Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with the big news of two major acquisitions in the world of advisor financial technology (FinTech), including Fidelity’s purchase of financial planning software provider eMoney Advisor (and their popular PFM client portal) for more than $250M, and SS&C’s acquisition of Advent for a whopping $2.7B (raising questions of what the future may hold for Advent Axys and Black Diamond).
From there, we have a few more technical financial planning articles this week, including: a review of the new Section 529 ABLE accounts for disabled beneficiaries; new research from retirement researcher David Blanchett on the optimal asset allocation glidepath in retirement; a look at the emerging use of longevity annuities for retirement (including in qualified retirement accounts); and some ideas of how to generate “tax alpha” for clients.
We also have several practice management articles, from a look at whether it’s better to hire a new or more experienced financial planner for your advisory firm, to whether and how advisory firms can really scale as they grow (and the problems to watch out for in trying to do so), and a discussion of how one financial planner has increased her closing ratio for new clients from 20% to more than 90% by focusing heavily into a niche and then refining her services and sales process to appeal to her unique clientele.
We wrap up with three interesting articles: the first looks at whether the debate about how to fund more exams for SEC-registered investment advisers is misplaced, and whether there’s really any actual problem with the current (admittedly low but not historically aberrational) exam rate at all; the second looks at new questions being raised about whether two-tier AUM fees (e.g., a lower fee on cash and fixed income, and a higher fee on equities) is creating a problematic conflict of interest for advisors who are now financially incentivized to invest their clients in a riskier manner; and the last looking at a recent report on the world of financial advisors in the UK, which two years ago implemented an industry-wide ban on commissions and finds that the sky is not falling after all (though some early advisory gap is emerging).
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end, including a further discussion of the Fidelity acquisition of eMoney Advisor, SS&C’s acquisition of Advent, and the recently announced (and somewhat dismal) results of the SEC’s cybersecurity sweep of broker-dealers and RIAs! Enjoy the reading!
Weekend reading for February 7th/8th:
Fidelity Acquires eMoney Advisor PFM Dashboard, Gets Financial Planning Software Thrown In? (Michael Kitces, Nerd’s Eye View) – The big news in the world of financial planning this week was the announcement that Fidelity acquired financial planning software maker eMoney Advisor (in a deal rumored to have been for more than $250M). Yet while eMoney Advisor was a “fine” and competitive financial planning tool, the question has arisen why Fidelity would have made a move to acquire the software provider, as an RIA custodian acquiring financial planning software is new ground in the financial services world. In this blog post, I make the case that the “real” story of the eMoney Advisor acquisition was not its financial planning software, but its Mint.com-style Personal Financial Management (PFM) client portal, a tool that Fidelity could not only deeply integrate to its systems and roll out to advisors on its Institutional platform to help them compete with “robo-advisors”, but also use as a direct-to-consumer offering in its retail branches to give its own financial consultants “Personal Capital” level capabilities, and given eMoney Advisor’s existing client base there is already a veritable “treasure trove” of potential big data insights that Fidelity might potentially tap. Notwithstanding the crossover potential to Fidelity’s other divisions, though, the company maintains that eMoney Advisor will still be run independently, and that it will continue to maintain its integrations and relationships with other custodians as well, implying no disruption to current non-Fidelity eMoney Advisor users (though it wouldn’t be surprising to see Fidelity provide a discount on the software to advisors using its custodial platform at some point in the future).
SS&C Buys Advent For The Geneva Crown Jewels So What Happens To Black Diamond And Advent Axys? (Brooke Southall, RIABiz) – Also in the FinTech news this week was the ever-bigger (financially) acquisition deal for Advent Software, purchased by SS&C Technology Holdings (a “technology roll-up” company with more than 40 software firms) for a whopping $2.7B. While Advent is most popular amongst independent advisors for its Advent Axys portfolio accounting and Black Diamond portfolio reporting tools, though, the article notes that SS&C’s primary goal may have been to acquire “Geneva”, the performance-reporting product that Advent provides to roughly 400 “super-premium” asset managers (e.g., hedge funds, prime brokers, and other elite firms), so that it can cross-sell other SS&C Technology tools t those firms. And notably, an estimated 2,400 SS&C personnel already use Geneva themselves within SS&C’s various businesses. Yet given SS&C’s apparent focus on Geneva, it raises the question of what the fate will be for the Axys and Black Diamond solutions, whether the product will receive the same focus under SS&C, and/or whether it might be spun off in the future; notably, though, follow-up coverage from RIABiz on the acquisition citing SS&C executives suggests that the company may in fact be prepared to reinvest into Advent and make product improvements that its advisor users have been waiting for given the growth in the RIA industry, even while others still question whether a company that has the United Kingdom Treasury as a client will really be interested in a “run-of-the-mill” RIA with $150M of AUM.
