Executive Summary
Enjoy the current installment of "weekend reading for financial planners" - this week's reading kicks off with a fascinating discussion of a younger planner who specializes in working with retirees decided to launch a series of specialized blogs to grow his AUM... and in only his second year, is already on pace to bring in more than $40M of new assets to his advisory practice (and his clients are older retired clients, not "young" people!).
From there, we have several investment related articles this week, including a look at the growing actively-managed ETF space, the ongoing rise of alternative investments, the opportunity to use Master Limited Partnerships (MLPs) to invest in the infrastructure around the oil and gas boom, a detailed look from Morningstar at different types of MLP structures and their yields and tax treatment, whether advisors should steer clients away from bonds in the current environment, and whether it makes sense to keep a mortgage or not in today's low-mortgage-rate (but also low-yield) environment.
There is also a pair of practice management articles: the first looks at some of the key "hot button" issues cropping up in the space of mergers and acquisitions (and succession planning) for financial advisors; and the second gives a good overview of the SEC's "testimonial" rule for RIAs and how it relates back to social media.
We wrap up with three interesting articles to give you something to think about: the first is a creative look at different ways that we can characterize advisory businesses, from geographically-based businesses to commodity-based solutions to community-based offerings (and the benefits and disadvantages of each); the second provides a good reminder that while regular communication and "touch points" are key to client retention, too much communication can be bad thing too, especially if what you're sending out in your communication isn't truly meaningful and substantive and relevant for clients; and the last is a fascinating discussion of a recent presentation by Blogger and Twitter co-founder Ev Williams about what it really takes for an internet-based business to be successful, noting that ultimately what really has the most success is not trying to invent something entirely new, but simply looking at what humans already do and the ways we connect and simply making the experience easier and more convenient. Enjoy the reading!
Weekend reading for October 5th-6th:
How A 33 year-old advisor Used Mad Blogging And SEO skills To Propel Giant Growth - This article tells the fascinating story of Jason Wenk, a 33-year-old advisor with a $110M AUM retirement planning practice who moved from Michigan to California and decided that he'd rather transition to a virtual business than figure out how to restart himself in a new location. Accordingly, he built an online presence and launched a blog, and in just his second year he's already on track to bring in more than $40M of new assets using the approach. Wenk's key was that instead of just trying to be easily found as an advisor - e.g., to come up at the top of the search rankings for "Laguna Beach Financial Advisor" - instead he crafted his blog around the problems his clients might be searching for online, like whether they're holding a good annuity product. Accordingly, he tried writing a specific review of a particular annuities, along with an hour-long video and a detailed model about how it might perform, and suddenly he found he was getting 500-600 unique visitors every month just for that one review. Wenk suggests that the reason why the approach worked so well is that by reviewing a specific annuity, he drew in people who were looking for specific, actionable solutions (as opposed to someone who just generically searched for annuity information). As Wenk has added more blog posts and annuity reviews, an increasing number of people contact him with their concerns and problems, and with a fairly systematized and automated response and scheduling process, a large number of them turn into meetings, and many become clients. As Wenk adds new niches, the business is growing rapidly; Wenk had 105 prospective new clients in the month of August alone, and is now funnelling those prospective clients to other advisors in his office. While the content might seem daunting, Wenk notes that in the end, the time it takes to blog is still less than how much time he used to spend cold calling or putting on seminar dinners.
