Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that robo-advisor Betterment has raised yet another $70M round of venture capital funding, and boosted its valuation up to $800 million... though the company intends to use the dollars primarily to hire more human financial advisors, and launch new products, suggesting that even the leading pure robo-advisor is pivoting away from its roots to try to become a broader wealth management platform and brand.
From there, we have several more articles around the theme of advisor technology, including a fascinating look at how Morgan Stanley is planning to use big data and AI to augment the productivity of its financial advisors (with everything from tools that automatically monitor and provide updated portfolio recommendations to clients, to solutions that pre-draft relevant emails to clients and allow advisors to more easily customize and then send), a review of the advisor technology platforms of some of the smaller RIA custodians (including RBC Advisor Services, TradePMR, and SSG), a new advisor technology solution called "BizEquity" that helps advisors to do business valuations for their small business owner clients (either as a value-add, or a prospecting tool), and some tips on how to run an effective internal cybersecurity training session for your advisory firm.
We also feature a few practice management articles this week, from the reason why advisory firms should do less customization of their financial advice as the firm grows and adds more advisors, to how the rise of back-office custodians and technology has powered a growth of independent advisors and made it possible for even small "solo" advisory firms to be very successful (without the resources of a traditional wirehouse), why advisory firms need to focus on building a firm foundation before executing new growth initiatives, and a look at the relative dearth of internship opportunities in the independent advisory community (and some steps to take to fill that void).
We wrap up with three interesting articles, all looking at the ongoing evolution of investment theory: the first looks at how, even with the rise of passive index funds at an ever-lower cost, the fact that retail investors can't effectively own a market-cap-weighted index of global wealth means all investors ultimately have to make some "active" decision when it comes to asset allocation across the available indices and asset classes; the second is an in-depth look at the Adaptive Markets Hypothesis, and how it aims to explain the behavior of markets better than the Efficient Markets Hypothesis; and the last is a good discussion about the fundamental purpose of investing itself, and how a true goals-based approach to investing may entail different kinds of investment choices than asset allocations than the classic diversified equity portfolio (although for very long-term goals, even goals-based portfolios still end up being rather equity-centric!).
Enjoy the "light" reading!
Weekend reading for July 22nd/23rd:
Startup Betterment Gets $800M Valuation (Julie Verhage, Bloomberg) - The big news this Friday is that "robo-advisor" Betterment has secured a new $70M round of funding, boosting its valuation to $800M (from an estimated $700M in their prior financing round in early 2016). Over the past 18 months, the company's AUM has grown 150%, from $4B to nearly $10B, but at the same time the company has also made a number of notable shifts, including launching its Betterment For Business 401k platform (which had just been announced leading up to the prior round), rebranding and expanding its Betterment For Advisors platform, raising its advisory fees by 66% for its most affluent users (from 15bps to 25bps for all accounts above $100,000), and pivoting to launch an even higher (and more expensive) tier of service with human financial advisors. In fact, with growing competition from other human-technology "cyborg advisor" competitors, including Vanguard's Personal Advisor Services, Schwab Intelligent Advisory, and recent cyborg newcomers like SoFi, Betterment CEO Jon Stein explicitly notes that their new funding will go towards further expanding its human advice component, and launching additional new features beyond its core robo-advisor solution. All of which suggests that even as Betterment holds the lead in assets amongst robo-advisors, the declining rate of growth in pure robo-advisory business means that Betterment increasingly sees its future beyond its core robo-advisor offering, in a world of tech-augmented human advice and more holistic financial advice services (and at higher price points). And notably, the fact that Betterment's 150% growth rate in the past 18 months brought "only" a 14% increase in valuation suggests that most of its recent growth was already priced in... which doesn't bode well for Wealthfront, which back in early 2016 was nearly tied with Betterment in AUM, and also had a $700M valuation (per its last round of capital in October of 2014), but has grown at only about half Betterment's rate since early 2016, while virtually all other robo-advisors have since been sold or otherwise partnered with human advisory platforms.