ABLE Accounts: An Option for Families with Disabled Children (Randy Gardner & Leslie Daff, Journal of Financial Planning) – As a part of the “tax extenders” legislation last December, Congress also passed the “Achieving a Better Life Experience” (ABLE) Act, which establishes a new form of tax-free-growth Section 529 plans, to be created not for children to pay for college, but for disabled special needs beneficiaries. In order to qualify for the account, the beneficiary must be disabled (such that he/she is eligible for Social Security disability benefits, or is certified as disabled by a physician), and the disability must have occurred before the individual turned age 26. The 529 ABLE accounts will be maintained by the state in which the disabled beneficiary resides (or another state if the home state has contracted to use another state’s plan). Like other (college-based) 529 accounts, contributions will be after-tax but growth will be tax-free if used for qualified expenses for the beneficiary, the normal gifting rules for funding the accounts will still apply, there will still be a limited on maximum contributions, investment selection will be limited to the list of available investments, and those investment allocations can only be changed twice a year; in addition, there will only be one account allowed per eligible beneficiary. The upside of using the 529 ABLE account is that assets in the account will generally not disqualify the disabled beneficiary from state or Federal benefits like Medicaid (although some SSI benefits are suspended if the account balance exceeds $100,000). However, the downside is that any amounts left in the 529 ABLE account must be paid to the state to reimburse for Medicaid expenditures, and only the remainder (if there is any) will go to named beneficiaries. Given this Medicaid payback provision, it’s likely that family members gifting money for a disabled beneficiary may still wish to establish a third-party special needs trust, especially if the family wishes to contribute more than the 529 maximum account limitations, and/or expects that not all of the money will be used and wants to be certain any remainder left over will go to other family members.
Revisiting the Optimal Distribution Glide Path (David Blanchett, Journal of Financial Planning) – In this study, retirement researcher David Blanchett tackles the “glidepath” question in retirement – how asset allocation should change throughout the retirement years – by testing a wide range of constant, rising, declining, and other retirement glidepaths, through an even wider range of varying assumptions regarding initial withdrawal rates, starting equity allocations, supplement Social Security income, return and inflation environments, life expectancy, and more. Outcomes are evaluated using a utility function that assumes clients wish to maintain constant spending, with greater aversion to spending decreases and diminishing marginal enjoyment of spending increases. Across the over 6,000 combinations of assumption scenarios, the results generally showed that decreasing equity glidepaths (starting retirement at higher equity allocations and reducing later in retirement) were superior on average to rising equity glidepaths (that start lower and increase later), although overall the ideal glidepath was highly dependent on the assumptions; rising equity glidepaths tended to fare better when equity allocations were higher in the first place (e.g., starting retirement allocations of 60%), when Social Security was a higher percentage of total income, at “higher” withdrawal rates (e.g., 5% withdrawal rates), and fared worse in higher-return environment and those who were concerned about leaving a significant bequest at the end of retirement. Overall, Blanchett finds that the rising equity glidepaths are most sensitive to assumptions (doing much better with some assumptions but far worse with others), while the decreasing glidepaths tend to produce the most stable outcomes (for better or worse) across a wide range of scenarios.
