Your Money
Understanding the Philosophy Behind Your Investment Portfolio
JULY 18, 2014
By PAUL SULLIVAN
While always tough, the decision must now be more self-reflective: Do you understand what investment model your adviser is using and know if he or she has the skill to make good on what that approach promises?
In a new report, the consulting firm Casey Quirk evaluates four new investment models being pursued by financial advisers. While the report is intended for investment management companies, it contains valuable insight for investors who are trying to understand how their money is being managed and how their advisers are being paid to manage it.
All four models seek to distinguish themselves from the old model — in which an adviser or wealth management firm essentially relied on a select family of mutual funds for all of a client’s investments, whether stocks or bonds.
While this model seems simple, it is not always in the best interest of the client. And it’s unlikely that all of a company’s investment strategies are going to be top performers. Although 34 percent of advisers use the strategy, it’s eroding for several reasons: First, advisers are looking less at a client’s risk tolerance and an investment’s benchmarks and more at what clients want to get out of life and how much they’re going to need to pursue their interests. Second, more complex products are being created in hopes of delivering the desired outcome in both up and down markets. And third, since many advisers have a fiduciary responsibility to their clients, they have to look for the best-performing investments, not stick with one fund company for everything.
On the surface, the four new approaches might have advantages over the cozy relationship of yore with one fund company. But they all also have pitfalls that an investor needs to be aware of as well.
Here’s a look at each to prepare for your next chat with your adviser.
PORTFOLIO MANAGERS
These advisers try to take on the role of big institutional money managers for their clients. But instead of concentrating on just one type of stock or industry, they aim to make selections across a broad array of investments.
Their pitch to clients is that they, and not a distant fund manager, are ultimately in charge of how money gets invested. They can customize a portfolio for a specific client and manage it to minimize taxes.
It’s a lot of work, though, since those advisers are still going to be asked to do financial planning, offer more general advice — on college savings, for example — and keep bringing in new clients. For this reason, the approach probably works best in teams. Jeffrey A. Levi, a partner at Casey Quirk and one of the report’s authors, says he would be skeptical of a solo adviser who promises to act as a portfolio manager for all clients.
The obvious downside here is that the adviser — who is making more money by managing everything alone — may not be qualified to select investments. According to a separate study by Cerulli Associates, a Boston-based research firm focused on financial services, only 4 percent of financial advisers in 2013 held the chartered financial analyst designation, perhaps the most rigorous investment designation. Some 17 percent were certified financial planners and 11 percent were chartered financial consultants.
Many of the larger brokerage firms have programs that aim to accredit advisers who want to manage clients’ money directly. Sometimes called “reps as portfolio managers,” they may not be true portfolio managers. Instead, they’re executing the firm’s strategies. For these advisers, though, being accepted into the program means they will probably also be able to keep a higher percentage of the fee revenue for themselves.
PASSIVE ALLOCATORS
This group of advisers believes that investing broadly at lower costs through index funds and exchange-traded funds will be better for their clients.
“The adviser earns his fee through asset allocation and financial planning,” said Tyler Cloherty, a senior manager at Casey Quirk and an author of the study. “They punt on security selection and show that asset allocation is more important because it lowers your costs.”
The knock against this approach is that it is passive. Some investors want active management if they’re paying a fee. They don’t see the value in an adviser allocating their money into passive vehicles that will replicate an index.
Clients might also think they can buy index funds from Vanguard and exchange-traded funds from State Street Global Advisors on their own and save even more on fees.
THIRD-PARTY OUTSOURCERS
These advisers put money into more sophisticated funds whose goal is total return and not beating a benchmark. (For example, if a benchmark is down 30 percent but the stock fund is down only 20 percent, the fund beat the benchmark but the client still lost money.)
Mr. Levi said a typical execution of this strategy would be for advisers to put 45 percent of a client’s portfolio equally into three different multi-asset-class investment funds — the Blackrock Global Allocation Fund, for example, invests anywhere it finds the best opportunity — and to give the rest to other managers or to do it themselves.
A concern with this approach is that the adviser may not know exactly what the client’s money has bought, beyond a fund that says it invests globally across sectors. This is where the client needs to be confident that an adviser is doing the due diligence on the various funds, or the three seemingly different multi-asset-class funds could have very similar strategies and holdings.
There is also a secondary risk akin to the one that plagues the old manager selectors who get wined and dined by firms trying to have more money sent their way: Instead of spreading money out among a number of funds all operated by one company, the adviser is putting more money into a single product.
HOME-OFFICE OUTSOURCERS
This approach is similar to third-party outsourcing except that nothing is really outsourced. The responsibility for a broad investment approach leaves the adviser’s office but not the firm itself.
With this approach, a large firm has a central office that is doing all of the research and security selection. It also asks the advisers to funnel money its way. On the positive side, that central hub should have more knowledge than an individual adviser and be easier to monitor than a third-party firm.
There are, however, quite a few negatives, at least in terms of perception. Such a strategy is one-size-fits-all. A client could reasonably wonder what conflicts of interest are contained in the home-office approach.
It also makes the advisers fairly interchangeable: If everything they’re doing for a client comes from the home office, what’s the incentive to stay with that adviser? And do the advisers actually know anything, or are they simply parroting what they’re being told from headquarters?
WHO WINS?
Casey Quirk isn’t saying which approach is best. But the firm does make predictions as to which strategies are likely to gain market share in the next three years: Portfolio managers and third-party outsourcers will gain 8 percent of the money being managed, at the expense of the manager selector approach.
Beyond that, the firm is taking the position that this is a sea change moment for investment management. “We’re talking about the evolution of an industry,” said John F. Casey, chairman and co-founder of the firm. “It’s a relearning about investing and how it’s done and how to apply some of the things that are being done.”
As with any new approach, some things are going to work and some things are going to fail. It’s going to be up to the clients to understand what their advisers are doing for them.
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