Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big industry news that asset manager Blackrock is partnering with Microsoft to create a new digital financial planning and retirement platform for consumers, aiming to leverage both Microsoft's tech prowess and workplace reach to insert Blackrock-created digital advice tools directly into the employer marketplace... for which the software's recommended solutions will include new Blackrock retirement income products, as Blackrock increasingly focuses on technology, not just as an effective tool to manage portfolios, but literally a distribution channel for its investment products.
Also in the news this week was a surprising "double-header" of fee-only news, as both Ron Carson and Ric Edelman have converted their practices to be entirely fee-only going forward, with Edelman's firm shedding the last sliver of its commission-based trails (which were down below 1% of revenue anyway) and Carson forming his own limited-purpose broker-dealer to house and sell off his prior commission-based trails to (in order to drop his own FINRA licenses for good).
From there, we have a slew of investment-related articles this week, including: a look at the significance (or not) of the recent inversion of the yield curve; how the U.S. is now reaching the crossover where, for the first time in 75 years, it is now a net exporter of oil, as the country approaches energy independence (albeit still in a globally-interdependent energy marketplace); a deep-dive look at securities lending and its rise as a tool to reduce the cost of ETFs; Betterment's decision to launch a new "two-way sweep" that shifts client cash into short-term bond funds with higher yield (including automatically transferring and investing "excess" client cash held in outside bank accounts, potentially attracting over $2B in new AUM in the coming year); the shift of ultra-high-net-worth investors towards "direct investing" into businesses in lieu of public market (or even hedge fund or private equity) investing, and what may be underappreciated risks in doing so; and a fascinating study from Riskalyze that finds a substantial relationship between the risk tolerance of clients... and other individuals who live in the same state, providing yet another reminder and affirmation that investing is often a herd behavior.
We wrap up with three interesting articles, all around the theme of looking out to the opportunities and challenges of 2019: the first is a look at the major challenges likely to loom in 2019, from the SEC's anticipated re-proposal of Regulation Best Interest and the rising risk of a bear market to the industry's ongoing transition away from an AUM-centric model and the growing availability of "fee-only" insurance and annuity products; the second explores similar industry trends in the UK, which remarkably mirrors the US in everything from the need for succession planning, to the rise of next generation advisors, the emergence of the "second generation" (i.e., non-founder) CEO of advisory firms, and the growing pressure on advisory firm founders to develop business skills to manage their growing advisory business enterprises; and the last is a fascinating discussion around Vanguard's stated intent to come into the financial advice business and drive away high-cost low-value financial advisors just as they did to high-cost low-value mutual fund managers... even as the firm builds its advisory business on top of its own (admittedly low-cost and popular) mutual fund and ETF business, raising the question of whether Vanguard really represents the future of financial advice or the last remnant of its proprietary-product-centric past?
Enjoy the "light" reading!
Blackrock And Microsoft To Build Retirement Planning Platform (Dawn Lim, Wall Street Journal) - This week, Blackrock announced a partnership with Microsoft to build new digital financial planning tools for consumers that can be provided directly through the workplace (where Microsoft dominates) and in the process can help position Blackrock's retirement income solutions to the end employees. In essence, Blackrock will use the technology platform as a distribution channel to reach (workplace) consumers directly, as opposed to simply trying to get their funds into existing 401(k) plans or capture them as rollovers through the advisors they work with, and when paired with the recent announcement earlier this month that Blackrock was also taking a nearly-5% stake in Envestnet to more deeply integrate its iRetire tools into Envestnet's technology platform (and this week, integrated iRetire into eMoney Advisor as well), helps to solidify Blackrock's new multi-channel strategy of distributing its funds through any/every place it can develop financial- and retirement-planning technology tools. Notably, thus far the tools are still in the "early" stages of research and development, with ideas ranging from mobile apps for saving that reward thrifty behavior to financial literacy educational content (and ostensibly may also include Blackrock's existing iRetire tools as well). Though Blackrock is also upfront in acknowledging that it is not just developing technology tools, and does fully intend to bundle together its new digital tools and asset management offerings... with a particular focus on developing new retirement income vehicles intended to create a blend of portfolios returns and guaranteed income in retirement (e.g., combining target date funds and annuities together).