Testing The Active ETF Waters - This article takes a dive into the growing space of actively managed ETFs; with assets totalling about $14 billion, there are some serious dollar amounts invested, but it still represents a miniscule less-than-1% portion of the estimated 1.5 TRILLION overall ETF marketspace. Most active ETFs are still tiny, given that they represent about 20% of all ETFs (321 out of 1,497 ETFs available) but only 1% of assets, and in truth about 2/3rds of all managed ETF assets are in one fund: PIMCO's BOND. Nonetheless, the space is actually growing more rapidly in its first 5 years (the first active ETFs launched in 2008) than index-based ETFs did in the 1990s when they first began, and actively-managed ETF companies are beginning to market themselves more aggressively, eyeing in particular the roughly $6 trillion taxable mutual fund market space where actively-managed ETFs hope to compete with actively-managed mutual funds head-to-head. So far, most of the actively-managed ETFs have been bond funds, and are used by smaller investors, but fee-based advisors in particular are anticipated to start using them more often going forward (given that they don't rely on the commission-compensation structure of mutual funds). When evaluating a actively-managed ETF, clearly the first question is simply whether the asset class would benefit from the active approach in the first place (e.g., less traded below-investment-grade credit might make more sense than an actively managed government bond fund), and the second question is about the managers' strategies and track record of results. Ultimately, then, advisors may end out with a blend of both passive and actively managed ETFs, depending on the managers and the appeal of each asset class. Notably, if actively-managed ETFs begin to get further adoption, their numbers could quickly explode further, as many actively-managed mutual fund companies have filed for active ETFs, but haven't launched them (yet?) as long as their traditional mutual funds are staying competitive (especially given that the companies often generate higher fees via their mutual fund structure). Also, some companies may be launched 'hybrid' versions of actively-managed ETFs that will trade like ETFs, but use a daily NAV price like traditional mutual funds; the upshot is that investors will know what they're getting for an intra-day price, but the downside is that's because the investors won't be able to see within the ETF on a daily basis, reducing the transparency of the fund.
Facing Alternative Investment Reality - In Research Magazine, Texas Tech professor Michael Finke looks at the world of alternative investments, noting that while they can have a role in portfolios, expectations for their performance may be rising to dangerous levels. The rising appeal of alternatives is not surprising, as short-term bonds have negative real returns, long-term bonds face price declines if/when/as rates rise, and equities are at elevated valuation levels (based on Shiller cyclically adjusted price/earnings ratios). And Modern Potrfolio Theory does imply that the optimal risky portfolio should include some allocation to alternatives (presuming that they have a less-than-perfect correlation to other asset classes), which has been used to justify allocations to everything from commodities to private equity. In addition to the sheer diversification argument, in theory alternative investments that are not as actively traded may have some pricing inefficiencies, creating further opportunity for excess return in addition to risk management. On the other hand, the jury is still out in some areas; for instance, Finke notes that while Hedge Funds have some allure, their selective disclosures of performance and strategy have left the academic research unclear about whether their costs can really be justified (though that apparently hasn't done much to slow investor flows into hedge funds over the past decade, as many institutions have increased hedge fund allocations from less than 5% in 2000 to over 20% by the end of that decade!). Another popular "alternative" area is market neutral funds; though there is no standard definition, these are generally viewed as funds that go both long and short assets in the same category to hedge away systematic risk and just try to earn money through effective asset selection. Because they aren't exposed to the "beta" of the market to capture its risk premium (and take the associated risk), they're often viewed as safer assets. Nonetheless, the performance hasn't been great, as last year the average market-neutral fund drew a return of only about 1%, right around the return of safe-but-less-uncertain short-term government bonds. Overall, though, the primary issue Finke notes with alternatives is simply that their value is "squishy" - with inconsistent pricing policies for often less liquid assets, there is a risk of distortion or mispricing (as witnessed with some of the non-traded REIT lawsuits in recent months). The bottom line - while alternatives may continue to hold allure as, well, an "alternative" to stocks and bonds, the jury is still out about how much they're really adding at the end of the day.
Pipe Down - There is an oil boom underway, as 2012 saw the greatest increase in domestic crude production ever (and 2013 is already on track to beat it), and natural gas is on the rise as well. This has been driven in large part by oil companies finally figuring out how to drill wells that run horizontally rather than straight down through the rock formations under them, allowing companies to drill radically longer wells, and reach some otherwise-hard-to-get resources (that are more accessible to horizontal drilling to real oil-rich layers rather than being forced to drill down through dense rocks to get to them). While the boom makes oil and gas investments appealing, the author cautions that there are still many pitfalls in the details of how such investment deals are structured, especially for non-insiders who may not understand the nuances and fine print. Accordingly, it may be wiser to invest not directly in oil and gas, but in the infrastructure it will need to succeed, such as Master Limited Partnerships (MLPs) that provide much of the pipeline systems necessary for the oil and gas boom to occur. The article then details several MLP options, from Exchange-Traded Notes (ETNs) to various ETFs as well.