Longevity Annuities: Their Time Has Come (Michael Finke, Research Magazine) – Given that the ongoing great challenge of retirement income with defined contribution plans is the “idiosyncratic risk of longevity” (the danger that you, individually, will happen to live for an unusually long time), Finke suggests the time has come for longevity annuities as a solution. The idea of such products is for a group of retirees to pool together their assets to fund their late-life spending, recognizing that most won’t live long enough to benefit, but that allows for a much larger payment (relative to the contribution) to ensure the later years can be funded for those who do live so long. Unfortunately, the decisions to consider in a longevity annuity are complex – such that, as Finke notes, “the only people buying longevity annuities are actuaries, engineers, and college professors!” – but policymakers in Washington are considering ways to “nudge” retirees towards such solutions, spearheaded by the Treasury Department’s Mark Iwry (who is generally regarded as a retirement policy savant, and was instrumental in bringing automatic investment choices to defined contribution plans in the Pension Protection Act of 2006). The first step in opening the door for longevity annuities in retirement accounts was the issuance of the Qualified Longevity Annuity Contract (QLAC) regulations, which both implicitly encourages the use of longevity annuities, and provides a small tax deferral benefit (to the extent that RMDs would have begun at age 70 1/2 but QLACs can defer payments until age 85). The QLAC rules limit retirees to put in the lesser of $125,000 or 25% of their account balances into a longevity annuity, ostensibly using the rest to fund their retirement between now and their later years, but the hope more generally is the fact that longevity annuities require relatively small payments now for significant cash flows in the future (which feels more like “insurance” than an investment) may be more appealing than the generally-unpopular traditional immediate annuity. The biggest caveat for the time being, though, is that longevity annuities aren’t being heavily marketed and sold in the first place, and the limited size of the market may be limiting the pricing, especially since the few who are buying such contracts appear to have above-average longevity (an adverse selection issue which itself makes payouts less favorable). On the other hand, if Iwry and the Treasury are successful in making longevity annuities a default option in retirement plans, the solution may both widely increase the use of such solutions, and make their pricing more favorable by reducing the adverse selection concerns.
Tax Alpha: How to Fix a Client Portfolio (Allan Roth, Financial Planning) – While tax consequences shouldn’t purely drive investment decisions, they are clearly a factor, especially when new clients are coming on board and decisions must be made about what to sell, what to keep, and how to position the portfolio going forward. A transition plan for the client portfolio should start by taking stock (no pun intended) of the potential capital gains exposure, and evaluating how close the client is to marginal tax breakpoints, such as where new capital gains tax brackets kick in, where the Medicare 3.8% surtax on investment income begins, and where the phaseout of itemized deductions and personal exemptions may come into play. In some cases, there will be “low hanging fruit” to transition, such as investments with losses or minimal gains; for larger gains exposure, it’s a trade-off of tax consequences for (ostensibly) better investment selection going forward. As the portfolio is repositioned going forward, it’s important to consider not just the investments being purchased and their tax-efficiency, but also their asset location – in which accounts will which investments be placed? To the extent that (higher return) tax inefficient investments are being purchased, they should be located primarily inside of tax-deferred (e.g., retirement) accounts. Once clients retire and need to take withdrawals, an additional layer of tax-efficient planning emerges – how to generate cash flows while managing tax exposure, from the impact of portfolio income on premium assistance tax credits for early retirees and their health insurance, to managing Roth conversions and capital loss (or even capital gains) harvesting, where often the ideal strategy is income or deduction “bunching” where income or deductions are clustered together in one year or another, to either maximize the current year tax savings, or avoid even less favorable tax consequences next year.
Should I Hire a New or Experienced Planner? (Caleb Brown, Investment Advisor) – As advisory firms grow, eventually they need to hire planning support, but is it better to hire a newer advisor, or someone who’s more experienced? Financial planner recruiter Brown makes the case that either can be appropriate for the firm, but there are some clear advantages and disadvantages to each. Hiring a new planner is often more “cost effective” (i.e., cheaper), as an entry level position has lower salary demands, and can be filled by recent college graduates who are willing to relocate (which increases the candidate pool beyond just “local” options), many of whom will have already completed a CFP Board-registered financial planning program; on the other hand, hiring a college graduate as a newer planner means literally getting someone who is younger, which at least can be a problem for some advisory firms, and it may be years before the young/new advisor can bring in business themselves (and may even be waiting to complete 2-3 years of experience just to use the CFP marks). Hiring an experienced advisor, on the other hand, generally means getting someone who already has the CFP marks, possibly some business development experience or a natural network (or even some existing clients to bring along), and someone who will typically require less training, mentoring, and hand-holding; however, starting salaries for experienced advisors can be as much as $150,000/year, they may be less willing to relocate (further narrowing the pool), and it may be more difficult to “untrain” any prior bad habits and to integrate an experienced planner into the firm’s existing culture (and/or find the perfect cultural match in the first place).
