Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a big AdvisorHub expose on the Barron's Top 100 Advisors list, finding that a whopping 60% of the advisors on the list over the past 5 years have had at least one disclosed consumer complaint, regulatory action, or criminal conviction (compared to "just" 7.8% of all brokers who have misconduct records, according to another recent controversial study).
From there, we have a number of technical financial planning articles this week, including a discussion of whether or how the CAPE ratio should be adjusted in today's market environment (and whether reasonable adjustments would show the market isn't as overvalued as the CAPE 10 implies), a new study finding that how stressful a job is may be one of the biggest predictors of whether people keep working well into their 60s, a look at just how ugly the statistics really are for those who play the lottery, and a good reminder that while the data increasingly shows how expensive actively managed funds lag index funds it's still worse to sit on the sidelines and not be invested at all.
There are also several practice management articles this week, including: how the internet made it easier to work virtually, but a surprising number of people still go to the office every day, or are seeking out new "co-working" spaces; the growing pressure on advisory firms to move up the "wealth management pyramid" to provide a greater level of value-add; why the key to success with advisor niches is not just niche marketing but actually crafting niche services; and a look at how the 12(b)-1 fee is in steady decline and being replaced by advisor AUM fees paid directly by the client instead, and how the DoL fiduciary rule may just further accelerate the trend.
We wrap up with three interesting articles: the first looks at how direct-to-consumer FinTech (e.g., robo-advisors) has been the hot area for the past several years, but "InsurTech" may be the next big technology trend (but given the challenges of direct-to-consumer insurance, may be even more likely to go through advisors rather than around them); the second is a look at how even Goldman Sachs is getting into FinTech with a new online bank offering, but that the reasoning may be more about old-world bank liquidity ratios than a next generation consumer push; and the last is a fascinating look at how the entire asset management industry is being disrupted from multiple directions all at once.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, which this week includes coverage of Redtail CRM's announcements of integrations with both Morningstar and Zapier, the new release of MoneyGuidePro's G4, and highlights of the National Association of Broadcasters (NAB) annual trade show with all the latest (easy-to-use and affordable) audio and video equipment that advisors can use to create their own content.
Enjoy the "light" reading!
Weekend reading for April 30th / May 1st:
Curse Of The Barron's List: Why Advisors And Clients Should Worry (Jed Horowitz & Hilary Johnson, AdvisorHub) - The Barron's Top Advisor rankings are touted by the magazine for their rigor in checking regulatory records and weighing dozens of "qualitative" criteria about the advisors that make the list. Yet while an already controversial recent study found that 7.8% of all brokers listed in FINRA BrokerCheck have had a misconduct event, AdvisorHub finds that an average of 60% of advisors on the Barron's list over the past 5 years have had at least one consumer complaint, regulatory action, or criminal conviction already disclosed in their BrokerCheck records. And as AdvisorHub notes, the problems with Barron's list has become problematically linked to the profits that Barron's derives from the effort, which has expanded its Top 100 list into related Top 100 Women Advisors, Top 100 Independent Advisors, and Top 1200 Advisors by State... which it pairs with a ten-times-a-year "special advertising section" that advisors pay a whopping $5,000 to be listed in. In addition, Barron's now holds half a dozen annual "summits" at resorts and large hotels that bring in hefty sponsorships from brokerage firms and product providers, not to mention charging the advisors themselves to attend and be seen. Still, the problems from the list are growing; one customer testified before the SEC that he was persuaded to invest with independent broker Dawn Bennett after seeing her in the 2009 Barron's Top 100 Women FAs... and the SEC is now prosecuting Bennett for "grossly inflating" her firm's AUM to attain a top spot on the list (which Bennett then routinely used in her advertising). Other problematic examples include: Indiana #1 advisor Tom Buck, who was permanently barred from the industry last July on fraud charges (and while he had a clean regulatory record, was known locally for having been booted from an exclusive Indiana Country Club for cheating in two different golf tournaments); Barron's #43 listing Phil Scott in the latest 2016 rankings published just two weeks ago, on whose behalf Merrill Lynch has paid $5.1 million in damages tied to disputes with his clients; John Rafal of Essex Financial Services, who ranked in the top quarter of the Top 100 FA list from 2008 to 2015 and was recently suspended and fined by the Connecticut Department of Banking for dishonest or unethical practices in the securities business; and Ami Forte, who along with Morgan Stanley lost a $34M arbitration case last month for unauthorized trading and was fired last month (yet was previously was Barron's Top Woman Advisor in 2010, 2011, and 2012). Nonetheless, Barron's maintains that its lists represent "the state of the art in outstanding wealth management."
