Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with an edgy new academic study finding that dual-registered advisors on average charge fees that are significantly higher than standalone RIAs, face more conflicts of interest, and end out with a higher rate of regulatory complaints, raising serious concerns about whether the shift towards, and growing popularity of, dual-registered investment advisors may ultimately face a regulatory backlash.
Also in the news this week is a decision by the New York State Supreme Court to uphold its new Regulation 187 that would require all insurance agents and brokers to meet a fiduciary duty when providing insurance and annuity recommendations to clients, and a blockbuster investigative report from Financial Planning magazine finding that JPMorgan not only inappropriately fired a whistleblower for raising a red flag about its practice of selling proprietary products to fiduciary clients, but appears to have falsified client complaints against the advisor as well… and FINRA still disciplined the advisor and refuses to retract it, while FINRA itself faces the conflict of having JPMorgan’s former top lawyer as a member of its own Board.
From there, we have several technology-related articles, including a look at the growing number of tools for advisors that help to estimate healthcare costs in retirement and plan for senior medical expenses, a look at the slow-but-steady rise of artificial intelligence in wealth management (which thus far, is actually being driven in large part by CRM provider Salesforce), and how “digital marketing” technology is becoming the hot area for advisory firms to spend more on (given the potentially immediate positive ROI for investments into marketing technology versus other areas like compliance tech).
We also have a few articles on investing, including a guide on how to select the right outsourced investment management provider (i.e., TAMP), a prediction that only two types of asset managers (high-performance boutiques and mega-scale behemoths) will survive in the coming decade, and a Morningstar analysis of what exact drives the tax-efficiency of ETFs.
We wrap up with three interesting articles, all around the theme of the ways our future is changing through the power of technology: the first looks at the rise of technology-driven homebuyer services like OpenDoor and OfferPad, that are applying algorithms to turn residential real estate into an “e-commerce” environment with faster buying and selling; the second explores how, despite the eye-popping rise of platforms like Uber, such mega-platforms can still be highly prone to disruption themselves depending on the nature of their networks; and the last looks at how the near-ubiquity of smartphones is leading them to be increasingly used as our identification device, with initiatives underway to digitize into our phones everything from MetroCards to even our Driver’s Licenses.
Enjoy the “light” reading!
Academic Study Finds Dually-Registered Advisors Have Conflicts And Higher Fees (Mark Schoeff, Investment News) – In an academic study released this week entitled “The Worst Of Both Worlds?“, professor Nicole Boyson found that dual-registered financial advisors charge an average of 2.1% on assets under management, significantly higher than the “traditional” 1% AUM fee typically assessed by standalone RIAs, driven at least in part by the more common use of proprietary investment products and revenue-sharing with third-party mutual fund families (resulting in the use of higher-cost mutual fund share classes by dual-registered advisors). In addition, Boyson also found that dual-registered advisors are more likely to be the subject of disciplinary actions brought by securities regulators than standalone RIAs, and more generally face a wider range of conflicts of interest (e.g., being a fiduciary with respect to one investment account, but a sales agent with respect to a cross-sold insurance product). The results came from an analysis of a whopping 6,866 unique RIAs, including approximately 1/3rd that were dual-registered and 2/3rds who were independent, from 2003 through 2016, in addition to a comparative analysis of the ADV Part 2’s for the top 75 dual-registrants versus the top 75 independent RIAs since 2011. The results are notable, not just for the finding themselves, but because the dual-registrant structure has actually become significantly more popular since 2007, when the FPA vs SEC lawsuit struck down an exemption allowing broker-dealers to offer fee-based accounts and instead forced brokers receiving advisory fees to become (at least dual-)registered as investment advisers, and especially since the SEC’s new Regulation Best Interest explicitly gives more flexible standards to dual-registered advisors vs standalone independent RIAs (whereas Boyson’s research suggests that consumers are adversely impacted by the lower standards for dual-registered advisors versus standalone independent RIAs).
