But as the article pointed out, advisors view their book as an annuity and they are going to do whatever is necessary to protect their business and their future. Wirehouses are not going to go away – they will adapt just as banks may have to again after financial reform is passed.

Another important consideration that is often overlooked, however, is that going independent turns an advisor into a business owner overnight. To me, this is the biggest issue that will determine whether an advisor or advisor group considers going independent or not if they decide that their current home is not the best place for them. I know many wirehouse advisors that would consider moving – but only to a similar firm (or to a firm that is up and running) because they don’t want the hassles of running a business.

There is a trade-off that must be made when the decision is made to switch firms. Wirehouses may become a great place to work again as the mergers work themselves out. But at the crux of the issue is whether or not an advisor can truly function in an independent environment or is more comfortable at a firm where many of the services are provided for him.