Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with a recent investigative reporting effort from the Wall Street Journal that found FINRA's BrokerCheck system is failing to provide consumers information about bankruptcies and even criminal charges of brokers, in some cases because brokers simply fail to report them and in others because the broker-dealer doesn't record the incident (even in situations where the broker-dealer was named a party to the suit!).
From there, we have a number of practice management articles this week, including an overview of some of the latest trends in compensation for advisor employees (where base salaries are declining but incentive compensation is rising, with total pay up significantly in recent years), a look back at recent M&A activity amongst advisors from Schwab Advisor Services naming 2013 "the year of the tuck-in", a look at how adoption of e-signatures is beginning to accelerate, a good overview of some of the "unsung" custodians beyond the Big 4 (Schwab, Fidelity, TD Ameritrade, and Pershing) that are looking to grow and attract advisors (often by trying to offer superior tools and technology), and an interesting survey that found advisors who were worried how clients would react if they outsourced their investments but did so anyway found clients were far more "OK" with the transition that they had first feared.
We also have a few investment articles, including a good discussion of the Shiller "CAPE" P/E10 ratio and why it's still credible (and the warning signs it is flashing), how the financial services industry's transition to AUM on a massive basis (from the rise of RIAs to the shift of wirehouses to the AUM model) may be setting a "relentless bid" under today's stock market, and an intriguing look at whether we may be approaching the point where Vanguard is actually getting so big that it could actually stifle competition or even pose systemic risks.
We wrap up with three interesting articles: the first looks at whether the real blocking point to advisors engaging in succession planning might be less about the financial value of the firm and more about the fear of losing the "psychic income" our rewarding work provides to us; the second explores how an increasingly consumer-centric world will put new pressures on advisory firms to create even more client-customized and convenient experiences (while trying to maintain efficiency); and the last is from marketing guru Seth Godin about how Girl Scouts are trained to talk about the features and benefits of buying Girl Scout cookies instead of asking a simple question that evokes an emotional response (a problem that has some disturbing parallels to how we often "sell" financial planning as well). And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end! Enjoy the reading!
Weekend reading for March 8th/9th:
Stockbrokers Fail to Disclose Red Flags - In an investigative reporting effort, the Wall Street Journal has discovered that more than 1,600 stockbroker records on FINRA's BrokerCheck system are failing to show all of the appropriate 'red flag' disclosures they should, including 1,500 bankruptcies and 150 criminal charges of the brokers, by comparing BrokerCheck records to the criminal and bankruptcy-court filings in 21 states. While such wrongdoings don't necessarily indicate the advisors have actually caused any harm to clients, they are required to be disclosed, in part because industry data does show that individuals with such "red flags" are twice as likely to be fired and 65% more likely to have customer complaints or terminations. In addition, brokers with little assets can also leave investors with little recourse in the case of wrongdoing (the broker may not even be able to pay FINRA fines, much less client damages), especially if the broker's employer has left the business as well, as is illustrated in a particularly sad case the WSJ found with one senior investor who was allegedly duped. Because of the sheer number of brokers, firms and FINRA itself has difficulty tracking everyone, and the SEC acknowledges that some aspect of requiring self-reporting is a necessity; nonetheless, the WSJ also highlights that in some cases it's not just the brokers themselves failing to do the reporting to FINRA, but the brokerage firms as well (even in some situations where the brokerage firm itself was named in the broker's bankruptcy!).
How Advisors Get Paid Now - This article looks at some of the trends in compensation for advisors who work as employee advisors within a larger firm environment. Historically, compensation in such firms has tended towards a base salary with a discretionary year-end bonus like other employees. However, compensation is increasingly being tilted towards incentive-based structures that focus on "sales" (new clients/assets), relationship management measurements like client satisfaction or client attrition, and expertise, especially as firms struggle to figure out how to sustain growth beyond the founders of the firm; in some cases, base salaries are even being reduced, with compensation tilted substantially towards incentive compensation. Overall, there appears to be significant upward pressure on income for employee advisors, due to a severe talent shortage for the top people with experience; according to Angie Herbers' Salary Advisor service, total compensation for senior advisors was up 18% in 2013 to a whopping $218,600 (and compensation for mid-level advisors also jumped, up 16% to $135,250). Beyond base salaries and incentive compensation, larger firms are also increasingly using equity to compensate top advisors, and/or at least providing a clear track of the performance/results necessary to earn partner status.
