Weekend Reading For Financial Planners (Nov 5-6)

Schwab Sets Labor Day Weekend 2023 To Transition Advisors, Clients, And Assets From TD Ameritrade

(Ryan Neal | InvestmentNews)

The biggest development in the RIA custodial platform space during the past few years has been Charles Schwab’s acquisition of TD Ameritrade. Announced in late 2019 and closed in October 2020, the deal brings together two of the largest RIA custodians with trillions of dollars… creating a challenging multi-trillion-dollar integration process to transition advisors and clients from the TD platform to Schwab.

And now, Schwab has announced that the transition for advisors currently on TDAmeritrade Institutional to Schwab Advisor Services will happen over Labor Day weekend 2023, meaning that advisors returning to their desks on Tuesday, September 5, will (hopefully without hiccups) find all of their client accounts and data transferred and available within Schwab’s platform (and advisors on each of the pre-merger platforms will gain access to the capabilities of the ‘other’ platform, e.g., TD advisors accessing Schwab’s Portfolio Connect and Schwab advisors gaining access to TD’s iRebal). The company is in the process of simulating the migration of data from TD to Schwab, and advisors will soon receive credentials to view their client data on Schwab’s platform in a preview mode (so they know what to expect when the transfer goes live next September).

Speaking at the company’s IMPACT conference this week, Schwab executives asked RIAs for patience throughout the transition, noting that some IT headaches are likely to be inevitable. At the same time, executives continued to reassure advisors currently on the TD platform that they will not have to go through a time-intensive ‘repapering’ process for their clients as part of the move (noting that while advisors will need to sign some documents to update their custodial relationship from TD to Schwab, their clients will not). In addition, Schwab Head of Advisor Services Bernie Clark said that the firm does not plan to implement a custodial fee that some other RIA custodial competitors have been considering amidst market headwinds.

Altogether, Schwab’s announcement gives advisors on the TD platform greater certainty of when the long-awaited changeover to Schwab Advisor Services will occur, a better opportunity to start preparing for the transition (and access to the combined-entity tools and capabilities after the integration), and perhaps some confidence that the transition will be relatively pain-free (or at least that Schwab is aware of the challenges of such a major integration and is taking action to be ready to provide the necessary support to prevent major snafus). Nevertheless, the shift could lead some advisors currently using TD to consider changing custodial platforms as they look for the right ‘fit’, both technologically and culturally, to meet their firm’s needs in the future if they don’t want to continue to be a small fish in Schwab’s very large pond!

SEC Seeks More Input On FINRA Proposal To Allow Supervision From Home Offices

(Mark Schoeff | InvestmentNews)

At the onset of the pandemic, many firms shifted to a remote work-from-home environment, and while some have returned to the office, others have continued remote operations, allowing their employees to work from home on either a full-time or hybrid basis. However, remote work raises a range of regulatory compliance concerns (particularly around the security of client communications and data), as a firm’s operations are no longer centralized in fixed offices, which makes it harder (or at least different) for an Office of Supervisory Jurisdiction (OSJ) to actually “oversee” their advisors for compliance purposes (when the OSJ doesn’t even have a branch office location themselves!).

In July, the Financial Industry Regulatory Authority (FINRA) filed a proposal with the Securities and Exchange Commission (SEC) that would create “residential supervisory locations” (RSL) that would allow a broker working remotely to supervise other brokers, without the broker’s home being designated as a branch office (which would otherwise subject the supervisor’s home office to additional regulatory requirements, particularly with respect to office inspections). Among other restrictions in the proposal, only one broker would be permitted to work at each RSL, the broker would not be allowed to meet with clients or handle securities or funds at the location, and the broker would be required to use the parent firm’s electronic communication system. Notably, while an office of supervisory jurisdiction is subject to an annual inspection by the parent brokerage, the new RSLs would only be subject to examination once every three years (reducing the compliance burden on the brokerages, as a growing number of RSLs would expand the number of locations requiring inspections).

The SEC (which must approve FINRA rules) in the summer put the proposal out for an initial comment period, which resulted in support for the rule from many broker-dealers and industry groups, but also some opposition from organizations concerned that remote supervision would undermine investor protection. Given the breadth of responses, the SEC appears to want to gather more information, and has opened another comment period on the proposal.

Notably, while this proposal would apply to FINRA-regulated broker-dealers, the SEC’s eventual decision on the matter could signal its thinking on the supervision of remote workers for financial advisors more broadly, especially as RIAs both increasingly have multiple office locations (including more work-from-home advisors) and the SEC has already been giving greater scrutiny to how RIAs handle local ‘branch office’ supervision. The SEC’s interest in the matter also suggests that firms with remote workers might want to consider reviewing their cybersecurity practices to ensure compliance with current requirements, particularly with respect to Chief Compliance Officers who themselves are ‘remote’ and not in a physical office with those they are supervising!

