Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the big industry news that wirehouse Morgan Stanley is acquiring E*Trade for $13B, in a major shift for the wirehouse to move (back) towards the mass affluent with a more online digital offering via E*Trade, which opens a new pathway to E*Trade's significant business of administering employer stock plans (that can now be referred to Morgan Stanley's own advisors)... and that raises significant questions about whether E*Trade will even remain in the RIA custody business (and/or whether independent RIAs would want a custodian owned by a wirehouse competitor), and in turn, whether the potential loss of E*Trade as an RIA custody option could put even more pressure on the Department of Justice's view of the prospective Schwab-Ameritrade merger (which may have even been a factor in Morgan Stanley's timing to announce the E*Trade deal in the first place?).
Also in the news this week is a new FINRA exam sweep of how brokerage firms (including the ones serving as RIA custodians) plan to make their money in a zero-commission future and whether the prospective conflicts of interest in their alternative revenue streams are being sufficiently disclosed to clients (and their advisors), and the emerging surge in a new kind of "Registered Index-Linked Annuity" (the "RILA") that is becoming an increasingly popular risk-managed variable annuity alternative to the living benefit riders of old.
From there, we have several practice management articles, including a review of the big themes from the recent T3 advisor tech conference (from more mobile apps and integrations to an outright focus on advisor time efficiency), the ongoing rise of virtual firms (from young advisors to more senior, small firms to large), and a fresh look at other ways to measure what constitutes a "good" advisory firm (beyond just rankings of their AUM and recent growth).
We also have a few investment-related articles, from a look at the new SOFR rate that is expected to replace LIBOR in two years (and the complications that loom between now and the end of 2021 for that transition to happen), the concerns of a recent proposal from the mutual fund industry to shift more of their disclosures to be online (instead of mailed or emailed out directly), and a candid look at whether direct indexing is really a threat to the ETF industry (or "just" a kind of alternative product for certain client needs... albeit one that might still soon become a trillion-dollar AUM opportunity?).
We wrap up with three interesting articles, all around the theme of better communications with clients: the first looks at what it takes to finally see clients who are difficult to schedule for meetings (recognizing that the real problem may be that the advisor's 'check-in' meetings aren't really actually all that valuable to the client and that a better purpose is often necessary!); the ways that advisors sometimes unwittingly damage their empathy with clients in an attempt to prove or defend their own professionalism; and some tips on how to have and get through the sometimes-difficult conversations with clients that arise (and how best to introduce a difficult conversation where there's never a 'good' time to bring it up)!
Enjoy the 'light' reading!
Morgan Stanley Is Buying E*Trade For $13B And Casts Doubt On Future Of E*Trade Advisor Services (Jeff Benjamin, Investment News) - The blockbuster news in the industry this week is the announcement that wirehouse Morgan Stanley is buying online broker (and RIA custodian) E*Trade Financial for a whopping $13B; combined, the joint platform would house almost $3.1 trillion in client assets, $8.2 million retail clients, and $4.6 million employer stock plan participants (a major component of E*Trade's business). According to Morgan Stanley's own Investor Deck about the proposed acquisition, the goal of the transaction is to expand Morgan Stanley's reach into the mass affluent (akin to Merrill's rapidly-growing Merrill Edge program), and provide Morgan Stanley with a full range of offerings (from "full-service" wealth management for the high net worth, to a digital direct-to-consumer offering for the middle market) in order to compete with other fast-growing retail brands like Schwab and Fidelity. The move is to some extent an about-face for the wirehouse, that in recent years has been pushing their brokers towards higher minimums (e.g., $500k+), and instead appears to be viewing the market now as a place to develop advisor talent (where newly minted CFP professionals can serve existing and inbound clients virtually via the digital platform instead of being required to prospect for their own). Notably, the size of the deal is also anticipated to draw government scrutiny (including not only the Department of Justice, but also the Federal Reserve since Morgan Stanley is also a bank that is deemed to be a "significant financial institution", which could easily take until the end of the year), though commentators suggest the deal is probably more likely to go through (as in the context of the retail investor focus of the transaction, Morgan Stanley still doesn't hold nearly enough market share for anti-competitive concerns). On the other hand, the news is raising concerns about the future of E*Trade's recently-acquired (from Trust Company of America) RIA custody business, which Morgan Stanley characterized as "relatively small" (with $20B of AUM and 230 advisory firms) and not a primary motivator for the deal (recognizing that even if Morgan Stanley did want to focus on the RIA custody offering, it would be difficult to do so as a wirehouse brand that many RIAs proactively compete against, and instead would more likely be used as a waypoint for departing Morgan Stanley brokers who want to go RIA, akin to Wells Fargo's recently launched RIA offering). In fact, the potential elimination of yet another RIA custody player is also raising questions of whether Morgan Stanley's acquisition of E*Trade could itself put even more pressure on the anti-competitive concerns of the prospective Schwab acquisition of TD Ameritrade, as fewer and fewer options remain for RIAs that don't want to work with Schwabitrade or Fidelity?