Advisor M&A: Who's Buying RIAs Now? - The latest from Schwab Advisor Services on the M&A landscape for RIAs is out, and 2013 is being declared as "the year of the tuck-in" as a growing percentage of transactions now appear to be larger (e.g., $1B+) RIAs acquiring mid- or smaller-sized firms (a trend I had predicted back in 2012 as advisors look for succession planning alternatives). Overall, 44% of the deal activity were advisory firms acquiring other firms, while the "roll-ups" or aggregators like Focus Financial and United Capital accounted for only 32% of the 2013 transactions (down from 53% in 2012). And notably, this trend towards advisory firms acquiring others appears to be broadening further; a recent Schwab study found that 25% of firms with $100M or $250M in AUM were also in the process of actively looking to acquire another firm. Overall, the activity amongst "smaller" firms brought down the total amount of AUM acquired in 2013 (from $58.8B in 2012 vs $43.6B in 2013) even though the total number of transactions was up, but perhaps the most notable trend is that while volume was up it's still not up nearly as much as some have been predicting given the anticipated wave of retiring baby boomer advisors selling practices.
Strong Signs E-Signatures Set For Takeoff - The use of "e-signatures" in financial services appears to be gaining stream, now that legislation has affirmed that properly executed e-signatures are as legally binding as handwritten ones, and as the technology to facilitate the process continues to improve and advisors find the sheer efficiency benefits of having documents completed electronically on the go. The benefit is not just about the ability to get an electronic signature itself, but also the associated workflow benefits as documents move around digitally through the process, and the ability to track where the (digital) paperwork is as well. The biggest player in financial services appears to be DocuSign, which has a growing number of partnerships with many major custodians and broker-dealers, and recently completed a whopping $85 million round of funding to fuel its ongoing growth. However, not all custodians and broker-dealers use the same platform, and at this point advisors will generally need to use whatever e-signature provider their custodian/B-D uses for investment paperwork (though in theory the advisor could still use a different system for their own internal documents like client financial planning agreements).
Unsung Custodians - In this article from Financial Advisor magazine, advisor technology consultant Joel Bruckenstein looks at the landscape for investment custodians beyond the "big 4" behemoths of Schwab, Fidelity, TD Ameritrade, and Pershing; notably, many of the "smaller" competitors are stepping up their game, including with respect to their technology offerings (as a way to attract advisors). The first notable player in this category is LPL's RIA division, which is already the nation's largest independent broker-dealer (with about 13,500 advisors on the platform), but is now also the 5th largest RIA custodian, having attracted more than $55B in the past 5 years. LPL has invested heavily into its technology support, driven by its Chief Information Officer (CIO) Victor Fetter, the former CIO and CTO for Dell, who's been focusing heavily on investing in technology resources that improve advisor efficiency, including allowing access to its whole platform via mobile devices. Another player in this space is Scottrade Advisor Services, which now serves more than 1,250 advisors on its platform, including many newer/smaller advisors (their "core" advisor-client is a state-registered advisor with under $100M of AUM), as Scottrade does not impose an asset minimum nor an enrollment fee; while early on its advisor custody platform was criticized as being somewhat lacking, its technology has evolved significantly in recent years, including enterprise deals with for RedtailCRM (as well as Redtail document imaging and email archiving) and MoneyGuidePro. Scottrade is also preparing to release its "next-generation" custodian platform later in the first quarter of 2014. A third player in this space is Raymond James, another broker-dealer that now has the flexibility of RIA custodian support as well (in fact, "flexibility" is a key aspect of Raymond James, given the wide range of "AdvisorChoice" business model options it supports), and includes access to several supporting software tools (including CRM, financial planning software, and portfolio management software). The last in Bruckenstein's list is RBC Advisor Services which now serves about 50 RIAs with $10B of AUM, as part of the broader RBC platform (they're the fifth-largest clearing firm).
Clients OK With Outsourced Investment Management - Outsourcing investment management has been on the rise amongst advisors in recent years, though one of the most common concerns amongst advisors if a fear about what the client's reaction will be; a recent study from Northern Trust, though, found that amongst advisors surveyed, 92% of their clients had a positive reaction when the advisor announced they were outsourcing at least a portion of their investment management services, and 80% said they lost no clients at all when transitioning. Interestingly, amongst those who did have some speed bumps, "large" firms (with more than $150M of AUM) were more likely to see a negative response, while smaller firms were more likely to report losing clients (27% of small firms reporting a client loss, versus only 16% for large firms). In terms of explaining the outsourcing, the most common positioning explained to clients was a decision to outsource to improve resource allocation, with 43% saying their decision would allow them to leverage their time and expertise and 35% stated outsourcing would allow them to hire the best money managers (and replace them as needed). Notably, only 9% positioned investment outsourcing as a move to enhance or focus more on service, and only 5% stated it was done as a way to reduce costs. The most common reason cited for not outsourcing was specifically because "in-house management" was part of the advisor's value proposition. Of those who outsourced, 70% of the advisors stated that their business grew after they started, and 90% report they they're satisfied with outsourcing. Most advisors surveyed stated they were using multiple providers for their needs, often by outsourcing specific asset classes or strategies; overall, only 29% outsource all their investment management activities, though 53% are at least working with a TAMP (Turn-key Asset Management Program).