New York Best Interest Rule For Annuity & Life Insurance Sales Upheld (Greg Iacurci, Investment News) – Back in July of 2018, the New York Department of Financial Services issued Regulation 187, which would create a uniform fiduciary standard of care for insurance agents and brokers that requires them to act in the best interests of the client when making recommendations with respect to existing or new life insurance or annuity policies, to take effect this August 1st (for annuities) and next February 1st of 2020 (for life insurance). However, the National Association of Insurance and Financial Advisors (NAIFA, which advocates on behalf of insurance agents), along with a group of insurance agencies and brokers, sued the new DFS regulation claiming it was “arbitrary” and “capricious” and that the regulator had not properly exercised (i.e., over-exercised) its regulatory powers in promulgating the rule. But New York State Supreme Court Justice Zwack ruled that DFS acted within its regulatory purview, noting in particular that insurers had submitted a whopping 44,624 new policy forms and types to DFS in just the 6 years from 2011 to 2017 (for various new insurance and annuity products with new riders and features), signifying a level of complexity with respect to insurance and annuities that would cause consumers to rely more heavily on the selling agent’s advice (and thus necessitating that the agent’s advice be regulated as advice), especially given that most of the compensation to the selling agent is still front-loaded even as the lapse rate for such products is almost 50% after 10 years (implicitly suggesting a potentially high volume of inappropriate sales that are ultimately surrendered or replaced). Ultimately, though, it remains to be seen if the industry attempts to appeal the ruling further. But the real question is, given New York’s common role in being a leader in insurance regulation across the country, if its fiduciary rule for insurance and annuity agents might soon be adopted in other states across the country as the industry’s Great Convergence continues.
JP Morgan’s Chase Private Client Group Used False Evidence To Fire A (Whistleblowing) Advisor (Ann Marsh, Financial Planning) – Having originally started out as a bank teller, Johnny Burris worked his way up to become one of the top performers in JPMorgan’s private bank division, but eventually blew the whistle that JPMorgan was engaging in inappropriate sales practices of pushing JPMorgan proprietary products that were breaches of its fiduciary duty. Subsequently, Burris was fired for “being difficult to supervise” and what JPMorgan showed were a series of client complaints – which Burris challenged in FINRA arbitration, though the arbitrators sided with JPMorgan and dismissed the case, painting Burris as a “one-man monsoon” out to destroy the reputations of his managers (with the bank going so far as to point out that Burris had a permit for a gun silencer [as a hunter who had tinnitus from too many years of hunting without ear protection], and convincing FINRA to hire two armed security agents to screen everyone with metal detectors before the arbitration hearings, and implying that Burris would someday try to bring violent retribution against the bank). After the arbitration, though, it has come to light that the client complaints that JPMorgan reported were filed against Burris were in fact manufactured by JPMorgan itself, and that the clients themselves had never made any complaints against Burris. Nor did JPMorgan communicate to the arbitrators that it was near the end of a 5-year investigation where it would eventually admit that Burris’ whistleblower allegations were correct and the company had been breaching fiduciary duty to clients (for which JPMorgan eventually paid $307M in fines, more substantive than even the $185M that Wells Fargo had to pay for its nationwide scandal of opening millions of unauthorized customer accounts). And even after this information came to light, FINRA still proceeded with subsequent disciplinary action against Burris… ironically making Burris as the whistleblower the only JPMorgan employee actually punished publicly over the fiduciary breaches, while even the manager who actually manufactured the false evidence and then gave false statements under oath about their veracity received only a private letter of caution. Ultimately, though, the questions Marsh raises are broader: to what extent did JPMorgan’s top lawyer Stephen Cutler, who sat on FINRA’s Board during much of the conflict with Burris, influence the case, and more generally how can FINRA act as a neutral arbiter of industry disputes when its board is controlled by the financial services mega-firms it is meant to oversee? Especially when even OSHA (which administers the whistleblower protection program for financial services employees) has already found that JPMorgan retaliated against Burris and awarded him $474,000 in damages and legal fees… even as FINRA continues to stand by its disciplinary ruling against Burris.