Ron Carson Tells Why He's Dropping His FINRA License (Janet Levaux, ThinkAdvisor) - Earlier this month, Ron Carson announced that he is dropping his FINRA license, a stunning shift for someone who just 2 years ago was still a 27-year advisor at LPL (and the broker-dealer's top-producing rep for most of that time period). The challenge, of course, is that even for advisors who want to shift to the RIA channel, existing clients still may have broker-sold products from years ago that aren't necessarily appropriate to replace now, raising the question of what to do with all of those securities products. Carson's solution was to create a subsidiary "limited-use broker-dealer" that will buy out his old commission-based business and service the old clients directly but not do any new business, thus allowing the broker-dealer to be "limited use" (and operate at a lower cost, with independent broker-dealer Cetera, in turn, providing additional servicing support) and making it feasible for Carson himself to drop his FINRA license. In turn, Carson is also making the arrangement available to other advisors that join his Carson Institutional platform, effectively providing a new roadmap for brokers or hybrid advisors who want to drop their FINRA licenses but ensure their "old" clients are taken care of, where existing commission-based business can be sold to a "friendly" party to cooperatively service the clients (and not compete with the selling advisor who otherwise retains the rest of the advice relationship) and the advisor can transition the rest of his/her business to Carson's platform directly.
After 3 Decades, Edelman Goes Fee-Only (Ann Marsh, Financial Planning) - Similar to Ron Carson, Ric Edelman also built his advisory firm in a broker-dealer environment, and only in more recent years did he transition to a predominantly RIA model. And now, similar to Carson, Edelman announced this month that he is walking away from the remainder of the firm's commission-based securities business entirely, becoming fully "fee-only" effective November 1st under the newly reconstituted Edelman Financial Engines. Notably, Edelman still maintains that commissions themselves aren't necessarily bad when used properly by good advisors, but that with changing consumer sentiment and a brokerage industry that has failed to cleanse itself of bad apples, that now "even though we are drinking water in the bar, there are too many drunks so let's not go into the bar" anymore. Especially since, as the firm has increasingly focused on the fee-only RIA model anyway, that commissions were only about 1% of the firm's remaining revenue at this point anyway, thus effectively completing a multi-year transition to fee-only status (as opposed to dropping a substantial base of commission trails cold turkey). And to the extent that clients still need to purchase insurance policies, Edelman's firm simply refers clients to an outside insurance firm that they have partnered with (and ostensibly who will honor and respect the fact that they are still "Edelman's" clients and only focus on providing the necessary insurance).
Is There A Signal In The Noise? Yield Curves, Economic Growth, And Stock Prices (Aswath Damodaran, Musings On Markets) - Earlier this month the markets experienced a significant uptick in volatility, coinciding with an "inversion" of the yield curve, where longer-term yields on government bonds dipped below the shorter term yield. An inverted yield curve is significant because most of the time, interest rates are a combination of expected inflation rates and expected real interest rates, on top of which there is a maturity premium (i.e., higher yield) on longer-term bonds to compensate for their longer duration and higher risk. As a result, the yield curve typically only inverts if investors are anticipating significantly lower rates in the future and thus are trying to lock in higher current rates (at a cost of giving up their maturity premium). And why would interest rates go lower in the future? Either because the Fed keeps increasing rates (causing short-term rates to go higher), or expected long-term rates go lower because of an anticipation that the inflation rate will decrease, and/or the real interest rate will decrease... both of which tend to occur in a recession (and in response to which the Fed begins to cut interest rates, fulfilling the expected-lower-future-rates prophecy). In fact, an inverted yield curve has preceded (and thus effectively "predicted") all 8 recessions that have occurred in the past 60 years, sending only one false signal (an inverted yield curve that didn't actually turn out to be a recession) in the mid-1960s. However, as Damodaran notes, there are many different ways to evaluate the slope of the yield curve (e.g., 3-month vs 1-year Treasuries, or 2-year vs 5-year Treasuries, or 2-year vs 10-year Treasuries), and not all of the yield curve comparisons are currently negative... and in cases where the yield curve is even "just" flat or remains very slightly positive, often economic growth resumes and a recession never actually occurs. Nor is there necessarily always a connection between inverted yield curves and future stock returns, either (as markets sometimes already have anticipated the recession before the yield curve inverts anyway, and by the time the inversion comes the bottom is already near). Nonetheless, the fact that at least some parts of the yield curve have started to invert does raise some potential warning signs about the economic outlook heading into 2019.