CAPE 10 Ratio In Need Of Context (Larry Swedroe, ETF.com) - The Price/Earnings (P/E) ratio is a fundamental metric for evaluating whether a particular investment (or markets in the aggregate) are overvalued, undervalued, or fairly valued, with the caveat that the P/E ratio can be highly volatile from year to year and across the business cycle. As a result, even Graham and Dodd in their classic book "Security Analysis" suggested that a multi-year average of P/E ratios across 5, 7, or 10 years may be helpful to smooth the effects - a recommendation that economists Robert Shiller and John Campbell later enshrined into his "Cyclically Adjusted P/E" (or CAPE) ratio. Yet while Shiller and Campbell found that taking a 10-year average of earnings to formulate the CAPE ratio did have predictive value, Swedroe points out that there's nothing particularly sacred about using a 10-year average in particular. For instance, while the CAPE 10 ratio (using 10 years of earnings) puts the market at 57% overvalued (a 26.3 CAPE compared to a 16.7 average), using a CAPE-6 ratio, the market is only 19% overvalued (a 22.7 P/E ratio compared to a long-term average of 19 since 1960), and a CAPE-5 ratio similarly puts it at 18% overvalued (a CAPE 5 of 22.1 compared to a historical average of 18.1 since 1960). In addition, Swedroe also suggests that the long-term baseline of the CAPE 10 ratio may be flawed, given both changes in FASB accounting rules (particularly regarding the write-off of goodwill, which allows corporations to write off losses more quickly, depressing earnings and making the CAPE ratio appear more elevated), that corporations are more likely in recent years to retain earnings and reinvest them to raise Earnings Per Share (EPS) rather than pay them out as dividends (and different EPS growth rates can support different CAPE ratios), and that investors may be more tolerant of higher of higher CAPE ratios now because markets are more liquid and investors demand less of a liquidity premium. Ultimately, all these adjustments might still lead to a conclusion that the markets are at least slightly overvalued at current levels, but Swedroe suggests that the 57% overvaluation implied in the headline number may be overstating the case.
Stress Is One Reason People Retire (Squared Away Blog) - The current data finds that amongst U.S. workers in their late 50s, only about half are typically still employed at age 63, and less than 1/3rd make it past age 65. And while we know that some people leave the workforce due to health problems, and that many blue-collar workers face physical limitations that drive them to retire earlier, a new study from the Michigan Retirement Research Center finds that the ability to work longer is driven by three key characteristics of the jobs involved: their ability to accommodate a transition to part-time work, stable job demands and duties, and low stress. Thus, people tend to work longer in jobs like tax drivers, chauffeurs, security guards, and couriers (flexible time, and also social engagement), and retire earlier from jobs like computer scientists (where the pace of change and continuous requirement to learn new skills is challenging). And the finding that job stress has a material role may actually help to explain a wide range of retirement-transition behaviors, from the early retirement of high-stress jobs (e.g., licensed nurses on the front lines of challenging medical situations), to the fact that those retiring after age 65 are often in "creative or labor-of-love" jobs that are either lower stress or where stress is mitigated by the feelings of personal fulfillment that the work brings.
