Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's edition kicks off with some regulatory announcements, including ongoing efforts by FINRA to implement its "CARDS" analytical tool that would monitor investment activity in clients' accounts across the entire industry looking for inappropriate broker trades and recommendations, and a discussion of the potential paths the SEC may soon take to update the "accredited investor" definitions for the first time since 1982 (and raising the question of whether income and net worth are even appropriate measures to determine an accredited investor in the first place).
From there, we have a few practice management articles this week, including a prediction that the rise of the "mega-advisor" firm may soon present challenges for small independent advisors trying to compete, coverage of the recent buzz at the Deals and Dealmakers Summit that the amount of M&A activity in the industry may be 20X as much as widely reported, and a good discussion of what it really means for an advisory firm to have a true CEO (not just a founder who puts the title on their business card).
We also have a few more technical articles this week, from a New York regulator looking into whether Equity-Indexed Universal Life policies are being illustrated with unrealistically optimistic projections that aren't likely to come to fruition, to a good discussion of the events leading up to the departure of Bill Gross as advisors and clients across the country consider whether it's time to fire PIMCO from their portfolios, to an interesting discussion of the impact of time diversification and how it can legitimately lead clients to owning more equity exposure for the long run, and discussion of an emerging trend in long-term care insurance where carriers are increasingly asking about family history looking for clues about any potentially-genetically-inherited disease factors that would/should impact underwriting.
We wrap up with three interesting articles: the first looks at how to become a "super connector" as a means to build your network and advance your business/career; the second is a look at the "reverse mentoring" program being implemented with the executive committee at Pershing (and the benefits that come from getting a young, fresh perspective); and the last looks at how advisors interact with and communicate with clients, raising the challenging question of whether sometimes the biggest problem is not that clients won't act on advice, but that advisors need to learn better communication skills in how to deliver it in the first place.
And be certain to check out Bill Winterberg's "Bits & Bytes" video on the latest in advisor tech news at the end, including announcement of a high-profile (human) advisor firm that's launching its own online "robo-advisor" solution, to a discussion of the upcoming release of a big new version of Redtail CRM, and more! Enjoy the reading!
Weekend reading for October 4th/5th:
FINRA Releases New Guidelines For Brokerage Tracking System (Scott Patterson, Wall Street Journal) - This week FINRA released Regulatory Notice 14-37, providing updated guidelines about its proposed (and controversial) Comprehensive Automated Risk Data System (CARDS), which would automatically collect data from investor accounts across most brokerage firms and use big data analytics to monitor for and detect questionable broker-directed trading activity. Critics of CARDS have raised concerns that a central database of brokerage account information could be a target for data thieves who want to gain access to the broad-based information about investor holdings and activity, and possibly engage in identity theft as well; FINRA's updated guidelines attempt to address this issue by proposed that personal account holder information (e.g., names and Social Security numbers) will not be captured, and that the data will not be linked directly to "live" accounts that could present an additional risk for a security breach (instead, updates will be submitted on a monthly basis). The recently updated proposal also includes a cost-benefit analysis, suggesting that it will cost FINRA $8M - $12M over 3 years to develop the technology and systems, and that the cost to brokerage firms will range from $390k to $8.33M to build and $76k to $2.44M to maintain annually (relative to the size of the brokerage industry, these costs are rather "modest" and the analysis was intended to ameliorate concerns that the system could be too costly to implement). The current proposal will remain open for public comment until December 1st, and if adopted would be implemented in phases (200 clearing firms initially, then another 1,850 brokerage firms in phase two, then the rest in a third phase) over several years.