Morningstar Launches Direct Indexing Investment Offering

(Jeff Berman | ThinkAdvisor)

Amid growing interest in direct indexing (whose use cases and potential users have expanded well beyond its original focus on tax management for high net worth individuals), competition has heated up among asset managers to provide direct indexing services to advisors and retail clients on their platforms. In April, Charles Schwab introduced its Schwab Personalized Indexing platform, available to advisors and retail clients with a $100,000 account minimum. And last month, fellow mega-asset manager Fidelity introduced a new direct indexing platform for advisors, the Fidelity Institutional Custom Separate Managed Account (SMA), available now to select clients and broadly to RIAs and other wealth managers next year.

And now, Morningstar has joined the fray with its Morningstar Direct Indexing offering. Despite the growing competition in the space, the firm appears to see room to grow, suggesting that the strategy will grow 12.4% annually from 2021 to 2026 and that 61% of advisors are either using or are considering implementing direct indexing solutions. Morningstar’s direct indexing platform offers portfolios in two categories: “core beta” (including U.S. large cap growth, large cap value, and global markets portfolios, among others) and “sustainability” (including dividend yield focus, moat focus, and women’s empowerment portfolios).

Altogether, Morningstar appears to be seeking to leverage the depth of its investment research and data as well as its existing investment management platform to offer a competitive direct indexing alternative for advisors. And as more companies roll out direct indexing platforms, advisors will have the opportunity to choose the option that fits best for their client needs, whether it is one that includes advanced tax management features, advanced Socially Responsible Investing screens, the ability for advisors to implement their own custom strategies, or just a user-friendly interface that makes implementing a direct indexing approach more efficient!

Why I Don't Want I-Bonds

(Brett Arends | MarketWatch)

With inflation reaching levels not seen in decades, the Series I savings bond, or 'I Bond' for short, has gone from relative obscurity to one of the hottest savings vehicles during the past year. What makes I Bonds unique is their interest structure, which consists of a combined “Fixed Rate” and “Inflation Rate” that, together, make a “Composite Rate” – the actual rate of interest that an I Bond will earn over a six-month period. Bonds purchased before November 1, 2022 will receive an annualized 9.62% rate for the first six months they are owned, after which they will earn an annualized 6.47% for the subsequent six months. In fact, due in part to this record-high rate (and the subsequent drop-off for bonds purchased after that date), the Treasury Department sold $979 million worth of I Bonds on October 28, more than the total amount sold for the entire period between 2018 and 2020.

While I Bonds have offered an attractive rate during the past year, they do come with some conditions, including a required one-year holding period (and the forfeiture of the previous three months of interest if they are cashed in within five years of purchase), and, perhaps more notably, a $10,000 annual limit on I Bond purchases per individual (though there are a range of potential ways to increase the amount that can be purchased). Separately, as Arends notes, I Bonds allow purchasers to keep pace with inflation, but with the fixed rate (which, unlike the Inflation Rate, lasts for the duration of the bond) currently standing at 0.40%, investors will see little “real” return.

Swimming against the tide of I Bond popularity, Arends currently prefers investing in Treasury Inflation Protected Securities (TIPS) to I Bonds. TIPS are a type of U.S. government-issued debt whose principal value and recurring interest payments are linked to the rate of inflation. More specifically, the bond’s principal increases at the same rate as the CPI, with the interest payment (which is a fixed percentage of the principal) rising in turn. Unlike I Bonds, there is no limit on the amount that can be purchased (whether directly or through a mutual fund or ETF). In addition, TIPS have the potential to earn a greater real return than I Bonds, with 30-year TIPS currently paying the inflation rate plus about 1.8% per year and 10-year TIPS paying inflation plus about 1.6%, according to Arends.

In terms of potential downsides, TIPS can decline in value if not held to maturity (if interest rates rise in the meantime, making the bonds less valuable) or if they are purchased at greater than face value and inflation does not rise fast enough to make up the difference between the face value and the purchase price. And, as those who own TIPS in fund form have experienced this year, such funds can decline in value even amid high inflation. Further, while the interest payment provides a return in excess of inflation, this return could lag behind the long-run inflation-adjusted return of equities going forward.