Tech To Help Advisors Plan For More Years Of Healthcare Costs In Retirement (Ryan Neal, Investment News) – The ongoing rise in life expectancy means retirees will live longer and longer in the retirement phase… and also potentially face more and more years of what can become substantial health care costs (especially as health declines in the later years). Yet in practice, advisors at the most typically just guess at a ‘reasonable’ medical expense amount in retirement, and perhaps add a separate (higher) inflation rate to it, without much further detail (and not personalized to the actual health conditions and needs of the client). Which in turn is leading to more tools for advisors to help estimate what those health care costs in retirement might realistically be. One new tool, Aivante, will collect information about a client’s health history, and their geographic location (given regional differences in cost of living and cost of care) to make a personalized projection of healthcare costs in retirement, and how consumption of those healthcare services may change over time. Another advisor tool, Genivity, looks into lifestyle and hereditary factors to similarly estimate healthcare expenses in retirement (and can be embedded into an advisor’s website as an interactive experience for clients). And Whealthcare goes even one step further, helping advisors work with clients to plan for the “logistics” of aging (e.g., where clients will live as they get older, how they’ll transport themselves when they can no longer drive, etc.), and has tools to assist in the development of a “financial caretaking” plan and a “proactive aging” plan. Ultimately, though, the key point is simply that as advisory firms are increasingly under pressure to add value beyond just managing a retirement portfolio, helping clients to plan for healthcare costs in retirement is increasingly becoming a topic of concern… for which a growing number of tools are emerging for advisors to support in the planning process.
Who Are The Leading Vendors In AI For Wealth Management? (Craig Iskowitz, WM Today) – In recent years, dozens of vendors have launched various forms of Artificial Intelligence (AI) solutions for the financial services industry, including wealth management firms in particular… such that it’s actually now become difficult to figure out which are really gaining traction (or not), and even who the leading vendors are in the first place. The starting point, though, is to recognize that even the label “AI” encompasses a wide range of solutions, from voice recognition tools (used in a wide variety of contexts), to tools that analyze data to provide predictive analytics, or ones that can even generate recommendations (either for the firm itself, or its advisors to use with clients as a form of “augmented intelligence”). And while some industry pundits have predicted that AI will soon replace advisors entirely, arguably the challenge right now is simply that advisors are so immersed in “administrivia” (behind-the-scenes admin and support tasks that still take up nearly 2/3rds of an advisor’s day), such that AI might actually increase the relevance of advisors by freeing up more of their time to actually be advisors giving advice to clients (i.e., where AI doesn’t replace advisors, but automating the behind-the-scenes ‘stuff’ so advisors actually just spend more time advising). In this context, perhaps the biggest player in AI today is actually Salesforce, both with the growing impact of its Einstein for AI tools, and simply because Salesforce is becoming the ‘single pane of glass’ that can gather together data from all sources and produce AI-driven insights and actions (although other players like NexJ Systems, a lesser known CRM vendor, is trying to make gains against Salesforce by targeting even more specific wealth management needs like optimizing the advisor’s book of clients, client profitability, and then service and engagement and determining “next best actions” based on that data, and Microsoft is anticipated to become a contender soon as they have all the core “pieces” necessary). Other emerging vendors include: Personetics (chatbot that helps banks anticipate client needs), Narrative Science and Agolo (draws in data from disparate sources to create human-sounding summaries), Clinc (chatbot used by large firms like USAA for financial-services-specific support needs), and Rage Frameworks (with a wide range of AI-powered products including automated Fund Manager Due Diligence). The real key, though, is whether or how effective firms are at gathering data in order to analyze it in the first place, and figuring out how to structure and tie together a large firm’s data infrastructure.