Inside Morgan Stanley's AI Strategy (Penny Crosman, Financial Planning) - In recent years, wirehouses have typically been characterized as behemoths that are too large to innovate on technology and are too hampered by legacy technology tools. But since hiring Naureen Hassan away from Charles Schwab (where she oversaw the creation and launch of Schwab Intelligent Portfolios) to lead new internal initiatives, Morgan Stanley is trying to set a fresh vision for how technology can be used to augment its nearly-16,000 brokers... and providing a glimpse of how large-firm technology might be built to leverage the time of a financial advisor. A few of the notable areas where Morgan Stanley is attempting to innovate include: "Next Best Action", a system that will analyze client portfolios and provide suggestions about a next/new investment action to the advisor that might be of interest for the client (e.g., when a stock is downgraded, the advisor would automatically get an alert of the event, which clients hold the stock, and what changes they might consider, so the advisor can contact the client); a communication system that pre-drafts emails for financial advisors to send clients (for anything from birthday reminders to investment opportunities based on Next Best Action events), which the advisor can then edit/customize as appropriate and send along (soon to be supplemented with pre-drafted messages to go out via text message and/or various social media platforms as well, such as a quick investment commentary in the midst of a Brexit-style event to soothe clients' nerves); technology to make it easier for clients to self-service simple operational tasks through mobile devices (e.g., completing a wire transfer, which might start with a call to the advisor, but then initiate a text message confirmation to the client's smartphone, to be confirmed with a fingerprint swipe). The broad goal of all the technology is to allow advisors to spend more time actually meeting with, communicating with, and advising clients (not replacing them).
The Evolution Of The Advisor Platform (Joel Bruckenstein, Financial Advisor) - In recent years, there has been an intense focus on the technology arms race amongst the leading RIA custodians, along with non-custodial firms vying to become advisor platforms (e.g., Advyzon, Black Diamond, Envestnet, Morningstar, and Orion). But Bruckenstein notes that, flying under the radar, are a subset of smaller RIA custodians that have been making their own substantial investments into technology to compete. For instance, RBC Advisor Services built an internal "Marketplace" of vendors that integrate with them (though the depth of integrations does vary), in addition to a "turnkey" advisor platform called RBC Black that is built around the CircleBlack account aggregation and reporting system, with pre-configured integrations to Redtail for CRM, Riskalyze for risk tolerance assessment and Autopilot for asset allocation models, Vestmark for trading and rebalancing, and MoneyGuidePro for financial planning software, for a combined all-in price of just $175/month for the core technology. By contrast, TradePMR built its advisor platform in-house for its advisors; dubbed EarnWise, it's a combination of an advisor workstation (including CRM), a client portal, and a "robo" models solutions (but with additional integrations for portfolio analytics and trading, including FinMason for portfolio analysis and metrics, and Smartleaf for rebalancing and overlay management, and advisors can choose to fully white label their own robo platform through AdvisorEngine instead). On the other hand, Shareholders Service Group (SSG) takes yet another approach, providing a more open environment built on the Pershing platform for custody and clearing, where advisors can choose their own technology to plug in (e.g., Jemstep for digital onboarding and a client portal, and Tamarac for asset allocation and rebalancing, and any number of CRM, portfolio accounting, and financial planning software solutions).