A Better MLP Mousetrap? - This article from Morningstar Advisor looks at the latest form of Master Limited Partnership (MLP) ETFs, which typically ownpipelines and other oil-and-gas-related infrastructure, with high yields and some preferential tax treatment. The problem with MLPs in the past has been that owning their partnership structure outright results in cumbersome Form K-1s during tax season (and additional headaches if owned in a retirement account). One workaround has been for investors to purchase an MLP fund, which handles the K-1s and then sends a standard Form 1099 at the end of the year, but that tax convenience also results in an extra layer of taxation because the IRS stipulates that any fund with more than 25% of its assets in an MLP must be treated as a corporation. Alternatively, some investors purchase Exchange-Traded Notes (ETNs) based on an MLP index, but the ETNs introduce credit risk (for whatever company is backing the note), and because they don't actually hold MLP assets they lose the preferential MLP tax treatment. A new batch of MLP ETFs is trying to navigate these rules effectively, like the Global X MLP & Energy Infrastructure ETF (MLPX) - as the name implies, it avoids the MLP tax treatment issue by limiting its actual MLP ownership to only 25%, and owning "other" energy infrastructure investments (like MLP affiliates) for the remaining 75% (which appear to still track MLP returns fairly well). In terms of after-tax income, the new MLP ETFs don't quite stack up to true fully-MLP-invested ETFs, but Morningstar notes that on an after-tax basis, the new MLP ETFs may be quite compelling to the MLP ETNs (due to the unfavorable fully-ordinary-income ETN tax treatment, and without the credit risk). The bottom line is that the new MLP ETFs appear more compelling than MLP ETNs, and a reasonable option for cheap diversified exposure to energy infrastructure, but those looking for yield should stick to outright MLP ownership or even the corporate-taxed fully-MLP ETFs.
Should Clients Avoid Bonds Now? - In Financial Planning magazine, professor Craig Israelsen looks at the relevance of bonds in today's client portfolios, given the current ultra-low interest rate environment. The historical comparison points are not appealing; While bonds may fare well in flat or declining rate environments, when we look to the the late 1970s, the Federal discount rate rose from 5.46% to 13.42%, leading to a whopping 5-year annualized return on Treasury Bills of 9.84%, but intermediate government bonds generated a return of only 5.63%, and the long government bond index was hammered with a 5-year annualized return of negative 0.77%. It's notably, though, that while the intermediate bond results were lower than Treasury Bills, they weren't exactly "bad" - granted, they were assisted in part by healthy yields to start, but given their limited duration they were able to recover price losses relatively quickly as they approached maturity, and it was really only the long bonds that had "sustained" losses over the time horizon. In the 2002-2006 time period, the results were even more favorable, and ultimately Treasury Bills only yielded 2.64% while intermediate bonds returns 4.53% and long-term government bonds returned a "surprising" 7.38%. Notably, though, these periods of rising rates are often accompanied by favorable returns on other asset classes, as in the late 70s large cap stocks returned over 8%, small caps gained more than 25%, foreign stocks were up 14.%, REITs rose 26% and commodities grew 10.7%. Accordingly, Israelsen's conclusion is that abandoning bonds may not be a good idea, as if bond yields decline the returns will be favorable, and if bond yields rise the returns may still be decent (at least for intermediate bonds) and other asset classes are likely to perform better... and isn't that the point of diversification in the first place?