The U.S. Just Became A Net Oil Exporter For The First Time In 75 Years (Javier Blas, Bloomberg) - After nearly 75 years of continued dependence on foreign oil, this month the U.S. for the first time became a net exporter of oil, marking a transition of the U.S. towards "energy independence," driven by the shale revolution (hydraulic fracturing and horizontal drilling) that has created a massive boom in domestic oil production from the Permian region of Texas and New Mexico to the Bakken in North Dakota and the Marcellus in Pennsylvania. The significance of the shift, with the U.S. now producing more petroleum than Russian or Saudi Arabia, is not merely that the U.S. literally is less dependent on foreign oil thanks to domestic production (though with volatile weekly imports and exports, it will likely still be at least a slight net importer a little longer), but that now OPEC will have less control over setting oil prices, as OPEC decisions about whether to cut production or not now risk just shifting more global energy purchases towards the U.S. instead. Ultimately, though, the global energy marketplace is still heavily interconnected, which means the U.S. still does have some exposure to global energy prices, and the geopolitics of the Middle East. And while petroleum production is up, limitations in refining mean that the U.S. still, in practice, buys millions of barrels per day of overseas crude and fuel oil. Nonetheless, with even more production scheduled to come online in 2019, the rise of U.S. energy production has not only economic benefits in the coming years, but rising geopolitical implications as well as an increasingly major player in the global energy export market.
Examining The Risks And Rewards Of Securities Lending (Adam McCullough, Morningstar) - The phenomenon of "securities lending" occurs when investors "lend out" their investment holdings to short-sellers (e.g., broker-dealers and hedge funds), who in return pay a fee to the borrowers (and usually a small cut to the lending agent as well). The less widely held and harder the security to borrow (e.g., small-cap or international stocks), the higher the securities-lending fee is available (i.e., it is based on normal supply and demand factors). To reduce the risk that securities-borrowers default (and leave the lender without their investments), it is typically required that borrowers post collateral (in the form of cash or Treasuries) of at least equal value to the security (usually 102% to 105% of the value) that is loaned out. As a result, defaults are very rare, though securities lending can still have risk in the event that the lending agent is too aggressive in reinvesting the cash collateral during the interim (which in fact did produce some securities-lending-related losses during the financial crisis, though the SEC has since tightened the requirements for how cash collateral can be reinvested to reduce that risk as well). Accordingly, it's important to evaluate not just a firm's securities lending program, per se, but its lending agent, whether/how that agent is affiliated, and what cut the agent takes of the securities-lending revenue (which also speaks to its incentives with respect to how it manages the collateral). Ultimately, the revenue potential from securities lending isn't necessarily a "huge" return, but for long-term buy-and-hold index funds - which often have a stable base of securities to lend - it has been increasingly popular for the index funds themselves to engage in securities lending, using the revenue to offset their expense ratio (thus, for instance, the iShares Russell 2000 ETF has a 0.20% expense ratio but generated 0.19% in securities-lending revenue, making the net expense ratio of just 0.01%!). In fact, Morningstar notes that in general, TIAA, Schwab, Fidelity, and Blackrock all do a "good job" of offsetting a material portion of their funds' expenses with revenues from securities lending, to the benefit of their shareholders.
New Betterment "Two-Way Sweep" Feature Would Boost Yield On Client Cash (Michael Thrasher, Wealth Management) - As short-term interest rates rise and investors once again begin to care about their yields on "cash" savings, RIA custodians and broker-dealers have increasingly been reaping profits by shifting investor cash sweeps to their own proprietary money market funds or affiliated banks to earn their own interest rate spread. By contrast, though, Betterment recently announced a new "Two-Way Sweep" feature that will automatically help monitor clients' low- (or usually, zero-) yield checking accounts and transfer excess cash out to a Betterment "Smart Saver" account that invests 80% in short-term Treasury Bonds and 20% in short-term investment grade bonds, producing a yield of 2.09% (net of all expenses). To help avoid unwittingly putting clients into a personal cash flow crisis, the Betterment monitoring tool considers both ongoing deposits, withdrawals, and even erratic seasonal spending over the past year, to determine what is a "reasonable" amount of cash to keep held in the bank account, and what is truly "excess" cash that could be reinvested (and investors themselves can always immediately transfer the cash back as well). Of course, the caveat is that ultimately a series of short-term bond funds are not the same as an FDIC-insured bank account... but when savings accounts have an average yield of just 0.09%, and Betterment's cash alternative offering is yielding 2% and intended "only" for excess idle cash anyway, arguably the process simply automates a means of upgrading short-term cash returns with a slightly-more-appealing investment alternative. Not to mention generating a substantial business opportunity for Betterment itself, which has found that almost 30% of its 360,000 customers have nearly $20,000 of excess cash, representing a nearly $2.2B asset-gathering opportunity for the company that gives clients better cash returns to boot.