A Loser's Lottery (Salil Mehta, Statistical Ideas) - As recent lottery jackpots have continued to rise (including a record $1.6B jackpot this past January), more and more "otherwise rational" people have been trying their hand at the lottery. And this is despite the fact that lotteries are a remarkably bad deal. Not just because the odds of winning are so remote, but also because the state government administering the lottery typically takes around 45% of lottery ticket sales off the top to allocate towards government initiatives (e.g., education and school funding), and then only uses the 55% remainder to pay back to lottery ticket buyers... which is further reduced by everything from commissions paid to the stores that sell tickets, to the taxes that the state (and Federal government) assess on the winning. Fortunately, though, there is a remarkable amount of data on who participates in the lottery and the behavior of lottery players, and Mehta highlights a number of interesting data points, including: amongst those who play the lottery, the average lottery ticket spending is a whopping $3,000/year (and in some states like Massachusetts, the average lottery player spends more than $10,000/year on tickets!); the lower-odds bigger-jackpot lotteries seem to attract more participation, despite the 'obvious' fact that a lottery worth "just" 10s of millions of dollars would still be life-changing for any winner; since the financial crisis, lottery participation is on the rise, and one survey recently found that a whopping 1/3rd of people in the US think winning the lottery is the only way to become financially secure; there are consistent trends in what numbers people tend to pick or not (with lucky number 7 being the most popular, number 13 being very unpopular, and people more likely to pick "birthday" numbers from 1-30 than other numbers >30); overall, an estimated 95% of American adults either don't play the lottery or play at a very minimal level, but nearly 1/2 the total revenue is brought in by the last 5% who play in extremely high volume, and may waste as much as $135,000 in their lifetime on lottery tickets.
When Mediocrity Trumps Brilliance (Ben Carlson, A Wealth Of Common Sense) - The ongoing rise of index investing shows how investors are finally understanding the negative impact of high fees and the lack of real performance results from most actively managed mutual funds, a trend that is supported by analyses like the SPIVA Scorecard that finds over the past 10 years (including the 2008-2009 bear market), nearly 80%-90% of active managers are underperforming their benchmarks across almost every type of fund category. But Carlson points out that on an absolute return basis, the returns in the active mutual fund category have still been pretty good in recent years, with the average U.S. equity mutual fund still up nearly 10%/year. And this matters, because it highlights the real area of greatest harm when it comes to bad investment advice, which has been "the pessimistic parade of charlatans who have kept people out of the markets with scare tactics and fear mongering." In other words, being out of the market (or not) for the past 7-10 years has still been far more damaging than any of the differences between high-cost and index mutual funds. Of course, many of these investors claim that they'll simply get back into the market when it comes down and 'gets cheap' again, but Carlson notes that investors who have been afraid to get into the markets since the last crash will probably struggle to do so next time as well. Which means that in the end, while it's important to remember that costs do matter, they still don't matter nearly as much as the discipline to stay invested in any equity fund in the first place.
If Work Is Digital, Why Do We Still Go To The Office? (Carlo Ratti & Matthew Claudel, Harvard Business Review) - As the internet exploded forth in the 1990s, the interconnectivity it creates quickly raised the question of whether having an office would even be relevant in the digitally connected world of the future. Yet even as communication capabilities did explode over the past 20 years, most of us still commute to offices for work every day, and telecommuting has picked up some, but not nearly as much as many thought it would; in fact, many corporations are increasingly investing into new or renovated office spaces in urban areas. As it's turning out, the key distinction was that while the internet means we can work from anywhere, it doesn't necessarily mean most of us want to. Nor is it necessarily even good for business, as we increasingly recognize that it's human aggregation and our human interactions that allow us to most effectively share knowledge and generate ideas and creativity. As a result, even digital entrepreneurs are beginning to aggregate through solutions like WeWork, one of a growing number of providers of "co-working" spaces for professionals to have an office space without taking on a full-time lease for their own office space. And co-working spaces are now focusing so much on the design of office space to promote creative interactions, that they may be innovating the future of office design altogether.
Crawling Up The Wealth Management Pyramid (Joe Duran, Investment News) - While many different advisory firms use the "wealth management" label, Duran suggests that there are fundamental differences in the services that firms provide, and pressure on all of them to "move up the stack" to higher levels of value-add. The biggest segment of today's wealth management pyramid are the 'pure' investment advisors, who charge 1% for services like portfolio construction and rebalancing, which has less and less value-add as those services because commoditized by technology and outsourcing (e.g., what's the value-add to charge a 1% AUM fee when all the investment management is outsourced to a TAMP anyway?), and which Duran suggests will ultimately be priced around 30-50bps. The next layer of the pyramid is the financial planner, who crafts and delivers a financial plan using available financial planning software tools, and then invests the portfolio in line with the financial plan goals and results. Yet here, too, Duran suggests there's growing pressure, from firms like Vanguard who are finding ways to deliver planning nationally for just 30bps, and may be further challenged by a looming wave of self-directed planning technology tools that will help investors simply match portfolios to planning goals. Ultimately, Duran suggests the top of the pyramid is a more holistic advice offering (which he dubs the "Financial Life Advisor" or "FinLife" for short), which many advisors say they do but not many really do, and it's only been in recent years that technology tools have made it possible to start scaling such services. Yet even as technology enables the upper layer to be delivered more effectively, it relentlessly cuts away at the value-add on the bottom, forcing today's advisors to consider how they're going to move up the wealth management pyramid to survive and thrive. In addition, the need for systematized financial planning processes and solutions is starting to introduce an entire new category of advisor support platforms, which Duran has dubbed the Turnkey Advice and Planning Platform (TAPP, after a previous Nerd's Eye View article labeling them as a Turnkey Financial Planning Platform or TFPP), and may power the growth of planning-centric advisory firms in the coming decade just as TAMPs fueled the growth of the AUM model for the past decade.