A CAPE Crusader - This article from James Montier of GMO looks at the much-discussed "Shiller P/E10" ratio, which has been indicating that the market is overvalued (at about 25x earnings) and which has been under heavy criticism lately for its conclusions. Montier labels this criticism "sorcery" though, noting that the real problem is that Shiller P/E is breaking one of Wall Street's classic tenets, "the market is always cheap" (so all measures that say it is overvalued should be discredited, or replaced with other measures that suggest it's still cheap!). Yet a deeper look at the measure reveals that it really has been rather consistent in predicting market returns in the long run; a comparison of Shiller P/E predicted return to the actual subsequent 7-year return reveals that it actually is more likely to over-estimate returns than under-estimate them, with the only significant exception being the exceptional late 1990s (which didn't exactly turn out well in the long run, either). In fact, Montier notes that one of the problems to Shiller P/E is actually that sometimes earnings persist above their trend line for an unusually long time, and though the data does eventually revert towards the mean, it can take a long time. Re-running Shiller P/E using a long-term earnings trend line for the past 10 years instead of actual 10-year trailing earnings actually improves its predictability further, but on that basis the Shiller P/E isn't just 25x, but 34x, and the market is even more overvalued! And the trend is even more concerning given that profit margins have been running at above-average rates as well, and is further validated using Hussman's Price-to-Peak ratio (which avoids complications of the write-downs that occurred during the global financial crisis) and also Tobin's Q. The bottom line: Montier finds that a wide range of measures suggest that real equity returns are likely to be rather flat at best in the coming 7 years.
The Relentless Bid, Explained - From the blog of "Reformed Broker" Josh Brown, this article makes the interesting point that the ongoing rise of wealth management may actually be starting to impact the behavior of markets themselves, and explain the "relentless bid" supporting the markets that are buying every dip. It's hard to argue with the relentless bid trend itself - while the 2011 sell-off took months to play out, in 2012 it ended in weeks, in 2013 in days, and so far in 2014, most dips barely last for hours! So what's the big change in recent years to explain this? Brown suggests its the entire financial services industry's massive transition to AUM models and the impact of earning fees based on AUM rather than transactions. In just the past few years, the major wirehouses have made a big shift in this direction - 27% of Wells Fargo's assets are now in AUM-fee-based accounts, with 37% at Morgan Stanley and 44% at Merrill Lynch; overall, AUM in such fee-based accounts has exploded in the past decade from $198B in 2005 to $1.29 trillion in 2013. So why does this matter? Because the investments being bought inside of AUM fee accounts are different; it's not about buying and selling stocks now, but long-term mutual funds, managed accounts, and index ETFs, which is making Vanguard, State Street and iShares in this era what Janus, Fidelity, and daytrading were in the 1990s. Which in turn means the flow of money is increasingly towards broad-based index purchases where there is less focus on the news and every day is a day to add to the account and buy (down days you just buy more)... which just puts the market higher and higher with a 'relentless bid' of incoming asset flows. Notably, this shift can also help explain why there is less market volume, the depth-plumbing ratings of financial television, and more... people are behaving differently with their assets, both individuals and the professionals who invest for them.
Can Vanguard Become Too Big? - From Financial Planning magazine, advisor and writer Allan Roth raises an interesting question: with $2.3T of assets and a size that's nearly as big as its next two competitors combined (Fidelity and American Funds), can Vanguard actually become "too large" at some point? Roth notes that the structure itself of Vanguard is unique; it is organized as a not-for-profit mutual fund company owned by its funds, which in turn are owned by their shareholders, which eliminates the demand for profits and gives Vanguard its sustained competitive advantage. Although Vanguard's growth was troubled in its early years in the 1970s, through the 80s and 90s it grew to be the number 2 mutual fund company (behind Fidelity), and in the 2000s made a key strategic decision to enter the world of ETFs, executed with the innovation of making its ETFs a different share class of its mutual funds and patenting the method to prevent competitors from gaining similar economies of scale; the end result are Vanguard ETFs with an average expense ratio of 0.13%, versus 0.61% for the industry overall. With the support of its ETF growth as well, Vanguard now controls nearly 18% of the long-term mutual fund market (excluding money market funds), the highest share any fund company has ever had. While the growth of Vanguard has driven down costs for investors, Roth raises the point that eventually, Vanguard may become so dominant that it actually weakens the competitive landscape, which isn't necessarily positive and can even creative systemic risks. Nonetheless, at this point Vanguard seems to be spurring competitors to also offer more indexing opportunities as well, or to come up with creative low-cost alternatives like Research Affiliates' "smart beta" Fundamental Index offering.