Independent Advisory Firms Plan To Increase Digital Marketing Tech Budgets This Year (Ellie Zhu & James Gallardo, Investment News) – According to the latest 2019 Investment News Advisor Technology Study, advisory firms have now consolidated around a “core technology stack” of tools that includes a CRM system, financial planning software, and portfolio reporting/management tools (with account aggregation). From there are a range of “mid-tier” tools still gaining adoption, including Document Management, Portfolio Rebalancing, and Risk Analytics, followed by less popular solutions like Digital Marketing tools. However, while digital marketing software has “only” a 29% adoption rate amongst advisors, a whopping 25% plan to add some tool in the category in the coming year, and 50% of firms plan to increase their spending when it comes to digital marketing (by far the largest category of planned increase, even outpacing compliance software tools). The reasoning appears to be, at least in part, the fact that while most advisor software is a “cost”, digital marketing tools are perceived as something that positively impacts the bottom line (i.e., bringing in new business), which makes the software more appealing as a potential to adopt because it can literally more-than-recover its own cost when implemented well (whereas other software is more about freeing up the advisor’s time, or an enhanced client experience). More generally, though, the growing shift towards digital marketing also simply suggests a growing recognition and acknowledgment that digital marketing can be used as one of the foundation pillars of advisor marketing, and isn’t “just” about marketing to young clients alone.
What To Watch Out For When Outsourcing Investment Management (Scott MacKillop, Advisor Perspectives) – When it comes to making the decision of what TAMP (Turnkey Asset Management Platform) to use for outsourcing investment management, the reality is that today’s marketplace offers a wide range of solutions, with varying levels of services (or not), technology (or not), and range of models and investment flexibility (or not). Which makes it important both to find a platform that can provide the solutions the advisor actually needs… and also to avoid platforms that may provide far more than needed (which often includes additional cost that the advisor wouldn’t want to pay if the services won’t be fully utilized anyway). MacKillop suggests the starting point is to understand the different types of TAMPs available, from the “traditional” TAMP that offers in-house investment management services, that the TAMP itself manages, and the advisor is for better or worse tied to those models, to the “platform” TAMP (firms like Envestnet, Adhesion, or SMArtX) that offer access to a wide range of third-party managers who execute the relevant trades for the advisor’s clients via the platform TAMP’s single centralized platform, to the Model Marketplace where advisors get access to model portfolios from multiple asset managers (“strategists” in this context) and the technology helps the advisor facilitate the trades themselves (but generally doesn’t provide any other services), or simply subscribing to models directly from firms that offer them (e.g., InStrategy from Rowling & Associates or AdvisorIntelligence by Litman Gregory) usually for a fixed annual fee (with the advisor left to do all the implementation). A key distinction of this range of options is that there is a lot of variability in the services provided, which may or may not include: discretionary portfolio management (i.e., actual trading and rebalancing on the advisor’s behalf); account administration (opening and closing accounts, disbursements, etc.); performance reporting; billing services; marketing and investment proposal support; ongoing market commentary; technology tools; service team support; and practice management or other educational programs. Each of which may have its own cost (or at least, a different bundled cost depending on the breadth of what’s provided). Ultimately, though, the real question is “Is it for me?”… in other words, as the advisor, is your passion to do the investment management yourself (in which case, outsourcing likely isn’t appealing at all), or whether as the advisor, you’re willing to give up the control to work with a third-party provider (in order to focus your time and efforts elsewhere to grow the business or enjoy better work/life balance).