Ultimately, the decision for advisors of whether to recommend I Bonds or TIPS to counteract the effects of inflation is dependent on a client’s broader asset allocation and cash management strategy. For instance, while I Bonds could be an attractive alternative for short-term savings (as the interest rates on bank products continue to lag inflation), restrictions on the amount purchased could make TIPS a better option for a larger investment portfolio. The key point, though, is that knowing the specific risks, benefits, and conditions of each of these tools and how best to apply them to specific client situations is a way for advisors to add value to clients who are looking to combat the effects of inflation!

Investors Aren't Adding ESG To Their 401(k)s - Even When They Have The Option

(David Blanchett | The Wall Street Journal)

The market for Environmental, Social, and Governance (ESG) investment products has exploded during the past several years, with a range of fund companies debuting new funds to capitalize on the perceived interest among consumers to invest in a way that aligns with their values in these areas. And while both advisors and investors have expressed an interest in ESG-style investments, whether they are actually implementing them in their portfolios is a different question.

A recent study by Blanchett and Zhikun Liu looking at investment allocations within retirement plans that offered at least one ESG fund suggests that this investment style might not be as popular as it seems. According to their analysis, fewer than 10% of investors chose to allocate money to an ESG fund when it was offered in their plan, and for those who did, the average ESG allocation was about 20% of the total portfolio (notably, these only included investors who created their own allocations rather than using the plan’s default investment, so the percentage of total plan participants using ESG funds is even smaller). The researchers found one exception to this general trend, where a larger proportion of participants within certain company plans had a higher allocation to ESG funds (perhaps because of their company’s mission or an employee culture favoring an ESG alignment).

In the end, there are a range of potential reasons for the disconnect between interest in ESG investment and its actual application, from uncertainty of the ESG criteria being used within a fund (e.g., an investor could be more concerned about environmental considerations than governance ones) to questions about how a fund fits in their broader asset allocation. This presents an opportunity for advisors (who want to make the time commitment to do so) to add value by helping ESG-curious clients sort through the options that best meet their needs, ensure that their ESG investments fit within a broader asset allocation, and recommend appropriate investment vehicles that help them meet their ESG goals (e.g., direct indexing)!

Pulling The Curtain Back: What Do Millionaires Invest In?

(Elisabetta Basilico | Alpha Architect)

A wide range of factors go into an investor’s asset allocation, from their risk tolerance to their time horizon for needing the funds, and ensuring clients have an appropriately constructed portfolio is one of the key ways advisors can add value. But not all investors have access to the same pool of investments, as the wealthy can use vehicles, like hedge funds and venture capital, that are usually off-limits to smaller investors. But just because wealthier investors can access them, it doesn't mean all of them actually do, and so the question remains how often they really use these alternative investments?

To find out how wealthier Americans invest their money, researchers surveyed 2,484 individuals with at least $1 million of assets (18% of whom had at least $5 million and 4% of whom had at least $10 million). According to the study, about 94% of respondents held stocks, with these individuals' portfolios allocating an average of 53% to equities (and 83% of this allocation was to U.S. stocks). Further, 12% of those surveyed said that more than 10% of their net worth is currently invested in a single company (with 67% reporting that this concentrated position has no effect on their total amount invested in equities, despite the concentration risk). Bonds made up about 15% of these investors’ portfolios, while about 20% consisted of cash, certificates of deposit, and money market funds. Notably, only 10.2% of those surveyed invested in hedge funds, venture capital, or private equity.

In addition to these findings concerning millionaires’ asset allocation, the survey also asked respondents to report the relative importance of different factors in their equity allocations. Advice from a professional financial advisor took top billing on this question, with 33.2% of those surveyed saying it was very or extremely important and 53.3% saying this advice was at least moderately important (the second- and third-most important factors were years left until retirement and personal experience investing in the stock market).

Altogether, these findings indicate that today’s millionaires are receptive to receiving professional investment advice, and their asset allocations suggest that advisors do not necessarily have to be experts in more exotic investment products to work with them!

Which Beneficiaries Are Subject To RMDs By Year-End?

(Ed Slott | InvestmentNews)

The end of the year brings Required Minimum Distribution (RMD) season for many advisory firms, as they try to ensure their clients take the appropriate RMD to avoid a nasty 50% penalty from the IRS. And given the range of changes to RMD rules during the past few years, from the SECURE Act, which eliminated the ‘stretch’ IRA for most non-spouse beneficiaries, to recent guidance on how proposed regulations related to the SECURE Act will be enforced, advisors will want to be aware of how the current guidance applies to the range of clients they serve.