Tell Clients: Time To Pay Off The Mortgage - In this Financial Planning magazine article, Allan Roth makes an interesting case that a mortgage should be viewed as nothing more than an inverse bond, and given that approach there's really little reason to hold a portfolio (with long bonds) and a mortgage (a 'short' bond) at the same time... accordingly, most affluent clients should actually pay off their mortgage, notwithstanding the "cheap, tax-deductible money" that mortgages may represent. In fact, Roth suggests that the reality is holding a balanced portfolio and a mortgage is actually a more aggressive portfolio than the client may realize, as once the long and 'short' bonds are netted against each other, the reality is that the client ends out just holding a remarkably equity-centric portfolio... one that may actually even be beyond their risk tolerance once viewed on this holistic-balance-sheet basis. Even if clients are comfortable with the mortgage, the reality remains that as long as clients are using a 'short bond' mortgage and hold any bonds in their portfolio at all, the net result is a negative yield, given that even today's "low" mortgage rates are still a higher cost than the yield of a diversified bond index... which in turn means paying off the mortgage represents an immediate risk-free return improvement to eliminate the negative arbitrage! Of course, if rates rise enough then the comparison of bond funds to the mortgage may become more appealing, yet rising rates may cause some losses for those bonds in the first place, which means the client will be even further in the hole as rates rise, and will require significantly higher yields for a long period of time just to break even! Obviously, if clients really have liquidity issues - or in the extreme, "need" the mortgage obligation to have the discipline to build equity, there is perhaps a case to be made for still keeping the mortgage, at to say the least Roth suggests those should be the exceptions to the rule, not the starting point.
Advisor M&A: 4 Hot-Button Issues - This article discusses a recent "Deals and Dealmakers" summit on merger and acquisitions activity in the advisory world, and looks at some of the hot button issues that are arising in today's marketplace. The first issue is valuation, with ongoing debates about whether firms should be valued based on assets and revenues or EBITDA; ultimately, Mark Tibergien suggests that it's all about free cash flow and future earning potential, which means in the end it's more about profits than revenue (though in some cases, a multiple of revenue can still be a reasonable shortcut). For many firms, the primary challenge is not the valuation, but the buyer - will the founders look to conduct an external sale (often with a higher price, higher downpayment, and shorter payment period), or an internal one (lower risk, often better outcomes for staff, and likely more satisfied clients who are relieved familiar personnel and procedures won't change)? The summit attendees generally agreed that there will always be a place for large external firms that do offer the opportunity for founders to sell their firms at a fair price, but were less sanguine about so-called "roll-up" or consolidator firms, as over the past decade many have gone out of business and/or lost all of their acquisition momentum before they could execute their own liquidation strategy. Surprisingly, the summit also had little consensus about whether it's even a buyer's or seller's market right now; demographics would suggest that there should be a lot of sellers, but given the difficult in trying to find terms that align between buyers and sellers, even if there are a lot of sellers, it doesn't mean they're ready to sell to any of the buyers that are available.
Staying Compliant With the SEC’s Anti-Testimonial Rule - This article by Chris Stanley, Chief Compliance Officer for Loring Ward, takes a look at Rule 206(4)-1(a)(1) of the Investment Adviser Act, otherwise known as the "testimonial" rule. Specifically, the rule states that "It shall constitute a fraudulent, deceptive, or manipulative act, practice, or course of business within the meaning of section 206(4) of the Act for any investment adviser registered or required to be registered under section 203 of the Act, directly or indirectly, to publish, circulate, or distribute any advertisement… Which refers, directly or indirectly, to any testimonial of any kind concerning the investment adviser or concerning any advice, analysis, report or other service rendered by such investment adviser." Notably, though, the key word of the entire definition is "testimonial" and the SEC has never officially defined the word; its current guidance indicates that testimonials "include any statement of a client's experience or endorsement" but the regulations also state that, for better or for worse, the determination of whether a statement is a testimonial depends on "all the facts and circumstances." The takeaway for many advisors has been to simply eschew anything that might be a testimonial, for fear of finding out after the fact that the SEC interpreted the "facts and circumstances" unfavorably, but technology development is making the matter far more difficult - especially in a world of Facebook "likes" and LinkedIn "endorsements and recommendations" not to mention Twitter's "re-tweets" or Google's "+1" button. A social media click "could" be a testimonial, but it potentially might not be a testimonial either. Ultimately, it's up to the firm to have a social media policy that dictates what the firm considers to be permissible and not, and the use of these buttons doesn't necessarily run afoul of the testimonial rules, but if a firm will allow employees to use them, it should be prepared to explain its position. Stanley notes that although it's not specifically required, in many cases firms have simply been limiting their social media information to a static "business card" and hiding their endorsements and recommendations just in case.