Only Two Types Of Asset Managers Will Survive In 10 Years (Amy Whyte, Institutional Investor) – After a record-setting 2017, the assets-under-management industry saw its total assets drop by a stunning $3 trillion in 2018 (the first significant year-over-year decline in global AUM since the financial crisis), with net asset flows totaling just $944B (less than half of 2017’s $2.15T). Notably, though, within the asset management industry, the contrast of winners and losers is even more stark, with assets generally flowing to lower-cost passive strategies over active, private strategies over public, and with a widening gap between tech-savvy firms and the rest. Accordingly, industry analyst BCG predicts that there will be only two core business models that “work” for asset managers in the future: either to be a “boutique” firm that can consistently deliver superior performance in its core strategy, or become a “behemoth” that achieves $1T+ of scale and becomes a distribution powerhouse instead. In other words, the boutique managers will compete on their investment talent (and ability to market it), leverage technology to be efficient, and command a premium price for their results, while the behemoth managers will use their economies of scale to try to continue to drive down price while leveraging larger sales and marketing engines and advantaged access to intermediary platforms. The “good” news, though, is that BCG anticipates that strong niche boutiques won’t be edged out completely, as there will “always be room for the top-performing asset managers”. The real challenge will be the firms in the middle, that are too large to stay focused in 1-2 niche strategies, but not large enough to achieve the requisite economies of scale to compete against the mega-firms that all have $1T+ each.
What Drives ETF Tax Efficiency? (Ben Johnson, Morningstar) – While ETFs have long been lauded for their relative tax efficiency compared to mutual funds, in a recent Morningstar Research paper aptly titled “Measuring ETFs’ Tax Efficiency Versus Mutual Funds“, Morningstar actually drilled down to figure out where, exactly, the sources of ETF tax efficiency are compared to actively-managed (or index) mutual funds. One key driver is simply that the overwhelming majority of ETFs (84%) track some kind of market-cap-weighted index, which means there’s relatively little turnover in the fund to trigger tax events in the first place, with a median turnover rate of just 17% (compared to 48% for the average active mutual fund). However, non-cap-weighted strategic beta ETFs have a turnover rate of 47%, very similar to active mutual funds, while cap-weighted index mutual funds have a turnover rate of only 19% (similar to ETF index funds), which means in practice the turnover factor is less a function of ETFs in particular, and just that the majority of ETFs invest in a different (cap-weighted indexing) strategy than most mutual funds (which are still more actively managed). The real driver of ETF tax efficiency is the structure by which it adds and removes securities held by the ETF, and the ability to “purge” low-cost-basis securities in-kind as part of the creation/redemption process for ETFs (thus why ETFs have a slightly more favorable tax profile than mutual funds even when tracking the same index, and why mutual funds are more prone to tax events when facing net outflows as compared to ETFs). However, it’s important to recognize that ETFs are not immune to tax events, not only because they still distribute any interest and dividends, but because ETFs can still face capital gains distributions (albeit not common).
The Future Of Housing Rises In Phoenix (Ryan Dezember & Peter Rudegeair, The Wall Street Journal) – Residential real estate has long been a fragmented industry, driven by local real estate agents and local landlords coordinating with local buyers and local sellers. Now, however, technology firms are looking to make the real estate market more efficient – or more accurately, to leverage technology to take advantage of market inefficiencies – with newcomers like OpenDoor and OfferPad, and real estate pricing/listing website Zillow Offers, that are using their analytics and algorithms to buy and sell homes themselves. In fact, in the Phoenix area alone, those three firms bought nearly 5,000 houses (almost 1 of every 20 sold), with a goal of profiting on the resale through a combination of earning the real estate transaction fees, and perhaps putting a little work into fixing up the house for resale, or simply finding a good deal (e.g., that house with a sunny kitchen in a good school district!). Notably, “house flipping” in this manner isn’t new, but the distinction is that these new firms are attempting to do so both in a higher volume manner (buying 5,000 homes in a year, as compared to a flipper who might do only 1-2 per year), which in turn allows them to price the sale more aggressively (making less per house but more on the total volume of sales). The appeal from the seller’s perspective is that it makes the process of selling a home far easier, often requesting a bid from one of the platform simply by filling out a form and uploading some pictures and then getting an offer, which they can take without needing to work around the (human) buyer’s needs or whether the buyer will be able to get a mortgage and close on the purchase (and since the platforms all assume they’ll need to fix up the homes anyway, there’s no pressure for sellers to engage in extra maintenance fixes or complex staging to make the house more appealing for sale). The new platforms also make the process of buying simpler, as buyers no longer need to coordinate with sellers, and can simply use the companies’ own apps to open and access a potential new home for a walkthrough. The concern, though, is that ultimately such mega-buyer platforms could actually edge out traditional buyers, as sellers will likely prefer the all-cash immediate-close offers of OpenDoor or OfferPad over a buyer who has to secure a mortgage and might flake out… but in the end, such transactions that bring “e-commerce to residential real estate” may still make the housing market more efficient and better priced over time. And notably, they also appear to be making the market for various home contracts more robust and stable, by becoming centralized high-volume purchases of the services of various local contracts.