BizEquity Tech Solution Lets Advisors Lead With Business Valuations (Christopher Robbins, Financial Advisor) - While financial advisors have long marketing to and worked with small business owners, the reality for most business owners is that their single greatest asset if their business itself... yet few financial advisors have any experience in providing consulting on valuing (and improving the valuation of) a small business. Accordingly, BizEquity created a technology solution to help calculate a reasonable valuation for a small business – for all those financial advisors who may not be accustomed to reading balance sheets and cash flow statements themselves to extrapolate a value – based on inputted data to the software, and using BizEquity's analytics and available data on various industries to estimate a value. The basic process can be completed in less than 10 minutes, and BizEquity reports that financial advisors are using it as a means to open the door with small business owners, by being able to talk constructively with them about the asset that matters to them the most (as 75% of small business owners rely on their business' value to ultimately fund their retirement, yet most small business owners have never actually obtained a valuation estimate on their business). And recently, BizEquity created integrations with Form 5500 employer retirement plan data, and with Equifax, which allows them to provide further information on everything from the company's employer retirement plans, to available public data about the company, to provide even more context for potential business opportunities for the financial advisor. The software is available for $299/month (which allows up to 100 searches per month of the existing BizEquity database for business opportunities, and up to 20 individual business valuation reports per year), with higher tiers available for multi-advisor volumes and those looking to do a higher volume of business valuations.
Planning Your Cybersecurity Training In 9 Simple Steps (Will Stagl, Trumpet) - Cybersecurity is a hot topic amongst regulators lately, which makes cybersecurity compliance a pressing issue for financial advisors. Yet notably, a material portion of cybersecurity "risk" is actually not about an advisory firm's office computers being "hacked", but about financial advisors and their staff falling for fake phishing emails and fulfilling a fake wire transfer by mistake, or failing to take basic cybersecurity precautionary steps (e.g., avoid public WiFi hotspots!). Accordingly, engaging in "cybersecurity training" for your advisory firm staff is critical. Stagl suggests the following key considerations for running an effective internal cybersecurity training for your team: identify your 'advocates' (i.e., the leadership who will support your effort, and/or the early adopters who will help encourage everyone else to follow suit); plan out the structure of your education effort (e.g., a brief monthly or quarterly training? A big once-per-year annual?); request any examples that employees have already seen and witnessed, as learning by example what to watch out for is highly effective (and make it clear to employees that admitting making a cybersecurity mistake once in the past is OK – the goal is not to repeat it in the future!); understand what the primary objectives for the training are (specific activities/habits you want employees to avoid, or a new process/procedure you're putting in place?); decide what policies are going to be shared/taught in advance of the training (e.g., will you have certain required-password policies, will you allow employees to use home computers to connect to sensitive firm information, etc.); consider case study examples to illustrate common situations where mistakes occur (e.g., trying to do some "quick work emails" on a public WiFi hotspot while accessing secure client information); and be certain to give employees handouts so they have takeaways to reference in the future if an uncertain situation arises!
Why Your Firm Shouldn't Customize Its Advice (Glenn Kautt, Financial Planning) - One of the fundamental challenges that occurs as advisory firms grow is that it's increasingly difficult to ensure that all advisors in the firm are providing consistent and accurate advice to clients, given that the founder/owner simply cannot be in and supervise every (or even most or many) client meetings and communications across the entire firm. In fact, a recent study by Daniel Kahneman and colleagues found that the "noise" of variability from one professional to the next within a single firm (when they should otherwise make the same decisions based on the same data inputs) was 3X - 4X as large as managers had expected; in other words, advisory firms likely have far more variability in advice from one advisor to the next than they may realize, which is a real problem for an advisory firm trying to offer a consistent quality and experience to all of its advisors. Accordingly, Kautt suggests that if advisory firms really want to scale effectively, they need to craft their own optimal advisory process and experience for their ideal client, and stay focused on that type of client and not just customize every plan and advice situation for every new client; instead, customizing for every client just degrades the quality consistency of the advice itself, ultimately reducing the scalability and efficiency of the entire firm as it continues to grow. Especially since, in the end, the real driver of actual client outcomes is the client's behavior (and the client's susceptibility to noise), and if the advisory firm doesn't control its advice process, it can't then proceed to the next stage of training advisors how to better handle various client behavioral challenges that arise (which are easier to learn to deal with when the advice process that triggers them is consistent). Of course, for advisors who operate as a solo and run their own business solely for themselves, the challenges of customization may be less burdensome; nonetheless, as Kautt notes, for any advisory firm that hopes to grow beyond its founding advisor, the risks of "noise" from one advisor to the next that degrades the consistency of advice is a real challenge as soon as there's more than one advisor in the firm (and only gets worse as more advisors are added!).
