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What Trends Are Influencing The Future Of Wealth Management?

By Ed McCarthy The practice of private wealth management continues to change as quickly as it grows. For insight on key business trends that will influence wealth management over the next three to five years, CFA Institute Magazine invited three experts to share their views in a roundtable discussion: Stephen Horan, CFA, CIPM , managing director of credentialing at CFA Institute; Mark Tibergien , CEO and managing director at Pershing Advisor Solutions, LLC (a BNY Mellon company); and Scott Welch, chief investment officer at Dynasty Financial Partners. The following excerpts were taken from the participants’ remarks. A subsequent column will discuss the impact of technology trends. The Impact of Women and Millennials Stephen Horan (CFA Institute) : One thing that I think is getting some more recognition but is largely unnoticed is the increasing significance of women as clientele. Right now, women control about half of the wealth in the US, but they’re estimated to be in control of two-thirds of the wealth by 2020. That’s stunning. The reasons for that are they’re inheriting wealth, they’re entering the work force at a greater rate, and they have a greater longevity, so they hang on to that wealth and as a result have longer retirements. Women also tend to be better savers than men. So you’ve got this changing face of the investor base along the lines of gender, and I think any adviser would tell you advising a woman is very different from advising a man, which is different from advising a couple. We’ve spent so much time focusing on retirees and retirement needs that we’ve sort of taken our eye off the ball that there is an up-and-coming millennial investor base that is becoming increasingly significant in terms of numbers. It’s not so much about wealth yet, because they have yet to accumulate significant wealth, but they’re partly at the core of this robo-adviser movement. And what’s interesting about them (beyond their obvious penchant for digital solutions) is that they disintermediate investment planning. By that I mean you don’t really need an adviser to do all the things that they currently do; [investors] can interact more directly with financial markets. But millennials are also just very different types of investors; they are far more cautious and risk averse than prior generations. For example, they hold about half their savings in cash, compared with less than a quarter for all other age groups. They hold more than twice as much cash. What’s interesting about these things taken together is that we have an investor base that increasingly looks less and less like the adviser base, which is middle-aged men – and that perhaps could be generous on the age side [for the adviser base]. That’s going to continue to create challenges for advisers who are trying to serve clients who don’t share the same perspectives and life experiences, [who have a] penchant for digital solutions and things like that. Talent Shortage Mark Tibergien (Pershing Advisor Solutions): There is an acute talent shortage facing all the financial services. Since 2008, there are 50,000 fewer financial professionals in all. I think the average age for principals is around 61, but the average age for all advisers is about 50. Only 10% of the adviser population is under the age of 35. In fact, the CFP Board [Certified Financial Planner Board of Standards, Inc.] says they have more CFPs over the age of 70 than they do under the age of 30. Whatever you use as your data point, the face of the advisory business is gray and wrinkled, and that is a challenge because we as an industry have not done a good job of making this a compelling industry to work in. We [Pershing Advisor Solutions] asked our Millennial Advisory Board to casually inquire among their friends who are not in this business why they chose not to come into finance. There were three reasons cited: (1) I never studied it in high school and didn’t know it was a career choice; (2) everything I know about the industry is bad; it’s corrupt; it’s not a place that profoundly helps the lives of other people; and (3) it’s just a sales job, and I don’t want to be in sales. So, as a profession, we have a lot of work to do to demonstrate that it’s actually a helpful career; it’s not a sales job. If people are not learning personal economics in high school, that probably explains why people make a lot of bad financial decisions. Fluctuating Prices and Margins Mark Tibergien (Pershing Advisor Solutions): This is the only profession where clients pay for the value they bring rather than the value the professional brings – meaning that, the richer I am, the more that I pay. It’s kind of a classic Marxist sort of approach to pricing when you think about it. What’s happening is that firms do continue to charge basis points on assets, but in many cases, they’re also charging a retainer or a project fee for other services. But it’s not uncommon in the high-net-worth space to actually see a 5-10 basis-point increase in the asset management fee. There are six levers of profitability in a wealth management firm. Pricing is one of them and perhaps the most controllable, but the others relate to volume, meaning that many firms are not growing at a rate fast enough to keep up with withdrawals. Productivity is becoming a real issue, because [firms are] not managing workflow well, and that’s a function of capacity. Third, the service mix may not be well defined, and one reason it’s not well defined is because of the fourth lever, a poor client mix, where the firms don’t have enough clients within their sweet spot. The fifth lever relates to cost control. Finally, bull markets camouflage a lot of sins, and in some respects, we’ve seen this persistent growth in the equity markets, which has allowed for creeper costs to come into a number of advisory firms. If you look at those six levers [pricing, productivity, service mix, client mix, cost control, and creeper costs], you have to say it isn’t just pricing that determines my margins; it’s “How do I manage the rest of the ship in order to produce an optimal bottom line?” Evolving Investment Management Scott Welch (Dynasty Financial Partners): One trend on the investment side is the democratization of the investment solution set that’s available to clients. A second is simply what I call the “race to zero” in terms of active asset management fees. One aspect of the democratization trend is the explosion in the number of liquid alternatives, or alternative investment mutual funds, that are now available. Both the quantity and quality of those strategies continue to improve, and that will make accessible to a wider audience of investors the kinds of strategies that historically have only been available to qualified purchasers or accredited investors. This is not to suggest, by the way, that hedge funds or LPs (limited partnerships) are doomed for the graveyard. I think the good ones will continue to thrive and prosper. But the door is now open to a much wider set of investors to build far more diversified and sophisticated portfolios beyond simply stocks and bonds. A second trend is the explosion of exchange-traded funds (ETFs), so-called factor-based ETFs, and other low-cost structures now available to investors. I don’t like the phrase “smart beta,” but that is the industry shorthand for factor-based ETFs. As a simple example, Eaton Vance got approval not too long ago for a new kind of structure called an ETMF (exchange-traded mutual fund), which is an actively managed ETF. It has the daily liquidity of an ETF, but the fund company doesn’t have to disclose the underlying positions within that ETF on a daily basis like it does with a traditional ETF. Its disclosure is based more on the mutual fund standard of every six months, which will allow that ETF provider to more actively manage the strategy without daily transparency into it. I don’t know if it will be a good product or a bad product, but I do know it will work to drive down the price of active management. When you combine all the different lower-cost investment products that have and will continue to come out, I think it’s undeniable that there will be a deep impact on active managers. Premium managers will always be able to charge a premium price, but many active managers are going to have to change the way that they manage their books in order to justify their higher fees. That’s why I refer to this trend as the race to zero, and it’s happening both at the product level and at the advisory level because of digital platforms. I think we will see a similar impact in the LP and hedge fund space in the sense that the truly brilliant investors will survive and thrive, and they’ll continue to be able to charge premium prices for premium performance. Clients will still be willing to give up liquidity and pay a higher fee in order to get access to that performance. So, I suspect that “star managers” and things like private equity and other illiquid investments will continue to be very popular. But these pricing pressures pose a distinct competitive threat for the folks who aren’t premium providers. The bottom line from an investment perspective is that an end investor now can build a very sophisticated, very globally diversified portfolio at a far lower cost and with far better liquidity terms than that same client could have built even five years ago. Asset managers and wealth managers are going to have to respond to all of these trends. In an era of commoditization of services, they will need a differentiated business model and clear articulation of their value proposition to justify their higher fees. And in the wake of downward pricing pressure, they will need to focus on core competencies and increase their use of outsourcing to drive profitability. Ed McCarthy is a freelance finance writer in Pascoag, Rhode Island. This article originally ran in the September/October 2015 issue of CFA Institute Magazine . Disclaimer: Please note that the content of this article should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