For owners of traditional IRAs, the rules remain relatively simple, with those turning age 72 this year responsible for taking their first RMD by April 1 of next year (and while it might be tempting for some individuals to put off the tax hit of the RMD until 2023, doing so would result in needing to take taking two RMDs that year and potentially drive them into a higher tax bracket!).

For beneficiaries who inherited an IRA from a decedent who died in 2020 or later, the rules get more complicated. Advisors will want to review the impact of the SECURE Act on the various classes of beneficiaries, including eligible designated beneficiaries (who can still qualify for ‘stretch’ status) and non-eligible designated beneficiaries (who are required to withdraw the entire account balance by the end of the 10^th year after death). Notably, for beneficiaries in the latter category, while the IRS has proposed regulations requiring RMDs be taken during these years, the agency recently waived the penalty for beneficiaries in these categories who do not take RMDs in 2021 or 2022.

It is worth highlighting that the SECURE Act didn’t change the rules for non-designated beneficiaries (e.g., an estate or a nonqualifying trust), who must withdraw the entire account balance by the fifth year after death if the decedent died before their required beginning date for RMDs and must take RMDs over the decedent’s remaining single life expectancy if they died after the required beginning date. In addition, those who inherited accounts from individuals who died before 2020 can continue to take RMDs under the pre-SECURE Act rules.

Ultimately, the key point is that (given the penalties associated with missed RMDs) advisors can add significant value for their clients by ensuring they take the proper RMD each year. And given the range of clients potentially subject to RMDs, from older account owners to younger beneficiaries who inherited retirement accounts, it is important for advisors to take care to understand which of their clients are responsible for RMDs (and how much they must withdraw) before the end of the year!

How Medicare Premiums Will Change In 2023

(Bethany Cissell | ThinkAdvisor)

Many seniors felt a shock to their budgets at the end of 2021, when the Centers for Medicare and Medicaid Services (CMS) announced a 14.5% increase in Medicare Part B premiums for 2022 (related in part to projected spending on a new Alzheimer’s drug, Aduhelm), well above the 6% average increase seen in previous years. However, a subsequent reduction in the price of Aduhelm led many to wonder whether seniors could see a reprieve in their Medicare premiums for 2023.

Luckily for seniors, this turned out to be the case, as CMS announced that the standard Part B premium (not counting any Income-Related Monthly Adjustment Amount [IRMAA]) will decrease by $5.20 (or 3.1%) to $164.90 in 2023 and the annual deductible will decline by $7 to $226. On the other hand, the limited number of seniors who have to pay Medicare Part A premiums will see a slight increase next year, with monthly costs fixed between $278 and $506 depending on an individual’s circumstances.

Combined with the 8.7% Social Security cost of living adjustment for 2023, the decline in Medicare Part B premiums will help steady the budgets of many seniors. And for advisors, the current Medicare open enrollment period could be a good time to review their clients’ current coverage for potential cost-saving opportunities and to look for ways to minimize their clients’ IRMAA surcharges (which can exceed $6,500 on an annual basis per individual!).

'No Chance' For Tax Changes But Expect SECURE Act 2.0 Passage This Year

(Melanie Waddell | ThinkAdvisor)

The November 8 midterm elections have many Americans paying attention the future makeup of the House of Representatives and the Senate. And given the differing priorities of the two major political parties when it comes to financial issues, the results of the election could impact markets and future legislation.

But advisors will also want to keep an eye on Congress during the ‘lame duck’ session that follows the elections and is scheduled to last until late December, as key legislation is likely to be considered. And while Greg Valliere, chief U.S. strategist for AGF Investments, sees “no chance” that any major tax changes could pass this year (possibly referring to an expansion of the Child Tax Credit sought by Democrats or an extension of certain business-related tax measures prioritized by Republicans), changes to retirement accounts could come to fruition, as political watchers are anticipating that the so-called “SECURE Act 2.0” will pass by the end of the year. While bills introduced in the House and the Senate that make up “SECURE 2.0” need to be reconciled, the measures of the legislation (which include raising the RMD age from 72 to 75 and increasing allowed ‘catch-up’ contributions for certain individuals, among other measures) appear to have bipartisan support.

In the end, while much attention will be given to the results of the midterm elections, advisors will want to keep an eye on “SECURE 2.0” and its potential passage by the end of the year. Because although it is unlikely to include changes to the retirement landscape on the level of the original SECURE Act (which passed in the final weeks of 2019), the new law would nonetheless have planning implications for both retirement savers and retired clients alike!