FINRA Launches Exam Sweep Of No-Trading-Commission Broker-Dealers (Melanie Waddell, ThinkAdvisor) - This week, FINRA's Trading & Financial Compliance Examinations division announced that it was launching an exam sweep of brokerage firms that have cut to zero-commission trading in recent months (e.g., Schwab, Fidelity, TD Ameritrade, Wells Fargo, E*Trade, etc.). While the specific firms being examined have not been announced, FINRA indicated that its primary concern is that earning $0 on trading commissions could unduly influence how brokerage firms execute their orders (e.g., routing trades to certain partners to generate payments for order flow given the lack of trading commissions for those orders), how customers are selected for zero-commission (or not), which securities are eligible for zero-commission (or not), and any other areas of the brokerage business whether business practices may be changing (e.g., an undue incentive to drive customers into proprietary funds or cash sweeps to make up for lost commission revenue). In other words, FINRA is investigating both the extent to which zero-commission trading may have introduced new conflicts of interest for brokerage and custody firms, and whether or to what extent such newfound conflicts are being disclosed sufficiently to the customers (and/or advisors) who may be impacted. Notably, an exam sweep does not necessarily indicate that any kind of wrongdoing is occurring, but does suggest that FINRA has significant concerns that there may be issues discovered, and once better identifying current business practices in a zero-commission world and how they are being handled, may or may not put forth new guidance in regulations later in 2020 or beyond, based on the results of their examination (either to force new/additional disclosures or to limit certain business practices).
Annuity Sales Hit Record In 2019 Thanks To New Breed Of VA (Emile Hallez, Investment News) - According to the latest data from LIMRA, variable annuities had their best year of flows since 2008, topping $100B of new assets, driven by an explosion of new "Registered Indexed-Linked Annuities" (RILAs) that were up 55% (comprising more than $17B of the $102B total). RILAs are offered on a variable annuity chassis (with sub-accounts holding market investments that can go up or down), but offer caps on investment returns or losses (akin to structured notes), making them more appealing than many fixed annuities (with the additional upside of higher caps on growth), but increasingly popular as a way to manage downside risk as well (especially given the volatility in the 4th quarter of 2018 that helped to drive stronger RILA sales in 2019). Notably, 'traditional' (non-RILA) variable annuity sales continue to decline, though (down 5% from 2018), as the appeal of living benefit riders continues to decline since the financial crisis due to higher costs and more limited benefits; consequently, investors overall put more money into various forms of fixed and indexed annuities (almost $140B combined) than variable annuities (with only $102B, of which $17B was RILAs). On the other hand, companies like Lincoln Financial are noting that the launch of their Lincoln Level Advantage RILA last year accounted for nearly 20% of all its annuity sales, and was the most successful product launch the company has ever had, suggesting a growing focus and more RILAs likely to roll out in 2020.