Wealthy In The Hamptons Set Their Sights On Do-It-Yourself Deals (Simone Foxman, Bloomberg) - For the family offices of billionaires, it has long been popular to engage in "direct investing," where the investor invests their funds directly into the ownership of an operating business (in addition to doing so "indirectly" through hedge funds and private equity). However, the eye-popping wealth creation of private companies like Uber and Airbnb are attracting more interest from a wider range of "mere" multi-millionaires, especially when recognizing that being a direct investor can also give him/her more of a "say" at the table of how the company operates... which in turn raises concerns about whether those investors truly have the expertise and resources to do the proper due diligence to evaluate an individual company's business prospects. Nonetheless, in a recent poll of 157 ultra-wealthy families (with more than $250M of net worth), 2/3rds of them indicated that they want to do more direct investing, and SEC Commissioner Clayton recently stated he's also considering an overhaul of the accredited investor rules to make direct investments in private companies even more accessible to "mom-and-pop" main street investors. Yet ironically, the influx of additional capital into direct investing means that the return gap (i.e., excess return potential) between public and private companies has never been smaller than it is today, and there's arguably so much demand for good private investment opportunities now that any opportunity reaching "mere" millionaires and main street investors has probably already been passed on by more experienced investors... suggesting that they've already seen a risk or concern that the less experienced investor might miss. Which in turn is leading to a new surge in various "Private Ventures" offerings from investment banks trying to help facilitate "the best" deals in a more centralized fashion (and using those opportunities to attract affluent clientele).
When Your Neighbors Move In To Your Investment Portfolio (Jason Zweig, Wall Street Journal) - As a risk tolerance software platform used by over 20,000 advisors, Riskalyze has accumulated a substantial amount of data on consumer risk tolerance... and in a recently published data set, discovered that there are noticeable differences in the average risk tolerance of investors from one state to the next. At the top of the tolerant states were New York (perhaps not surprising given its closeness and familiarity with investment markets as the home of Wall Street), but also the pioneering states of Nebraska and Alaska, while the least tolerant states included New Jersey, New Mexico, Arkansas, West Virginia, and the proverbial epicenter of the conservative retiree: Florida. The fact that there are such strong trends in risk tolerance from one state to the next, though, suggests that - as separate research has shown - investors really are influenced by the investment behaviors of those around them (a phenomenon known as "Social Proof"). One study even found that portfolio managers of mutual funds were more likely to mimic each other's trades if they lived in the same city! On the plus side, this suggests that being in a community of others who invest may also help encourage more in the same city/town/area to become investors as well. On the minus side, the phenomenon also helps to explain the herd mentality of panic selling... as when all the neighbors are selling (or are less risk tolerant in general), you are more likely to comport yourself in a similar manner, too.
The Five Challenges Facing Advisors In 2019 (Bob Veres, Advisor Perspectives) - Good business management as a financial advisor entails being able to foresee potential business risks and establish a strategy to overcome them... and Veres sees a number of notable industry trends and risks that are likely to come to a head in 2019. The key challenges we'll likely face as advisors in 2019 include: 1) the battle with the SEC over the new Regulation Best Interest (Reg BI), which was praised by the brokerage and product manufacturing industry but harshly criticized by the advisory community as watering down the true fiduciary Best Interest standard for advisors (by literally just repeating the existing Suitability standard with the words "best interest" inserted) while burdening consumers with unclear "disclosures" about the overlapping-but-dissimilar standards... while providing an opportunity for real advisors to proudly and publicly affirm their fiduciary oath to clients as a differentiator; 2) the looming risk of a bear market, for which the timing is never certain, but between a recently inverted yield curve, equity valuations that are very expensive by historical standards, and simply a bull market that is almost 9 years long, arguably advisory firms should at least be preparing for the possibility of turbulent seas in 2019 (which means it's a good time to update every client's financial plan in advance and ensure they're on board with their current portfolio and goals); 3) the ongoing transition away from the AUM model (or at least being solely dependent on the AUM model), which has been very profitable during the bull market cycle but is challenging in bear markets (as revenue declines with market declines even as the client work load increases with more clients needing hand-holding during difficult times), and suggests that it may at least be time to re-assess the firm's smallest and least profitable clients to determine if a new minimum fee is necessary to ensure they remain profitable to serve in the future; 4) reconsider (especially if you're a fee-only advisor) revisiting your role with insurance and annuity products, as a fee-only insurance revolution is looming; and 5) get ready for a growing wave of new advisor technology, as while the good news is that it's now clear that robo-advisors will not replace human advisors, but as the technology is adopted industry-wide, it will create an environment where firms must adopt new technology to stay efficient and competitive with others who do as well.