Why 'Having' A Niche Market Isn't Enough (Julie Littlechild, Absolute Engagement) - While many advisors say they work with clients who are part of a defined niche, Littlechild points out that remarkably few actually build a real business around that niche; in other words, they have clients in the niche, but have not iterated their services and intentionally structured their business to deliver a specialized solution - echoing the infamous Seinfeld episode that lamented how many businesses take a reservation but don't actually follow through by holding the reservation. Or viewed another way, the key to success with niches is not niche marketing but actually delivering relevant niche services that meaningfully engage those clients. The upside, though, is that truly crafting a targeted niche makes it easier to derive deep engagement with clients (which Littlechild's research has found is what leads most directly to subsequent client referrals), because it's easier to systematically engage clients who have common needs. For instance, once clearly targeted to a niche, it's more productive to offer targeted educational events, create formal relationships, and hire dedicated staff, because you can be more confident the business will gain leverage from those investments since it applies across everyone in the target niche. More generally, though, the key point is simply that having a niche doesn't mean you say "I can work with this niche" or that "I do work with this niche" but is about saying "Every aspect of my business is built to help this niche group of people meet their goals and solve their unique challenges."
A Mutual-Fund Fee Falls Out Of Favor (Daisy Maxey, Wall Street Journal) - The 12(b)-1 fee that mutual fund providers pay to brokers who sell the fund has been facing increasing criticism in recent years, as the opacity of the fee (which is subtracted directly from the fund's NAV and never shown on transaction confirmations) has meant that most consumers don't even realize they're paying it. But over the past 15 years, 12(b)-1 fees have been under growing pressure, with the total amount that investors paid in 12(b)-1 fees up from $12B in 2000 to "only" $12.8B in 2015, which given the overall growth of the mutual fund industry (including no-load giants like Vanguard) means the industry-wide average 12(b)-1 fee has dropped from 0.17% in 2000 to only 0.08% today. This shift has been a result of pressures from both competition form ETFs and the demands of 401(k) plans to access cheaper share classes, as well as shifts in the advisor business model towards RIAs that charge a standalone AUM fee. A new crop of lawsuits against broker-dealers for putting investors into funds with 12(b)-1 fees, on top of wrap or AUM fees, and failing to properly disclose the conflict, is accelerating the trend as well. And now the Department of Labor's new fiduciary rule is expected to put even more pressure on 12(b)-1 charges, as firms like Schwab are already starting to walk away from such 12(b)-1 fee funds and instead offering advisors lower cost institutional class shares and letting them charge their own fees to clients directly, which will be important to help advisors meet the new Level-Fee Fiduciary requirements and comply with the Best Interests Contract Exemption.