Saving Time & Tech Integrations Are Big Themes At T3 (Ryan Neal, Investment News) - This week was the annual T3 Advisor Technology conference, and the big theme of this year's event was integrations, and specifically the ways that integrations can help advisors to (finally!) save time in their daily business activities. From LPL highlighting its new tech integrations and refinements, to Fidelity's expanded Integration XChange, and new Orion integrations as well, more and more companies are seeking to become the advisor's central workstation and dashboard from which all other tools can be accessed and through which a unified base of client data can flow (to hopefully improve business efficiencies). Also notable at T3, though, is a rising focus on "Artificial Intelligence" (AI), albeit with some debate about its proper uses and efficacy, as on the one hand there have been a number of recent controversies about AI (e.g., Amazon's AI program for reviewing resumes that unwittingly turned out to express a gender bias against women in selecting applicants to be interviewed), but on the other the potential for AI shows the opportunity to expedite and improve much of the financial planning process itself (as exemplified by the launch of the new FP Alpha platform). Other themes included: more focus on mobile app development for advisors, the role that technology efficiencies can play in the challenges of fee compression, and the rise of "advisor platforms" that seek to further refine and improve advisor efficiencies (but also, in the process, will increasingly necessitate that advisors figure out what the "right" platform is to build around in the first place!).
Happy Accidents Or Planned, Advisors Enjoy Virtual Practices (Jerilyn Bier, Financial Advisor) - In recent years, the availability of the internet has spawned a boom in "virtual" financial advisors, from mega-firms like Vanguard Personal Advisor Services and Merrill Edge, to fast-growing venture-funded firms like Personal Capital and Facet Wealth, and all the way down to solo financial advisors running 'location-independent' advisory firms. For many firms, the appeal of working virtually is an opportunity to reduce costs, either eschewing rent entirely and working virtually from a home office, or at least being able to set up offices in a less expensive area with lower rents (and/or to attract talent in less expensive parts of the country). Alternatively, for other firms, the driver to work virtually is about not being restricted to the local geographic area for prospective clients to work with, which can either expand their market of opportunities (e.g., if in a small town/rural area), or make it easier to focus on a niche or specialization (without being tied to only the niches that fit the advisor's local geographic footprint). In other cases, though, the desire to work virtually is more of a lifestyle decision, either driven by a desire not to be tied to one geographic area (e.g., an advisor who needs to move every few years for a spouse's career), or a change in life circumstances that 'forces' the advisor to have to start working with existing clients virtually from a distance (which can then morph into a model for the entire firm). Although ironically, many advisors' firms report that once going virtual, often even 'local' clients decide to meet using video conferencing tools, if only to avoid the local drive and commute to the advisor's office!
Measuring The Quality Of An Advisory Firm (Bob Veres, Advisor Perspectives) - Many or even most financial advisors bristle at the steady flow of "Top Advisory Firms" lists put out by various trade publications that in the end, often do little to measure which advisors are really "top" - as measured by any objective evaluation of quality - and instead look simply to the advisory firm's assets under management. Of course, to some extent, a firm's AUM and growth rates can at least be a proxy for quality - as presumably, if the firm didn't do good work for its clients, it would have poor retention rates and be unable to grow large and quickly (when clients are leaving as quickly as the firm can attract them). Still, though, there are firms up and down the size scale that deliver a high level of quality to clients, and in fact often some of the most client-centric firms deliberately remain "Small Giants" that take a proactive focus on being "great" more than just trying to be "big". So how should advisory firms be measured to evaluate their quality? Brent Weiss of Facet Wealth has proposed a new "RIA Health Index" as one way to measure quality, breaking the firm's value into multiple categories: 1) Quantitative Metrics (growth, productivity, profitability, customer satisfaction, which can be managed proactively and evaluated via industry benchmarking studies); 2) Qualitative Metrics (the firm's vision & values, mission, and the extent to which its human, technological, and financial capital is aligned with its strategy, recognizing that firms with the clearest vision of where they're going tend to be the most effective at getting there); 3) Equity Management (the business' financial management, cash flow quality, transferability, and culture, recognizing that two firms may be similar on paper in purely financial metrics may be radically different in the enterprise value of those cash flows); 4) Sustainability (operational leverage, human capital, leadership, continuing and succession planning); 5) Digital (technology, cybersecurity, and data security, given both the risks to the firm from hackers and the importance of leveraging technology efficiencies); 6) Risk (business risks, legal and compliance structure, credit/debt, and ability of the firm to maintain client confidentiality and protect its brand); 7) Clients (unique value proposition, client satisfaction rates, quality of planning, breadth of services); and 8) Responsibility (the firm's involvement in its community, advancing the profession, and diversity & inclusion). Of course, the caveat is that the range of areas to evaluate are so broad, and often only available internally, that it would be difficult to objectively measure and 'score' all the domains to compare across firms... which, ironically, further illustrates the challenge that clients themselves have in the first place in trying to determine who the 'right' advisor is with the quality to serve them well?