Why Hasn’t Active Investing Outperformed Passive Investing In Recent Years?

By Jason Voss, CFA Over the last several months, I’ve explored why active investing has been unable to outperform passive investing in recent years. My series is called Alpha Wounds, and so far, the issues covered are the unintended consequences of benchmarks on active management, the poor measurement techniques of investment industry adjuncts, and the lack of diversity in the human resources portfolio . In this week’s CFA Institute Financial NewsBrief , we decided to ask our readers their explanation for the lack of active management outperformance. Rare for our polls, we included a large number of options to try and capture a wide swathe of opinions. The options provided appear to have successfully reflected the broad range of views, as 90% of the 743 respondents selected one of the specific choices rather than “other”. Because it is difficult to know the precise reason for choosing the “other” category, it makes sense to recalculate the percentages without including “other”. These modified results are the ones listed in parentheses below. Note: We did receive one e-mailed response from a reader who opted for “other”. The reader explained, “I marked ‘other’ [because] the market is illogical, so trying to apply logic is bound to fail.” Why has active investing been unable to outperform passive investing in recent years? (click to enlarge) Active Managers Can Do Nothing to Outperform About 24% (27%) of respondents believe that the reason for active management’s underperformance is the deleterious effects of high fees on net performance . This is not surprising, given the large number of studies highlighting this fact. Many asset management firms are, in fact, trying to reduce their expenses to mitigate this alpha drag. Another 15% (16.5%) believe that individual investment managers cannot compete with the wisdom of financial markets. Combined, this means that about 40% (43.5%) believe that no matter what active managers do, they cannot beat passive investment strategies. Active Managers Can Do Something to Outperform Of the remaining five options, 10% (10.8%) believe that the concentration of top stocks in indices detracts from the success of active managers. For those not familiar with the argument, it recognizes that indices have built in momentum effects because many of them are market capitalization-weighted. Indices are, effectively, “must buy” lists of securities that create demand, not because of fundamentals, but because passive strategists must buy the securities in order to closely track their index. Controlling for these momentum effects is outside the specific capabilities of active managers as security prices advance. When indices fall, however, active managers not invested intimately with the securities in the index should be able to avoid some of the downside. What hope do active managers have of beating passive strategies? Together, the four remaining options provide some insight. Most importantly, according to 18% (20.2%) of respondents, active managers should minimize their use of benchmarking, style boxes, and tracking error, which lead to a sameness of results. Next, 13% (14.7%) believe that active managers are guilty of short-termism and need to change their investment time horizon and lower turnover. Incidentally, lowering turnover reduces trading costs and will reduce the expense ratio of active funds. Increasing diversity of opinion in active management is believed by about one in 20 respondents (5.5%) to be critical for improving success. Lastly, approximately 5% (5.2%) of those polled think that active managers should improve their due diligence to better compete with passive strategies. Active vs. Passive Tug-of-War Taken together, the above four tactics, all well within the purview of active management, represent about 46% of total responses as compared with the roughly 44% of responses from those who believe active strategies can never beat passive ones. This result indicates a tug-of-war between camps and, to my mind, reflects the conversation occurring in the financial community in the long-running active vs. passive debate. Disclaimer: All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.