Regulatory Changes Could Restrict Pool of Private Investors (Paul Sullivan, NY Times) - The SEC is expected to soon release new proposed guidelines to "update" and tighten the requirements for being an accredited investor, in response to provisions of the Dodd-Frank Act in 2010 that mandates the agency to go through what would be the first substantive reassessment of the rules since they were enacted in 1982. The current guidelines stipulates that accredited investors must have an annual income greater than $200,000 for two consecutive years, or $1M in investable assets (excluding their primary residence); merely adjusting for inflation would make these thresholds approximately $500,000/year in income or $2.5M in assets. The purpose of the rules is to protect "small" investors, who may be less able to recover from financial loss, from making private investments where available information may be scant and the need for due diligence is far greater. However, critics have pointed out that net worth and income alone are poor measures of whether an investor is truly educated and sophisticated enough to make private investments; the angel investing community is especially concerned, especially given many angel investing funds that are created by pooling assets of investors who may no longer qualify under the new rules, and on the other hand there are many wealthy individuals who still aren't necessarily financially sophisticated enough to effectively vet private investments, despite their wealth and income. An alternative solution is to potentially cap the percentage of an investor's net worth that is placed into private investments, allowing more flexibility at somewhat lower income/wealth levels for angel investors, and also preventing higher income/net worth individuals from overinvesting as well. The SEC is scheduled to meet on these issues on October 9th, with a potential proposal coming sometime thereafter.
The Big Squeeze II: Rise Of The Mega-Adviser (Joe Duran, Investment News) - The greatest threat to the local neighborhood RIA may not be coming from the future (in the form of a robo-advisor) but from above in the form of a growing collection of "mega-advisors", independent RIAs that are building rapidly in size and scale and are focused directly on comprehensive wealth management. Thus far, the threat of "large" RIAs has been limited because the industry is so fragmented that even very large firms are still rather small; there are only a handful of wealth management firms that have even $100M in annual revenue, but as the RIA movement continues to grow Duran predicts this number will soon rise and that we may be witnessing the creation of lasting national wealth management brands. And notably, the growth is not in the ultra-high-net-worth family office space, nor with firms serving $50M+ institutional clients, but the firms serving clients from $250k to $5M that are growing at upwards of 20%/year. Notably, the creation of nationally-based "mega firms" is not a unique emerging trend in the world of financial advice; the same trend played out years ago within both the legal and accounting professions, and while local mom-and-pop operations have survived, the whale's share of business in those industries now goes to national mega-firms and super-regionals. Ultimately, Duran see the trend playing out in financial services because many of the largest firms are now beginning to accelerate their growth rates (i.e., the big are getting even bigger), as their financial strength lets them invest in technology and systems that small firms cannot, they have pricing power to negotiate lower prices with vendors to manage their costs, they have the depth to build deep teams of knowledge and expertise, and their professional management and leadership allows time to focus on long-term strategic thinking. So what should the standalone independent advisor do? Duran outlines three options: ignore the trend if you're comfortable simply running a lifestyle business with a select group of clients (as you'll probably be fine in that environment); compete with them, which will require growing firms to go through significant reinvestment into their businesses to get through the difficult growth curve, or focusing into a niche where you can clearly differentiate; or partner with them, tying into the larger platform and participating in their growth wave.
Seivert Drops M&A Data Bombshell At His Dealmakers Summit To Gasps (Jason Lahita & Megan Carpenter, RIABiz) - After doing some analysis of Cerulli data, Dan Seivert of Echelon Advisors believes that the ongoing industry estimates of RIA M&A activity may be grossly understated. According to the annual tracking statistics of Schwab Advisor Services, the pace of deals has been an average of 47/year over the past decade. But using Cerulli data, Seivert notes that in 2013 there were just over 300,000 licensed financial advisors, and it's estimated that about 2% of them are retiring (which means an outflow of about 6,000 advisors), so if we assume that about half of them exited with some kind of M&A deal (internal succession plan, selling to a third party, etc.) then there were about 3,000 advisors involved with deals and with an average of 3 advisors per firm, that suggests there were about 1,000 "deals" done last year. This kind of activity estimate seemed to jive with the overall mood at Echelon's "Deals and Dealmakers" Summit as well, where the interest of potential buyers doing deals was described as almost "frothy". On the other hand, the Dealmakers audience was still tilted heavily towards buyers, not sellers, suggesting that it is still a seller's market for advisory firms overall, notwithstanding the long-anticipated-but-yet-to-appear wave of demographics-driven selling from retiring advisors.