The World's Most Quoted Interest Rate, LIBOR, Has Two Years To Live (Anneken Tappe, CNN Business) - LIBOR is the London Interbank Offered Rate, and it is the benchmark rate used for nearly $200 trillion in various contract and debt instruments, including a wide range of consumer loans and mortgages. However, during the financial crisis, it turned out that the LIBOR rate had been manipulated, with certain financial firms trying to rig the rate to generate greater returns or hide their financial risks, leading to a decision that LIBOR would be retired by the end of 2021. Unfortunately, though, it's not yet clear what the replacement rate will be. The leading proposal is SOFR - the Secured Overnight Financial Rate - set by the New York Fed and based on actual overnight transactions of financial companies borrowing cash using US government debt as collateral, and harder to manipulate because it is based on real transaction lending rates (unlike LIBOR). However, not all financial institutions are on board with SOFR, noting that last September the SOFR rate itself spiked (albeit temporarily, but forcing the Fed to inject billions of cash into the system to shore it up); in addition, SOFR may not sufficiently reflect credit risk in the marketplace (since it is all based on overnight government-collateralized lending), and because it's only an overnight rate, it lacks a term structure (rates at different time horizons) that itself is often used as an indicator about the direction of interest rates (unlike LIBOR which has a 3-month rate as well, and for which the New York Fed's often 30-, 90-, and 180-day SOFR averages may not be sufficient as an alternative). Given the concerns, adoption and switchover to SOFR has been slow... which is concerning only because the time itself to make the switch could be challenging, as while derivatives contracts are governed by the ISDA master agreement (which itself can make the switch to SOFR quickly), the $5 trillion loan market would require a substantial number of loan documents themselves to be re-written (a potentially very-time-consuming endeavor with limited time). And in the end, it still remains to be seen how well-aligned the new SOFR rate will be to the soon-to-be-old LIBOR rate, and whether various consumer loans themselves - and the associated payments - may get repriced under the new interest rate structure.
Mutual Funds Are Still Keeping Secrets (Arthur Levitt, The New York Times) - Last fall, the Investment Company Institute (the lobbying arm for the mutual fund industry) asked the SEC to reduce its current disclosure requirements for mutual funds, which currently includes an obligation to send investors information about the fund's performance and fees every 6 months, but which ICI suggests should be changed to a single once-a-year postcard alerting investors where to find that information on the internet instead. Yet while the internet is often quite effective at providing consumers access to information, the reality is that not everyone takes the time to do so, and putting information one step further removed - even if "easily" accessible via the internet - can ultimately reduce the flow of information. For instance, Levitt notes that when the SEC gave investors the ability to vote their proxies on the internet in 2007, the percentage of individual investors doing so actually fell significantly. In addition, an analysis of ICI's proposed reporting mechanism also found that just half of the investors looking at its prototype disclosure could even identify the fund with the lowest expense ratio. And the SEC already shifted just two years ago to allow mutual funds to "just" send three notices per year - one about where to find a prospectus online, and two about where to see recent performance and costs (which under the new proposal would be consolidated into one annual notice instead). So what's the alternative, in a challenging information-overloaded world? Levitt suggests the need for a simple one-page summary of a mutual fund's fees, top-10 holdings, and recent performance against major indexes - a kind of mutual-fund-company-produced Morningstar report, with a standardized structure that all mutual fund companies would have to follow, and then email directly to investors on a regular basis). Ultimately, though, the fundamental point is simply that it often seems "easier" to reduce disclosures and the flow of information transparency during a bull market - when fewer investors are asking questions anyway - but that it may inevitably bring regrets that can threaten trust in the entire financial services industry in the next bear market when it turns out the lack of information mattered after all.