Five Forces That Will Shape Financial Planning In 2019 (Brett Davidson, FP Advance) - In recent years, financial planning has become a global phenomenon, with the FPSB reporting more CFP certificants outside the U.S. than within. And while each country has its own consumer, industry, and regulatory trends, often the driving factors in one country are mirrored in others as well. In this context, Davidson shares the U.K. perspective on industry trends for financial advisors, with a number of notable parallels to the U.S. as well, including: 1) succession planning is looming ever larger, as the baby-boomer-driven rise in financial planning has resulted in an average age of financial advisors of "50-something" around the globe, and all advisors are now struggling with the same problem and question of whether to develop an internal successor, sell to a consolidator, or find another firm to merge with or be acquired by; 2) as advisory firms grow larger and develop internal succession plans (or just deeper management teams beyond the founder themselves), there is an emerging trend of "second generation CEOs," who are coming in to run advisory businesses as businesses, and face their own unique challenges as non-founder owners (and sometimes, non-advisor managers) of an advisory firm; 3) technology is increasingly becoming a threat and an opportunity, not just from the direct-to-consumer tech companies like robo-advisors, but also the tech-augmented human "cyborg" firms that are increasingly competing with independent financial advisors from a wide range of sources (including tech startups, asset managers, brokerage firms, and more); 4) the rise of the "NextGen" planner, with next-generation advisor organizations emerging both in the U.K. and also here in the U.S. that have a substantively different take on the entire advisory industry and value proposition; and 5) that, as advisory firms grow from practices into businesses, understanding how to run an effective business will increasingly become a required skillset for advisors (beyond just the knowledge of how to service and provide value to clients themselves).
Vanguard Doesn't Get A Free Pass (Bob Veres, Financial Planning) - Earlier this year at the Inside ETFs conference, Vanguard CEO Tim Buckley gave a keynote address where he stated that Vanguard was planning to attack financial planning and investment advice fees in the same way the company has already been steadily demolishing the fee structure of the mutual fund industry, driving down advisory fees to the bare bones lowest cost. On the one hand, Vanguard's pledged shift into financial advice is a booming affirmation for the growing value and relevance of financial planning for consumers... so much that even mega-asset-manager Vanguard sees a market and growth opportunity. On the other hand, the irony is that the recent years' growth of financial planning has been driven in large part by an ongoing shift of financial planning away from captive insurance companies and investment product manufacturers and into more independent channels that give consumers more objective advice. Yet with Vanguard's entrance to financial planning, and its rapid growth to a whopping $100B of AUM in its Personal Advisor Services in just a few short years, a bizarre conflict emerges - while Vanguard is long recognized as the low-cost provider, against which other "conflicted" high-cost advisors are judged, when Vanguard itself becomes the financial advisor, it faces its own conflict of selling "proprietary" funds attached to its financial planning process! At the same time, Vanguard's massive size also raises the concern of whether it may not only drive out some "bad" high-cost advisors - who can't compete with Vanguard's 30bps advisory fee today, not to mention what it may decline to in the future - but whether even good advisory firms may struggle to compete, at least until/unless they find themselves niches that allow themselves to maintain pricing power and differentiator from Vanguard's one-size-fits-all-low-cost-provider alternative. Of course, in the aggregate it's still arguably an overall benefit to consumers to have more access to lower cost advice... but the challenge remains that as long as Vanguard does so attached to its mutual fund and ETF product business as well, the company's efforts may still represent more of financial planning's past than its future?
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.