The PE Attack

(Bob Veres | Inside Information)

A trend in the financial advisory world during the past several years has been increasing interest from Private Equity (PE) firms in investing in financial planning firms. The significant profits RIAs have generated during the past decade are likely attracting this capital, and advisory firms looking to grow (often through acquisitions of smaller counterparts) are frequently seeking out this capital to fund these efforts.

With this situation, Veres sees challenges for both the PE investors and the RIA space writ large. For instance, while RIA profits were buoyed by the bull market of the past decade, recent weak market performance (and the potential for it to continue into the future) could create strain in the investor-firm relationship. For instance, in an environment where profits are falling (and where firms could actually experience operating losses) might a PE investor push a firm to cut staff to reduce costs (potentially damaging the culture of the firm, the service level provided to clients, and the firm’s future growth prospects)?

Further, as RIA consolidators continue to grow through (often PE-funded) acquisitions, will they be able to hold on to staff and clients of the acquired firm (particularly if the acquired firm’s founder leaves the combined firm after their contractual obligations from the deal are fulfilled)? In addition, will these mega RIAs be able to maintain a high level of personalized client service, or will their service offering become increasingly generic?

Finally, what does the infusion of PE money mean for smaller firms? While those looking to sell could see more bidders and higher valuations (though these could be hindered by weak markets and higher interest rates), firms looking to remain independent will be competing with firms operating on a national scale. At the same time, for owners of these smaller RIAs, the ability to make decisions on their own (without the influence of an outside investor) and to offer more customized service to their clients could allow them to not only survive but thrive going forward!

RIA Deal-Makers Face An Ebbing Tide

(Diana Britton | Wealth Management)

The Mergers and Acquisitions (M&A) environment for RIAs has been red hot in recent years, as serial acquirers (often fueled by outside capital) have looked to gain assets and talent through acquisitions of smaller firms. This has been a boon for firm owners looking to sell, as the number of buyers has been plentiful and valuations have spiked.

There were 203 RIA deals completed through the third quarter of this year, up 23% from the same period in 2021, and DeVoe & Co. is predicting that total transactions in 2022 will exceed last year’s total of 241 deals by 12% to 20%. But amid the current rising interest rate environment and weak markets, this momentum could be fading. For instance, because many active RIA acquirers fund their deals through debt, rising interest rates are increasing financing costs at a time when poor market performance is hitting the revenues of firms charging on an Assets Under Management (AUM) basis, making debt-financed deals less attractive. And given the amount of leverage on the books of some of the acquirers, lenders might be hesitant to extend fresh capital for at least the near future if they start to question the firms’ ability to repay the debt. Notably, some acquirers have less debt on their balance sheets, and these firms could be the big winners if their strategic acquisitions are successful.

Another factor impacting the M&A environment after the recent run of deals is the ability of acquirers to ‘digest’ the firms they have bought. This could mean that in the current interest rate environment, some firms might choose to spend their time integrating previously acquired firms under the larger umbrella to ensure a more consistent culture and product in an attempt to avoid a (potentially less efficient) situation where the corporation owns a collection of smaller firms operating differently.

Ultimately, the key point is that the torrid pace of RIA M&A activity seen in the past few years could be challenged in the current macroeconomic and market environment. This could lead to a more cautious group of buyers, and fewer options for firms looking to sell (who might find an internal succession increasingly attractive?).

RIA Aggregators And The IPO Endgame

(Evan Simonoff | Financial Advisor)

RIA aggregators have been on a tear in recent years acquiring smaller firms, growing their assets and talent pool in the process. But for many of these firms, growth for its own sake is not the endgame; rather, some are looking to go public through an Initial Public Offering (IPO), drawing in additional funding and allowing executives and investors to cash in some of their equity.

But while private market valuations for RIAs have been elevated (and the space has attracted significant attention from private equity firms), public markets have not been as kind to RIAs looking to IPO. To start, the IPO market as a whole has been weak this year amid broader market declines and the poor performance of companies across industries that went public in recent years. And in the RIA space, the few firms that are public have not experienced the kind of results that would attract buyers to an IPO (e.g., RIA aggregator Focus Financial Partners’ share price is currently below its July 2018 IPO price). Another problem facing some RIAs is slow organic growth, a critical metric for public investors who appear to recognize that strong market returns buoyed firm profitability during the past decade.

Altogether, while the IPO market had been relatively unfriendly to RIAs before the recent downturn, current conditions could make it less likely that aggregators will go public. This could lead some firms to look inward during the next year—improving their efficiency, processes, and talent to improve their growth prospects going forward—while others might even look for a combination with another aggregator to create an even larger firm that could be an attractive IPO candidate when market conditions improve in the future!

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We hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think we should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, we'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.