Direct Indexing To Kill ETFs? Not So Fast... (Lara Crigger, ETF.com) - The big buzz in the world of ETFs in recent years is whether "Direct Indexing" - where the investor uses technology to buy all the underlying stocks in an index directly and eschews the ETF wrapper (and its associated cost) - could become an ETF killer even as ETFs themselves are experiencing rapid growth, but Parametric Portfolio Associates (itself one of the largest direct indexing players, with over $170B of its $258B of AUM in such strategies), suggests that direct indexing still may not be the ETF category killer (or at least not for a while yet). As while the sheer size of markets suggests that direct indexing could someday be a trillion-dollar AUM solution, it is still ultimately more of a 'product' unto itself with very specific use cases. For instance, given that a direct indexing provider themselves will still have a cost, usually avoiding the already-incredibly-low cost of ETF wrappers is not itself a driver for direct indexing adoption. Instead, the primary appeal of direct indexing in practice has been customization - for instance, refining an index fund to build one's own factor weightings, or ESG weightings, etc. - but not everyone needs or wants such customization, may not have long enough time horizons, or may already be tax-exempt and not benefit from direct indexing's tax-loss harvesting benefits either. Though notably, such customization does have a particular appeal for the work that advisors do with clients, where an expert is involved who can help facilitate such customized portfolio construction for a particular client's goals or personal values. On the other hand, the sheer overhead costs and trading expenses of implementing direct indexing have also been a constraint, but one that is disappearing in a zero-commission world, suggesting that the asset minimums for such solutions may soon fall (e.g., Parametric's own minimum is $250k). Still, though, the nature and extent of customization means direct indexing may be difficult as a direct-to-consumer (e.g., "DIY") option, and advisors who are involved will likely still have to charge their own fees for their role in the process (which again makes direct indexing less about cost savings, and more about paying for complexity in order to get additional customization instead).
Getting More Return Calls From Clients When Scheduling Meetings (Steve Wershing, The Client Driven Practice) - One of the sometimes-surprising challenges for advisors who have been in the business for a long time is the difficulty in getting long-term ongoing clients to actually come in for a review meeting (not to mention the difficulty of getting some newer clients to schedule their meetings to provide data and go through the financial planning process in the first place). Yet as Wershing notes, having unresponsive clients doesn't just mean it's time to set up a more rigorous follow-up process to finally get them to schedule the meeting; instead, it should be viewed as important information about the advisor-client relationship and the meeting itself. After all, almost by definition, a client who is slow to respond to a meeting request isn't placing much of a priority on meeting with the advisor... which means the better approach is not to improve the meeting-scheduling process, but to figure out why the meetings aren't a higher priority for the client in the first place! For instance, is the outcome or purpose of the meeting really clear for the client (e.g., a "check-in meeting" just to touch base that doesn't have a clear purpose may cause the client to balk because they didn't actually have anything on their mind to check in about... even if the advisor did!)? Similarly, is there a clear value proposition to every meeting for the client, to justify to them why it's worth the time and effort for the client to gather requisite information, or drive to the advisor's office, etc.? And is the end value proposition really one the client values (e.g., if clients already feel like they get sufficient information about their portfolio from their client portal, maybe they don't feel the need to meet about it as well!?)? Which, notably, also means considering whether there's a better non-meeting way to accomplish the goal (that saves the client time and hassle and makes it easier for them)... and then (re-)consider a better meeting purpose for the advisor who wants to meet with the client more often (e.g., to also help support the ongoing client relationship as well).