Why Advisory Firms Need ‘Real’ CEOs (Philip Palaveev, Financial Advisor) - Most advisory firms have a partner (or sole proprietor) dubbed the "CEO", and in fact recent research by the Ensemble Practice finds that CEO is the second-most-common job title in the industry; nonetheless, the reality seems to be that most advisory firm "CEOs" are that in name only, and not really fulfilling the true role of being a CEO. In Palaveev's view, having a real CEO is primarily about leadership, and "making difficult decisions with the long-term strategy of the firm in mind" - in fact, Palaveev suggests that firms are evolving away from partnership models and more towards corporate governance structures specifically because the challenge of difficult decisions is more conducive to getting done under a strong single leader than with a consensus-based multi-partner approach that can get stuck when complex challenges arise. Notably, though, the CEO doesn't have to set the strategic vision; that can (and probably should) be determined by the collective ambitions of all the partners/owners, although Palaveev suggests that the test of a real CEO is his/her ability to create discipline in the partner group to set the vision (and in turn, once determined, the CEO needs to be empowered to actually drive the implementation of that vision). Because of the depth of what's involved, Palaveev suggests that a real CEO also needs to be able to be fully dedicated to the role, which means a partner/advisor may need to transition away all of their clients to really take on the role; alternatively, some firms will simply hire an external executive with experience in leadership (as it's difficult to really learn leadership without actually having spent time doing it) to come in and fill the CEO role, although Palaveev suggests internally-promoted CEOs tend to have the natural advantage all else being equal (because they know the firm, the culture, and are already accepted/known by the staff and partners). So what does it take to get such a CEO? Palaveev notes that based on limited industry data, advisory firm CEOs may be getting as much as $350k to $550k of cash compensation, plus bonuses of $50k to $150k, but the data may be 'tainted' by the fact that in many firms the CEO is a founder and one of the largest shareholders as well; on the other hand, many CEOs will actually take lower cash compensation plus an equity position specifically to be rewarded for driving growth, and Palaveev points out that firms will have to be deliberate in designing their own CEO compensation packages based on what's important and relevant for the firm.
Scrutiny of Stock-Linked Insurance Policies Grows (Leslie Scism, Wall Street Journal) - New York Financial Services Superintendent Benjamin Lawsky has launched an investigation into sales practices for indexed universal life insurance, the increasingly popular form of universal life insurance with both a death benefit and a cash value return linked to market returns (like indexed annuities, the policies provide upside with some caps or other limitations, in exchange for protection against losses if the market declines); sales of indexed UL policies were up 13% in the first half of 2014 compared to last year, even as overall sales of individual life insurance have been down slightly. Yet while the policies do provide some upside return in exchange for downside protection, the regulator is concerned that companies may be giving buyers overly optimistic projections of potential gains, and at the same time the National Association of Insurance Commissioners (NAIC) is also considering rules proposed by the American Council of Life Insurers (ACLI) aimed at protecting consumers by placing restrictions on the projections that insurers and agents use in selling the policies. For instance, policies might be required to show three illustrations, including a "worst case", a better outcome with returns as high as 10%, and a midpoint scenario (currently, industry executives state that many insurers show hypothetical returns of 8%/year); yet ironically, many insurers opposed the ACLI proposal because they insist that even this range of projections may be too rosy for the returns equity-indexed UL will realistically provide.