Demographics And The Emergence Of Robo-Surance (John Lefferts Blog) - For the past several decades, the financial services industry has been dominated by the Baby Boomer demographic, and their consumer behaviors have dictated how companies create and market their products and services. Yet a fundamental demographic shift is now underway, as last year the Baby Boomers were dethroned as the largest living generation in the U.S., replaced by the Millennials who are now over 75 million strong. And as the first "native digital" generation, Millennials are fundamentally changing the expectations of financial services companies with their demand for the "digitization" of everything. This looming digitization has spurred an explosion of investments in FinTech, and Lefferts suggests the next digitization will be the world of insurance. Yet the world of "InsurTech" will likely look different than today's crop of robo-advisors in the world of FinTech, because complex products and services (including most insurance products) are "sold, not bought" which means a self-service "robo" solution will likely struggle. Or viewed another way, comprehensive financial planning, permanent life insurance, and annuities are more likely to be digitized through financial professionals, rather than around them (a discovery the initial FinTech robo-advisors are also discovered, as even "simple" asset allocation services have challenging client acquisition costs). Yet given the ongoing shifts in the regulatory environment, and the potential deceleration of commissions with the DoL fiduciary rule looming (not to mention the average insurance agent approaching age 60), arguably insurance and annuity companies are in great need to find alternative forms of distribution anyway, and digitization provides them a significant opportunity. For instance, Assurance is aiming to restructure the nature of the insurance illustration from its historical precedent (a confusing 20-page document) into a digital interactive illustration that could be used by a wider range of advisors (including RIAs) to help facilitate insurance advice.
Why Goldman Sachs Is Launching An Online Bank (Yalman Onaran, Bloomberg) - The emerging trend of established financial services to delve into the world of "FinTech" and online solutions has been underway for a year or two now, but it was still notable when venerated investment banking giant Goldman Sachs announced last week that it was launching a new online bank (a division it acquired from General Electric) and is aggressively seeking deposits by offering a highly appealing 1.05% interest rate on new savings accounts opened online. Yet it appears that decision of Goldman Sachs to get into the world of B2C FinTech is driven not necessarily by its desire to capture a new market, but instead by regulatory requirements in the aftermath of the financial crisis that are requiring the company to increase its so-called "net stable funding ratio" (and bank deposits are viewed as a more stable form of financing, thanks to both consumer inertia and FDIC backing, compared to 'typical' liquid alternatives like repos). And in fact, deposits are also a cheaper form of funding for Goldman, which sold 5-year bonds last week at 2.625% but is offering "just" 2% interest on five-year certificates of deposit with its online bank platform. Notably, a similar shift and push for deposits is underway at Morgan Stanley, the other major investment bank that 'survived' the 2008 financial crisis by converting into a bank holding company but is now facing new long-term liquidity rules from global banking regulators.
Asset Managers, Prepare To Have Your Business Disrupted (Katina Stefanova & David Teten & Brent Beardsley, Institutional Investor) - While Wall Street has long had problems with its image, dating back to the famous 1940 classic "Where Are The Customers' Yachts?", arguably distrust of Wall Street is at an all-time high today, from skeptical regulators to critical pop culture (e.g., The Big Short or Showtime's Billions) to the Occupy Wall Street movement. And while those image problems have not stemmed Wall Street's incredible profitability, it does suggest that parts of the industry may be highly prone to disruption, given that high profit margins invite new players to pursue the profit opportunity, new technology is transforming how services are delivered, and the shifting demands of new demographics of clients are opening the door to new players (particularly from smaller and more innovative players outside the traditional set of competitors, who may not even be recognized as a threat until it's too late). Overall, there's nearly $270 trillion of global investable assets in play, currently in the hands of money holders, and being allocated to and through a combination of investments, money managers, and various intermediaries (including financial advisors). And the trend isn't helped by increasing scrutiny of the poor investment performance results of huge swaths of the industry. Still, most of today's established firms insist that the "robo threat" is not a risk, and that consumers' lives are still too complex to merit a fully automated solution. But even if that's true, given the technology today, a fundamental dynamic of disruption is that innovators at the bottom of the market may add new capabilities over time that do allow them to compete more meaningfully. Yet the industry is also still prone to inertia; in the aggregate, almost half the world's investable assets are still allocated to asset classes that were popular 200 years ago (cash and real estate), while only 2% has gone to new 'alternative' investments; and slowly changing incentive systems have created new problems, such as the 2% AUM fee from hedge funds that was originally meant to cover operating costs of emerging firms turned into an industry asset-gathering standard. Still, the combination of unhappy customers and profitable incumbents suggests that by some means or another, disruption is coming for asset management, and the authors suggest it's likely to be driven by the "money holders" who ultimately control the flows of their own assets, while technological innovation is the 'kinetic energy' that makes the disruption possible.
I hope you enjoy the reading! Let me know what you think, and if there are 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. You can see below his latest Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!
Good stuff, as always! I really liked the article about the “Barron’s 100”. Maybe they should call it the “Ryker’s Island 100”, instead.