Enjoy the current installment of “weekend reading for financial planners” – this week’s edition kicks off with a discussion of the newly implemented reductions in the CFP Experience requirement, which quietly took effect earlier this month without any public comment period for CFP certificants, or public comments from FPA or NAPFA. Also in the news this week was the revelation that Vanguard’s Personal Advisor Services platform added on another $4B of AUM in just the past quarter as its growth accelerates (potentially threatening both the robo-advisor platforms, and possibly even threatening established independent advisors in the coming years, too). There’s also discussion of a new push from PIABA to get the SEC to create its own one-stop-shop database of public disclosure information about brokers and investment advisers for the public to access, as complaints continue that FINRA’s BrokerCheck is not getting the job done.
From there, we have a few investment articles this week, including a discussion from Barron’s about the challenges of navigating bond investing with the looming potential for rising interest rates, a discussion of ETF liquidity and whether advisors may be overestimating how liquid their ETF investments really are, and a discussion of the recent move by Dimensional Fund Advisors (DFA) to begin offering ETFs through John Hancock (but with fewer solutions and higher costs than its existing advisor-distributed mutual fund lineup).
There are also a couple of practice management articles, from a look at how 2015 is shaping up to be the “year of the mega-deal” for RIA mergers and acquisitions, to a broader look at how the RIA channel continues to be the only segment of the advisory industry that is growing as insurance, broker-dealer, and wirehouse channels all continue to lose market share, and the last is an interesting discussion of what it really means to be an “independent” advisor and whether many advisors may think they’re more “independent” than they really are.
We wrap up with three interesting articles: the first is a look at a new book called “Endorphinomics” by advisory industry business consultant Steve Moeller, who looks at the surprisingly common phenomenon of advisors who are “successful yet miserable” in trying to find the right work/life balance with a thriving advisory firm; the second raises the question of when/whether financial planning will ever get a seat at the “big kids’ table” in Washington DC and have a role in contributing the unique knowledge and experience of financial planning to public policy discussions; and the last is a look at how the rise of robo-advisors and a new slew of technology solutions have reignited the “fee vs commission” debates as fee-only technology-based platforms show that it really may be possible to serve the middle market without commissions after all.
Enjoy the reading!
Weekend reading for July 18th/19th:
CFP Board’s Reduced Experience Requirement Quietly Takes Effect (Michael Kitces, Nerd’s Eye View) – This month, the CFP Board’s newly reduced CFP experience requirements quietly took effect. First announced late last December during the quiet season between Christmas and New Year’s Day, the new rules make two primary changes: for those eligible for “challenge status”, the “Capstone” financial plan development course can be avoided for those who choose instead to submit a sample financial plan to the CFP Board for peer review; and more significantly, the definition of what constitutes “experience” in the first place is expanded to include not only direct experience but also “indirect” experience in the financial services industry. And the CFP Board has noted that “indirect” experience will be construed very broadly; for instance, employee benefits administrator, compliance officer, and even journalists may now treat their work as qualifying for the CFP Board’s 3-year experience requirement. When paired with the CFP Board’s change in 2012 to allow for a 2-year “apprenticeship”-style direct experience requirement, the net result of the changes since 2012 is that while the CFP Board once required most certificants to complete 3 years of direct experience, it now effectively requires just 2 years of direct experience, or 3 years of any job experience in any financial-services-industry job regardless of whether it is directly related to financial planning for clients. Notably, while the CFP Board has drawn criticism for the reduced experience requirement (and also the fact that it never provided a public comment period for CFP stakeholders to weigh in on the proposal before implementing it), the FPA and NAPFA have provided tacit support for the CFP Board’s changes by refusing to publicly comment on the issue.
Vanguard’s White-Hot ‘Hybrid Robo’ Just Added $4B In Three Months (Lisa Shidler, RIABiz) – In just the past three months since it emerging from its “beta” status, the increasingly popular Vanguard Personal Advisor Services (VPAS) solution, which combines asset management with support from a (virtual) human financial planner for an AUM fee of just 0.30%, added a whopping $4B of AUM, bringing its total up to just over $21B. Notably, though, analysts suggest that most of the growth from VPAS is “cannibalizing” existing Vanguard customers, not necessarily adding new flows to the company; still, the transition of clients from low-cost Vanguard funds into a 0.30% financial planning wrapper is actually a significant increase in revenue on those funds for Vanguard (though not necessarily an increase in profits, due to the staffing obligations of delivering financial planning in the first place). Nonetheless, the growth of VPAS continues to put significant potential pressure on the so-called “robo-advisors”, which charge only slightly less (0.25% versus 0.30%) but don’t include the human financial planning support at all; in other words, the ‘hybrid’ human-plus-technology solutions are beginning to threaten the technology-only robo solutions. Though some – including yours truly – also note that Vanguard’s direct-to-consumer “insourced” financial planning solution is also a threat to traditional advisors as well, as human-financial-planning-plus-asset-management services for 0.30% may be even more disruptive than robo-advisors charging 0.25%; when competing against robo-advisors, traditional advisors can differentiate with their financial planning advice and human interaction, but when competing against Vanguard, traditional advisors will be pressured to even more clearly articulate where their unique value lies to justify a 1% AUM fee over Vanguard’s mere 0.30% cost.