Psychic Income - In Financial Advisor magazine, Deena Katz looks at the concept of "psychic income" - the mental value that we derive from working in our practices as advisors - and notes that for many advisors, it appears that their attachment to the psychic income may be the primary reason there aren't more succession plans being implemented right now. Of course, the challenge is that by holding onto an advisory firm to get the "psychic income" advisors may also be sacrificing the actual monetary value of the firm as the advisor and clients age. So how do you move past this point, if harvesting at least some economic value from the practice is important too? Katz encourages the reader to take a fresh assessment of the firm and where it stands - are you a "lifestyle practice" (where everything revolves around you and your schedule and you're not necessarily interested in building value), a "practice" (where you serve a lot of clients but do anything/everything for anyone/everyone, design your firm around the personalities in your firm, and profit is just what's left after overhead), or a "business" (focusing on profitable clients, leveraging yourself to your highest/best use, and only do things that fit the long-term business plan and create economic value for the firm). Katz then suggests taking stock of where you want to be in 5-10 years (and includes a number of good questions to think about), and then you can begin to formulate a plan of how to get there. The key aspect to remember at the end, though - just as your business can be sold and its economic value can be reallocated on your balance sheet to generate income by other means, so too can you re-engage yourself beyond your practice after selling it, deriving psychic income from new sources as well.
The Adviser Of The Future: 3 Trends Of Tomorrow - This article by United Capital CEO Joe Duran looks at today's "consumer revolution" that's leading to the explosive growth of new companies, from Facebook and Twitter to Skype and Amazon, or NetFlix and Google. Underlying these companies are a number of deep-seated human desires, which are relevant in both other industries, and our own for those who can figure out how to apply the principles for their advisory firms to survive and thrive. The key desires to consider that "we all want" are: 1) To feel special (everyone wants the VIP treatment, which means a personalized and specialized experience for everyone, and figuring out how to deliver this without completely deleveraging the efficiency of your firm); 2) To have convenience (solutions need to fit the rhythm of the client, not the firm); To belong to a tribe (we identify ourselves by who we affiliate with, from wearing a Rolex or carrying a Hermes purse, to shopping at Whole Foods or using an iPhone vs Android, so how are you creating this connection identity with your clients?). Ultimately, Duran suggests three directions that advisory firms will have to consider and focus on in order to succeed and deliver: 1) Go beyond money (just solving investment challenges for clients is being commoditized, so we need to go deeper); 2) Go beyond conventional geography (if you want to be able to connect with clients anytime, anywhere, you need to be ready to embrace digital communication tools!); and 3) Go beyond a mission statement (clients want to know what you stand for when they buy your product or service).
Girl Scout Cookies - On his blog, marketing guru Seth Godin talks about the valuable lesson and experience that girl scouts gain by selling girl scout cookies. Yet the standard approach for girl scout cookies is a rather complex "spiel", where the girl scout introduces themselves, talks in detail about the work that the Girl Scouts do, explains how the money that is raised will be used, etc. It's a complex sale even for a professional, much less a child. So what's the alternative? Just ask one simple sentence: "What's your favorite kind of Girl Scout cookie?" With this one question, the prospective buyer will now conjure up their own images of the Girl Scout cookies, an emotional connection to the cookies over time (there's a reason the flavors never change!), and a desire for fulfillment; the Girl Scout transforms from a pleading seller to a "valued supplier" instead. While the commentary is in the context of Girl Scout cookies, this arguably has a lot of relevance to financial planning, too; how often do we make the rational and emotional appeal for our services, instead of asking the prospect a simple question that tries to draw forth an emotionally connected response? For instance, instead of spending a lot of time explaining how great our retirement planning services are, what if we started every approach talk with "So what's the first thing you plan to do once you retire?" and just let the prospect articulate their own vision and a desire to achieve it (with your help)?
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! And click here to sign up for a delivery of all blog posts from Nerd's Eye View - including Weekend Reading - directly to your email!
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!
Information wise. This very informative. article about financial planners . Thanks for the writer.
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