Do You Have A Scalable Business? (Mark Tibergien, Investment Advisor) – The conventional wisdom in the advisory world is that the advice business isn’t very scalable, as advisors can only manage “so many” client relationships even with the support of technology. However, the reality is that even if the advisor part of an advisory firm doesn’t scale, other parts of the business may; for instance, the recent 2014 Financial Performance Study of Advisory Firms found that as firms grow, the percentage of revenue spent on overhead falls from 48.1% (for firms with $100k-$250k of revenue) to only 28.9% for “super ensembles” (with $10M+ of revenue). Similarly, the results also reveal that as firms get bigger, their revenue growth actually accelerates with size, as the firm creates a stronger discipline around business development and a capability to truly brand itself. These benefits that come with size are driving many firms to seek to grow, merge together, or acquire their way to the “breakpoints” where economies of scale begin to kick in, although Tibergien warns that the push towards such critical mass has risks as well, including creating cultural challenges, triggering higher turnover and employee defections, and making it harder to control the quality of the advice. In addition, Tibergien warns that as firms grow, they need to watch four key areas or risk losing any benefits of scalability: 1) managing new locations (is acquiring/merging with a firm in a new location really adding scale, or just creating a new point of risk for the firm dependent on a key employee to run that location?); 2) workflow and processes (they become absolutely crucial to manage growth effectively as the business adds people); 3) recruitment, retention, and development of people (it’s more difficult to manage rapidly growing staff, but absolutely crucial or the firm risks higher turnover and losses in efficiency); and 4) constant monitoring and measuring of critical ratios and key performance indicators for the firm (if you aren’t effectively tracking the results, how will you even know if you’re succeeding, or failing and need to make adjustments?).
10 Ways My Closing Ratio Topped 90% (Katherine Vessenes, Research Magazine) – Early in her career as an advisor, Vessenes’ close ratio with prospective clients was so bad, she had to get a salaried job on the side just to make ends meet; now, she closes over 90% of her prospects. What changed to move the close ratio for 20% to >90%? Key adjustments include: she picked a niche where she could have a clear differentiator (college professors); she’s taken an educational approach to collaborating with clients (especially appealing to her college professor clientele), and thinks of herself as a “dedicated, educated problem solver” not a “closer” in the first place; she’s very patient with the process, recognizing that some clients need a lot of meetings to get comfortable; the prospective client process itself is customized to the type of clientele (for the professors, it’s a lot of information and detail; for business owners, it’s short and to-the-point); she is tenacious about getting a first in-person meeting after an initial introduction (people are busy, persistence matters); they do not ask for any deposit on the financial planning fee up front, recognizing that prospective clients often won’t want to pay up front for an intangible service they haven’t experienced yet; she views the sales process itself as something for continual improvement and refinement (if there’s something that is persistently time-consuming or problematic, figure out how to change/fix it!); and she changed her attitude, shifting from the “desperation” of starting as an advisor with young children who was desperate for revenue, to one that is more relaxed and interested in working with the right clients than just anyone (and clients can read the difference).