Do We Need To Fire PIMCO? (Josh Brown, Reformed Broker) - With the news of Bill Gross' departure from the bond firm he founded, the buzz for the past week has been whether advisors should move clients out of Gross' now-former flagship fund, PIMCO Total Return, the second largest bond fund on earth and the largest active one. The long-term track record in the Total Return fund really has been astonishing, as has the growth of the fund itself built around both a Bill Gross "cult of personality" and the simple fact that as advisors have increasingly focused on asset allocation portfolios for the past two decades, PIMCO Total Return was the easy go-to for a huge slice of the client's fixed income allocation, especially when the fund delivered a 13% total return in 2000 amidst the tech decline and followed it up with five more years of benchmark-beating returns. Yet Brown suggests that the cracks in the PIMCO story appeared, at least in retrospect, back in February of 2011 when Gross took his incredible "bet" on government bonds, dialing the fund's Treasury allocation from 22% in December of 2010 all the way down to zero in just a few months, and then went public - loudly - cautioning advisors and clients to steer clear of Treasury bonds. The problem, though, is that when a bet is made this boldly and publicly, it's very difficult to be flexible in the aftermath if/when/as evidence to the contrary begins to surface, a serious problem for Gross as his huge directional bet turned sour and Treasury yields went lower, not higher. In 2013, the fund had its worst year ever (losing 2%), and its AUM peaked in April of 2013 and had been declining every month since. In turn, Brown notes that it's only when the outflows really begin that in-fighting begins and stress fractures begin to show within a firm's culture, which seems to be exactly what happened over the past 18 months at PIMCO, from El-Erian's departure and a Wall Street Journal article highlighting the personality clashes within the firm, to increasingly bizarre behavior from Gross himself. Brown suggests that while many advisors and clients may have been reluctant to go so far as to fire Gross and sell his fund, the fact that he has departed PIMCO altogether may drive significant outflows, as investors reallocate to everything from Gross' new fund at Janus, competitor Jeff Gundlach at DoubleLine (the new "real Bond King"?), to simply buying Vanguard's world's-largest-bond-fund offering. On the other hand, Brown points out that perhaps the right thing to do is simply sit tight, as perhaps "the worst is over" with PIMCO and now that Gross and the associated stress points are gone, and that new manager Daniel Ivascyn can take over and bring the fund new success once again.
Jeremy Siegel vs. Zvi Bodie: Does Equity Risk Decrease Over Time? (David Blanchett, Michael Finke, and Wade Pfau, Advisor Perspectives) - Most advisors are quite familiar with the concept of "time diversification" and the idea that equities are the asset class of choice in the long run (popularized by authors like Wharton Professor Jeremy Siegel), but notably there are other academics (most notably, Professor Zvi Bodie of Boston University) who have made the case that stocks actually become riskier the longer one owns them. The key issue is the idea that stocks are presumed to have a higher return because they are riskier, yet being risky must mean that there is a danger that stocks will not outperform bonds; after all, if stocks were always superior, they wouldn't actually be risky, and therefore shouldn't command such a risk premium to return in the first place! Yet when looking at the historical data - from around the world - there really does appear to be a case for the superior returns for equities in the long run. In fact, there appears to be some negative correlation over time - i.e., that high positive returns in one year are slightly more predictive of negative returns in the next (and vice versa), which would make the long-term results more stable and less risky. This is notable, as most Monte Carlo analysis tools ignore the phenomenon, assuming instead that each year's returns are "i.i.d.", which stands for Independent and Identically Distributed (i.e., even if the market just fell by 30%, it's presumed to be just as likely that the market could fall again by another 30% the next year and there is no assumption that a bounce back may be more likely, or vice versa in a raging bull market). In fact, the authors find that once these "mean reversion" effects are included (modeled over a 5-year time period), Monte Carlo analysis results suggest that investors might own 10%-20% more than they would have otherwise, and already-risk-tolerance investors might own 30% or even 40% more in equities (than they would have if returns were just independent each year) in light of the lower long-term risk.
Parental Medical History Now Influencing The Cost Of Long-Term Care Premiums (Juliette Fairley, Financial Advisor) - Last month, long-term care insurance behemoth Genworth announced that it will be considering whether an insurance applicant's parent had early onset coronary artery disease prior to age 60 or dementia prior to age 70 as a part of the underwriting process, and may limit an otherwise-healthy applicant's ability to get the best coverage rates. While not all carriers at looking at family genetic history, more and more are choosing to do so; for instance, many insurers will now outright decline an application if there is any family history of Huntington's Disease (a progressive, degenerative neurological disorder that has a high rate of genetic inheritance). Ultimately, wider industry adoption of family genetic histories may drive all carriers to follow along, or those that do not look to family history run the risk of adverse selection as those with genetic risk factors flock to the few companies that ignore those risks for underwriting purposes. Notably, use of family history for insurance is not entirely unique; while it's barred from being used with health insurance going forward under the Affordable Care Act, it has been a part of life insurance underwriting for many years. While the limitations on coverage for family history may seem cruel to those applying for coverage, the industry's overall goal is to do a better job matching insurance risk to premiums and coverage, to improve the overall stability of long-term care insurance pricing (and also keeping the cost of coverage lower for those who are healthy and don't have a problematic family health history).