Why Some Platforms Thrive And Others Don’t (Feng Zhu & Marco Iansiti, Harvard Business Review) – While the “platform” model of companies like Uber and Airbnb have become all the rage, they are also quickly becoming a very large high-stakes marketplace. A case in point example is in China, where Didi became the world’s largest ride-sharing company (25 million trips per day in China!), after merging with its rival Kuaidi and pushing out Uber by offering deep subsidies to riders and drivers and then raising prices after the competition left… only to have Meituan (which provides other online-to-offline services like food delivery) enter the ride-hailing market to compete with Didi, which it did by offering even more subsidies to riders and drivers (gutting Didi’s margins), and leading Didi to launch a competing food delivery service (heavily subsidizing those prices in an effort to disrupt Meituan!). From the classic business perspective, the surprise of all this competition is that in theory, platforms that have already reached scale (like Uber and especially Didi) are supposed to become so dominant as “winner-take-all” markets that others can’t compete… which has been the case with some (e.g., Alibaba, Facebook, and Airbnb), but not others (e.g., Uber, Didi, and Meituan). Zhu and Iansiti suggest that ultimately, the key distinction is the nature of the company/service-provider networks that get created (rather than traditional business bottlenecks), and that networks that are clusters of local concentrations (e.g., Uber or Didi with one city of drivers and riders at a time) are fundamentally less robust than truly global networks (e.g., Airbnb that facilitates renters and property owners literally around the globe), which makes it harder for providers to “multi-home” (e.g., offer services on multiple platforms at once, such as driving for Lyft and Uber at the same time, which leads to brutal price competition that may inhibit the platforms from ever being profitable). Ultimately, the opportunity for such companies is to “bridge” their networks, crossing over their users to other related services that makes it harder to switch platforms. The core point, though, is simply to recognize that while platform business models have been unique and astonishing for their ability to grow so large so rapidly… the “easy” by which they scale is also the door through which competitors can continue to enter to challenge their economies of scale.
Soon Your Phone Will Be Your Driver’s License, MetroCard, And More (Joanna Stern, The Wall Street Journal) – The rise of the smartphone and an increasingly wide range of ways to pay digitally for products and services is reducing how many “cards” of various types we carry around, to the point that for many, it’s little more than a driver’s license, MetroCard, and perhaps a work ID (and maybe a backup physical credit card just to be safe). In fact, while the NY Metropolitan Transportation Authority currently prints 80 million MetroCards per year, by July of 2023, it hopes to print zero and convert them to a new smartphone-based tap-to-pay system (or a credit card, or a mobile wallet like Apple Pay or Google Pay). And in Delaware, there’s a new “mDL” initiative action, a pilot program to create a mobile Driver’s License (rolling out in partnership with identification-technology company Idemia), with the added benefit that a validated mDL allows you to get carded and only show your name and age and not your address and other personal info (or more generally, to have your Driver’s License information validated by others, without showing unnecessary personal information). And a growing number of companies and colleges are working on smartphone-based digital versions of identification to move around the office or campus as well (potentially augmented by various forms of biometric identification). Of course, questions remain about what personal information will be tracked by the companies themselves, and the security of all the digital data… though ironically, in a world of increasingly frequent cyberattacks and identity theft, perhaps the reality will be that digital identities will simply be easier to fix and rebuild after an identity theft occurs (or faster to halt in the process of occurring)?
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
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 as well.