5 Common Ways Advisors Unwittingly Destroy Empathy (Matt Oechsli, The Oechsli Institute) - There are certain professions, like medicine, where consumers (or in this case, patients) naturally expect empathy from their doctors when discussing sensitive and challenging physical health issues. Yet Oechsli notes that in the end, financial advisors also relate to their clients about health - their financial health (which itself can be connected to personal and physical health) - and an effective show of empathy is equally relevant in the advisor-client context. Yet in practice, often the pressure to also be 'the expert' in the advisor-client relationship unwittingly leads advisors to show a lack of empathy in an attempt to prove or defend their perceived 'professionalism'. For instance, in the midst of a raging bull market, it's common for clients to want to get more aggressive or complain about their "good-but-not-good-enough" returns... so as an advisor, do you respond by trying to show them how they're wrong about the numbers or trying to take more risk, or instead reply with empathy (e.g., "I know these bull markets can make you feel as though you’re losing out, however for the long-term, adhering to the amount of risk we agreed upon taking with your family’s portfolio, everything is working according to the plan we established — we’re on track")? Or common situations where empathy accidentally fails include defensiveness (e.g., trying to defend fees that are different for clients who are friends or family members, instead of saying "Your question regarding how the firm charges fees for household accounts is a fair question. It’s rather confusing and fees could be better aligned. Let me look into it and see where I can make the fees more unified"), martyrdom (e.g., blaming the firm for sending too much correspondence to clients, instead of saying "It’s easy to feel overwhelmed with the amount of correspondence clients receive from financial institutions, and the statements can be very confusing. How about we schedule a meeting for the end of next month, which will give you time to collect every piece of correspondence and bring to our meeting? Then I’ll go through it all, piece by piece, with you, show what to trash and save, and teach you a shortcut for reading the statements."), counter-attacks (e.g., responding to criticism with criticism in return, such as complaining about clients who aren't following the advisor's recommendations), or premature problem solving (trying to tell the client what they should do to move forward when they're stuck, instead of helping them to figure it out for themselves).
Having Difficult Conversations: A Skill Every Financial Advisor Needs (Ashley Hunter, XY Planning Network Advisor Blog) - For many people, there are few conversations more chilling than the ones that start with "hey, we need to talk..." but the reality is that when difficult conversations loom, it's still better to confront difficult conversations than ignore the proverbial "elephant in the room" that may crowd out any other constructive problem-solving anyway. Of course, the reality is that because difficult conversations are difficult, the starting point is to always be investing into the trust of the relationship to be able to have frank conversations in the first place (for which Hunter suggests "The Outward Mindset" from the Arbinger Institute as a good starting point to shift one's own mindset from being too inwardly focused to be more outwardly trust-building and seeing others as people who matter as much as we matter to ourselves). It's also important to recognize that getting through a difficult conversation also entails really hearing what the problems are, and being able to actively listen without moving too quickly to the problem-solving phase (so as a starting point when preparing for a difficult conversation, remove your own distractions by silencing phone ringers, turning off notifications, etc.). In turn, proactive listening can help one to ask questions that probe the issue further and to uncover the real needs or challenges that have spawned the problematic situation (and then trying to restate and reflect what was heard to further affirm the connection in a difficult moment). For some, the biggest challenge around a difficult conversation is that it can also lead to the rise of strong emotions, which can't necessarily be avoided; however, it is within the advisor's control to manage their reaction to those strong emotions (e.g., take a pause and breathe from time to time, to help de-escalate any rising tension), and then give the client time to process their own emotions. And for those whose biggest struggle is to get those difficult conversations started - the kind where there's never really a 'good' moment to do so - Hunter suggests that the most straightforward approach may simply be to ask permission to have the conversation in the first place (which also helps to empower the recipient to make the decision that they are ready to deal with the issue and have the conversation).
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.