9 Skills Needed To Become A Super Connector (James Altucher, LinkedIn) - Being able to connect people and provide introductions is a valuable skill; although making connections may not provide an "immediate" return, Altucher makes the case that being a super connector that helps others ultimately comes back to you, and that many of today's billionaires (like Mark Cuban) succeeded in part because they are super connectors. So what does it take to be a "super-connector"? At the most basic level, the goal is to connect people, especially people who themselves are connectors (who will remember you as the connecting point). Other ways to connect people include: introduce people who have a common idea (e.g., know a book editor and a person who wants to write a book? Connect them); have/host a dinner of interesting people to give them the opportunity to connect to each other; once you make an initial connection, make sure you follow-up to continue the momentum; if you haven't connected with the person for a while, re-establish contact with them, as you never know what they're working on now (and where it might fit with you!); make sure you show up (i.e., if you get an opportunity to connect with someone, make sure you do it!); interview people (a great way to reach out to people who might otherwise be hard to connect with for an introduction); and produce something of value to create opportunities for connections (reach out to people with your ideas, and they may help you implement them!).
Mark Tibergien And His Reverse Mentor Kayla Flaten (April Rudin, RIABiz) - This article highlights the concept of "reverse mentoring" (originated by Jack Welch of GE), where an experienced person/advisor/business owner takes on someone much younger, not for the older person to mentor the younger, but the other way around. In the case of Mark Tibergien, CEO of Pershing Advisor Solutions, his reverse mentor is Kayla Flaten, as 25-year-old account manager with Pershing Prime Services. Flaten is not the stereotypical caricature of a Millenial, but that's actually part of the point; Tibergien's goal was to stay connected and keep perspective on what real-world young people are interested in. Ultimately, though, the mentoring relationship flows two ways; Flaten has coached Tibergien on his approach to social media and given perspective on ways to improve some Pershing services for young people, while Tibergien still serves some of the 'traditional' role as a mentor to Flaten as well; in other words, they challenge each other with new and different perspectives. Overall, the reverse mentoring program was instituted by Pershing in recognition that within a decade, 75% of the workforce will be Millenials, yet the leadership of most firms are almost all baby boomers (not to mention being almost all white and male); accordingly, Pershing instituted its reverse mentoring program to pair together 9 millenials as mentors to 9 Pershing executives (later expanded to all 20+ members of the Pershing executive committee). The bottom line: mentoring can be a two-way street, and for business owners looking to reinvigorate innovation in their business, it may be an especially effective approach to unleash some fresh creativity and perspective.
Communication Dynamics (Deena Katz, Financial Advisor) - While it's important in financial planning to be able to do the right analysis and come up with the right recommendations, Katz makes the key point in this article that improving outcomes is as much about helping clients change their behavior as it is just giving them the recommendation... and that to help clients to better change their behavior, we as advisors may need to step up our communication skills as well, and do more to better understand our clients. In Katz's view, this goes beyond just trying harder to talk to clients to understand them; instead, Katz notes that as the behavioral finance research is beginning to show not just that we have blind spots, but that we have consistent blind spots, there are opportunities to use tools to more consistently evaluate and understand clients and how they are likely to think and react in certain situations. The point is not just about risk tolerance questionnaires, but deeper personality profiles like Hugh Massie's DNA Behavior to pinpoint a client's underlying behavioral style. DNA Behavior groups clients into four broad types: goal-setters who look for opportunities; those focused on lifestyle; those who seek safety and stability; and analytical types who are information seekers. Once a client's mental approach is understood, the same concept and recommendation might be presented very differently, in order to better help them to actually follow through and implement it. But notably, a key part of the DNA Behavior approach is that you and your team also take the assessment, so that you can better understand your own behavioral style, where it may not match with a client, and how you need to adjust what you do to better provide what your client needs to hear to motivate them to action.
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!
Great articles for the weekend. Thanks!