Wealth Advisers Set Up Shop With A Shared Back Office (Landon Thomas, New York Times) - In the past, financial advisors built their businesses as employees of large financial institutions (e.g., wirehouses), that provided all of the infrastructure necessary for their advisors to serve clients. However, over the past two decades, we've witnessed the rise of the independent RIA, which is notable not just for the nature of the RIA model versus the broker-dealer model, but the fact that the RIA community comprises thousands and thousands of tiny advisory firms, none of which have the resources to create their own technology and infrastructure to do everything a full-service investment firm would need to do. Instead, the rise of standalone RIA custodians – with Schwab Advisor Services as the early pioneer – makes this possible, by creating a custodian platform with supporting technology that allows advisors to treat the entire back-end of an investment platform as little more than an outsourced investment back-office solution (run mostly from a football-field-sized trading floor in Phoenix). Taking a step back to look at the landscape, and how it has evolved over the past 20 years, reveals what a shock shift this actually is, to the point that RIAs are now cumulatively sitting on more than $4 trillion of assets, and Schwab's advisor platform is up to $1.3 trillion (though the assets from its 29% market share of RIAs are still behind the $2.2T+ of wirehouses Morgan Stanley and Merrill Lynch). But the fundamental point is simply to recognize how easy and feasible it is for "small" advisory firms with just $10s or $100s of millions of dollars to survive and thrive as entirely independent businesses, in a world where RIA custodians and the explosion of internet-based technology make it possible.
Not So Fast, Tortoise (Angie Herbers, Investment Advisor) - One of the most common challenges of growing advisory firms is that growth-oriented advisors typically just move on from one growth initiative to the next... without necessarily pausing to ensure they have a solid business foundation first (despite the fact that as advisors, we routinely discourage clients from just chasing new investment growth opportunities without having their own foundational financial plan in place first!). The problem is that for forward-oriented businesses, the idea of pausing to set a foundation – of taking one step backward, even if it's ultimately to take two steps forward – is very discouraging, or outright undesirable to the growth-minded entrepreneur. Yet the reality is that all too often, advisory firms assume that growth is the solution to a current problem – "if we were bigger, with more revenue, we would have the dollars to solve these problems" – without recognizing that without resolving the foundational issues, the bigger business will just create a set of new (and likely even more expensive and revenue-demanding) problems. So what kinds of foundational issues should advisory firms focus on? Herbers suggests a few key areas: 1) Take a fresh look at where the advisory business really is today (do you have the right people, in the right jobs, with the right equipment, serving the right clients, and offering them the right services? Or does something need to change first?); 2) Take some steps to manage your risk (in particular, spreading out your client revenue if 2-3 key clients are driving 20%+ of your revenue); 3) take a fresh focus on what your clients really want (e.g., have you been adding fancy technology to your client offering when, in the end, all they really want is the time to talk to you?); and 4) are you certain you've harvested all the growth you already have on the table (e.g., before you go find new clients, are you certain you've gathered all the revenue/assets you can from your existing clients first?)?
Where Are All The Interns? (Diana Britton, Wealth Management) - According to a recent TD Ameritrade survey, only 1/3rd of independent financial advisors have hired interns at any point this year, with just 20% of advisory firms using interns during the popular summer intern months. The problem appears to be due in part to the fact that not a lot of independent advisory firms are even prepared to hire and utilize interns (with 72% of advisors lacking any kind of formal internship program), but also that there is a short supply of prospective advisor interns – at least from college financial planning programs. In fact, the hiring demands for young talent so outstrip the supply, that promising seniors typically already have job offers by October of their senior year, and strong students usually get their summer internships by the preceding November (which means firms that seek out interns in the early spring are usually already out of luck). The most popular paths to finding interns include searching at local colleges, via word of mouth, or taking on an intern as an accommodation to family and friends (or even clients), with company websites and job boards less effective as a path to finding interns. Though given talent shortages from traditional college financial planning programs, advisory firms are increasingly starting to look to 'related' majors like accounting, finance, and economics, and even students in the social sciences (e.g., psychology) who might have an interest in coming into financial planning instead.