Is There Really an Advisor Exam Problem? (Melanie Waddell, Investment Advisor) – As 2015 begins, the debate continues about how best to increase the number of SEC examinations of registered investment advisors (RIAs), from Congress increasing SEC funding (or freeing up funding, as the SEC mysteriously spends half its exam budget on broker-dealers, even though examining B/Ds is already FINRA’s primary job), to charging advisors user fees. Yet at the same time, a second debate is emerging about whether there’s even really a problem to address in the first place. While there remains some fear of “rogue advisors”, the SEC has arguably allowed the low advisor exam rate to persist so long in part because it’s really not seen as a material risk, and in fact the current exam cycle of 10% (of advisors per year) is not materially different than the 11% average that’s been around for the past 30 years. And while Congress did recently allocate another $150M to the SEC’s budget, the SEC itself hasn’t been clear about whether/how it will use that budget to increase advisor exams. In the meantime, some have begun to suggest other alternatives as well, from having the SEC adopt third-party auditors to examine RIAs (since they can’t seem to manage it with their own examiner resources), or even raising the threshold for SEC registration from the current $100M up to $500M, pushing a large number of “mid-sized” advisory firms down to the states to audit and examine instead (though it’s not entirely clear that the states have the capabilities to handle so many advisor examinations, either!).
NAPFA Compensation Committee Member Says AUM Fees For Cash Raise Conflicts (Jeff Benjamin, Investment News) – An emerging trend amongst advisory firms that charge AUM fees is to charge a lower-tier fee for cash or bond positions than for equities, especially in today’s environment (or really, since the Fed cut interest rates and began quantitative easing after 2008) where the advisory fee itself may be greater than the entire return on a short-term fixed income position. Yet Bert Whitehead, a member of the NAPFA compensation committee, has penned a memo raising concerns about the compensation structure, and whether it should be considered an untenable conflict of interest for (NAPFA) advisors. The primary issue is that once the advisor charges more for the management of equities than fixed income, the advisor has created a compensation structure that incentives moving clients up the risk scale, as the advisor will be paid more to shift clients from cash/bonds into equities. In addition, Whitehead raises issues more generally about AUM compensation as well, including the pressure the clients are often placed under to move/consolidate assets to the advisor – such that sometimes, it’s easier for the client to just not admit to other assets, which in turn damages the advisor’s ability to offer effective financial planning advice and investment management services. While some suggest that these conflicts of interest are manageable, Whitehead raises the question of whether an advisor can really effectively implement a fiduciary duty to clients, especially with the two-tier AUM fee structure, and other advisors suggest that clients should simply pay the same AUM fee across all assets because the advisor is still providing a comprehensive asset management (and financial planning?) service.
Mind The Gap (David Armstrong, Wealth Management) – The recent leak of a White House memo supporting the soon-anticipated fiduciary proposal from the Department of Labor has triggered an aggressive response from the broker-dealer community, which insists that the allegations of harm are unfounded and that implementing such a rule would create an “advisory gap” with fewer advisors willing to serve the middle class. However, Armstrong points out that a real-world laboratory test of what would happen if commissions were banned and all advisors had to operate as fee-only fiduciaries is already underway in the United Kingdom, which two years ago implemented their “Retail Distribution Review” (RDR) reforms that actually did ban commissions for financial advisors. And while “just” two years is not really long enough to know the outcome, last month the UK financial regulator issued a progress report, and the results suggest that the sky is not falling. Product prices have fallen by at least the amounts previously paid in commissions, and many advisors have simply increased their fees to adjust – and in the process, the “true cost” of advice really has become more transparent, as was the goal. Furthermore, the increased transparency has compelled advisors to add more value, and the majority are successfully stepping up to do so; one survey actually found that 61% of advisors state their business has grown in the past two years, with 13% saying it’s grown significantly, and advisors in general seem to now be better qualified and are operating more efficiently and profitably. As for the advisory gap itself, the early results are more mixed; the shift of UK advisors towards more holistic advice seems to be fine for serving consumers who want such advice, but it’s not clear whether they will be effectively prepared for the approximately 60% of consumers who simply want more transaction (e.g., modular) advice. On the other hand, commentators in the UK point out that a lower-cost more modular advice solution may simply be an opportunity for innovation, and is possibly even a void that emerging UK robo-advisors could fill. The bottom line: the commission ban has not destroyed advisors, and to the extent that there may be some advisory gap present, it may simply be a gap that will be filled soon by new, tech-enabled, low-cost services.
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!
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 latest Bits & Bytes weekly video update on the latest tech news and developments, or read “FPPad Bits And Bytes” on his blog!