3 Types of Financial Planners – Which Group Are You In? - From the blog of Dutch financial planner Ronald Sier, this article looks at three ways that planners may try to differentiate their businesses. For some, the differentiation is based on their geography - historically, this might have been the local baker or pharmacy, and for planners today the geography-based business is about selling advice and products to local people at the time they need it... for instance, "if you want financial advice about {buying a house/divorce/pension/etc} then come to me {because I'm nearby}." The second type of business is more commodity-based - this is the business that says "we sell what they sell, but cheaper" (which of course requires that consumers have access to price information to compare and that you can produce a standard item cheap enough to succeed), or in the planning context "if you want a better/cheaper product or advice, then come to me." Of course, the commodity business often lives precariously, as the keys for success - more information, bigger areas served, efficient solutions - are also the keys for that a competitor can use to make the business obsolete, and in fact for many types of solutions they are so commoditized that they're now purchased online and there's no person (or planner) even needed. The third type of business is the community-based business, which tells a story of why it's different and remarkable; while the story won't attract everyone, the people it does attract may be so happy to work with the business that aligns with them that issues of price become less relevant, as doing business is more about emotion than rational pricing at that point. The message becomes "if you want to feel.... then come to me/us, because I/we are like you." While any of the approaches can potentially succeed, Sier suggests that being in a geographically- or commodity-based business is riskier, while the community-based "niche" business ensures that you always serve your ideal clients and helps them to stay more connected to you regardless of the business uncertainties that may come.
Too Much Communication - This article from the blog of Bob Seawright makes the interesting point that while industry publications have been encouraging advisors to communicate more and more with clients - noting that often "poor communication" is an even bigger driver of client attrition than just something like poor performance - we may be reaching the point where we're now communicating with clients too much. The key is that while "more communication" may be good, it really only counts if it's substantive and meaningful, otherwise you're doing little more than contributing to a client's spam folder. In fact, if you push information to a client that appears to be high priority but isn't actually substantive, useful, and relevant to them, you may even build resentment that the client was 'duped' into reading communication you sent that really didn't add any value. And if putting out information less allows the quality to be higher with what you communicate, then less may truly be more for clients. In addition, Seawright suggests that in the context of markets in particular, realize that it's more important to be real and authentic than trying to be the expert that knows everything - it's ok to sometimes admit you don't know it all about the markets or an advisory issue, especially if you follow up by finding out the answer and communicating it accordingly when you have all the facts.
Twitter Founder Reveals Secret Formula for Getting Rich Online - This article is a fascinating discussion of a recent presentation by Ev Williams, the internet "guru" responsible for co-creating/co-founding both Blogger (the first major blogging company/platform) and Twitter, who shared his insights and understanding about what kinds of internet businesses will not succeed and which will (and likely make their founders rich in the process). The real key, according to Williams, is not to go and do something on the internet that no one else has ever done - despite the obsession in Silicon Valley with trying to do so - but instead finding something that's tried and true that people already do, and just try to do it better through the use of technology and the internet to solve problems with greater speed and simplicity. Ultimately, William suggests that the internet is little more than a huge series of connections, both connections between computers (e.g., servers and internet infrastructure) and between people (e.g., a follow/like/friend on social media). Over time, these connections are proliferating in one particular direction: convenience, whether it's finding that particular product you're looking for, or a source for particular knowledge and information. Accordingly, this is how Williams characterizes the success of Blogger; all he did was take something that people already did - making web pages to share information and connect with others by creating a document, saving it, and uploading it - and turned it into an easier more convenient process, where people simply type what they want directly into a web browser and click the "Publish" button. The article is particularly relevant in the context of financial planners, as it suggests that as long as financial planning is about getting advice and making a personal trusting connection with a planner, the real online winners will not be those that use the internet to replace real financial planners, but those that use the internet to make it more convenient for clients to find and form a relationship with one.
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 new Bits & Bytes weekly video update on the latest tech news and developments, or read "FPPad Bits And Bytes" on his blog!
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!