No Investor Is Fully Passive (John Rekenthaler, Morningstar) - Last month, the New York Times had a feature article on Burton Malkiel, the legendary index fund "evangelist" (and author of "A Random Walk Down Wall Street"), who was "straying from his [passive] gospel" by supporting robo-advisor Wealthfront's new factor-based smart beta strategies, that still use broad-based diversified portfolios of stocks, but don't necessarily allocate based on market capitalization like "traditional" indexes (and what Malkiel has advocated for in the past). But Rekenthaler makes the point that regardless of your views on passive (purely market-cap-based) or more active security selection, that "everyone" is active when it comes to the portfolio formation process, given that virtually no one actually allocates their portfolio based solely on the total collection of assets of the globe's entire wealth (and across not only equities, but other asset classes as well). Arguably some financial institutions actually come closer to this "Global Wealth Index" approach by investing into private equity and venture funds, as well as investing in "alternatives" like direct real estate and commodities (as they are part of the total market capitalization of global wealth), but retail investors often don't even have such opportunities, which means they're left with only a subset of the pie to start. And of course, taxes complicate the matter as well – a pure Global Wealth Index would include assets like tax-free municipal bonds, which aren't relevant for certain investor types. And investors who ultimately wish to spend their money here in the US tend to buy more US assets, in part because failing to do so introduces currency risks above and beyond "just" being exposed to a Global Wealth Index (based on its economic growth alone). Which means in practice, to the extent that investors make asset allocation around these various issues – even using purely passive index funds as vehicles – there are still "active" bets, stated and unstated, that will be reflected in that asset allocation, above and beyond just the passive/active security selection debate alone.
What's The Point Of Investing? (Michael Finke, Research Magazine) - At the most basic level, the decision to invest represents a choice to not spend money today, and to save it to use in the future instead (ideally, enhanced by some rate of return), for which advisors typically try to design a portfolio that has a level of volatility that clients are comfortable enough with to stick out the investing growth journey along the way. In recent years, there has been a shift towards advocating portfolio design based not on (just) the client's risk tolerance, but more directly based on their actual goals. Yet Finke raises questions about what it actually means to develop goals-based investment strategies. For instance, if the goal is to fund a certain future level of spending, then perhaps the best parameter of "risk" is really the client's spending flexibility and tolerance for spending fluctuations... which would result in a very different (and primarily TIPS-based) portfolio than the traditional investment approach. Or at a minimum, if a "traditional" portfolio will be used to fund the goal, it means there also needs to be a plan for how the goal will shift if the portfolio's returns don't actually live up to expectations (though again, those with less flexibility in their spending goals may not be able to tolerate as much portfolio volatility that could necessitate such spending changes). Notably, once uncertainty is introduced to the picture, it also becomes more necessary to quantify those risks; accordingly, Finke advocates tools like Monte Carlo analysis to quantify the probabilities of various outcomes, and the likelihood that a riskier portfolio will actually improve the probability of achieving the goal (not just of achieving a higher return on average). Of course, in the end, as long as advisors remain confident that stocks will tend to outperform bonds in the long run, even goals-based portfolios often end out with "traditional-looking" equity-centric portfolios for long-term goals; nonetheless, the point remains that for clients aiming to invest for particular goals, there is potential value, and a potentially different optimal portfolio, when allocating specifically to achieve a goal, and not just a (higher) rate of return. Though of course, that still assumes that clients know and can effectively articulate what their financial goals are in the first place!
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.
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