Industry Groups Urge SEC for Advisor Disclosure Amid BrokerCheck Shortfalls (Shreya Agarwal, Financial Planning) – Despite recent efforts to improve, and a new ad campaign encouraging investors to use the system, FINRA’s BrokerCheck service continues to draw so much criticism over incomplete information that the SEC’s Investor Advisory Committee is now considering a proposal of whether the SEC should build its own database of disciplinary information about advisors. The potential for an SEC solution has garnered support for several major industry groups, including the Public Investors Arbitration Bar Association (PIABA), which has been extremely critical of the incomplete information on BrokerCheck, and is urging the SEC to create a “simple, and accurate one-stop-shop for consumers” for full disclosure of all publicly available background information about brokers and investment advisers. In the meantime, FINRA defends that its solution is still only meant to be a ‘first stop’ for investors seeking information, and suggests that investors should also consult state securities regulators and other sources as well… though unfortunately, many states either do not have such information available on a public website, and/or charge consumers just to access such information, which only further makes PIABA’s case that perhaps the SEC really does need to create a one-stop-shop solution.
A New Approach to Bonds (Sarah Max, Barron’s) – The math of rising interest rates is relatively straightforward: higher yields result in price declines for today’s bonds. And while investors who own individual bonds can aim to hold them until maturity to ‘ensure’ they get all their principal back (at least, assuming there are no defaults), the same is generally not true of bond mutual funds and exchange-traded funds (ETFs) which generally don’t their bonds until maturity and instead tend to rotate their bonds over time to maintain a fairly constant maturity and/or duration (consistent with the goals of the fund as stated in the fund’s prospectus). Notably, the potential risk of rising interest rates has not dissuaded investors from buying bond funds, which continued to see more than $75B in new flows in the first 5 months of the year; however, the tide may now be turning, as June saw bond investors withdraw a net $17B. An additional complicating factor has been the growth of bond-based ETFs, which are traded as though they’re more liquid than mutual funds holding similar bonds, although in the end either/both will have trouble redeeming investors if buyers shy away from bonds with declining prices and the bonds turn out to be less liquid than their external fund wrappers. Yet given a prospective desire to find alternatives to bond funds, the choices are still challenging – individual bonds may not be feasible for some investors (especially small ones who are chewed up by transaction costs and/or struggle to effectively diversify with limited dollar amounts, and a bond ladder can be difficult to construct with limited dollars as well), eschewing bond funds to buy stocks just increases the portfolio’s risk even further (after all, the traditional view of bonds is still that they’re meant to be a buffer against stock market volatility!), and going outright into cash may be the most stable solution but is difficult to justify as ‘idle dollars’ given near-zero yields. Ultimately, then, the question really comes down to the intended purpose and function of the bonds in the portfolio – historically, investors sought them out for both stability, income, and the potential for capital appreciation, but in today’s environment investors may have to accept only 1 or 2 out of the 3, and adjust the portfolio accordingly.
There’s More To ETF Liquidity Than Meets The Eye (John Gabriel, Morningstar) – ETFs are somewhat unique in the nature of their liquidity, because it occurs in two different contexts: in the primary markets, where ETF baskets are created and destroyed/redeemed, and also in the secondary markets, where the ETFs-as-baskets are quoted and traded in a similar manner to stocks. This is notably different than the baskets-of-investments held within mutual funds, where investors who aim to buy or redeem shares only work directly with the mutual fund, which in turn accesses the capital markets to buy/sell the necessary securities to deploy or free up cash. The distinction here – that ETF owners can trade those ETFs with other investors, while mutual fund owners ultimately only ‘trade’ those funds by buying or redeeming them directly with the mutual fund provider – is important in times of high demand for purchases or selling pressure, as it means ETFs can potentially trade at a premium or discount to the fund’s intrinsic NAV if buyers significantly outnumber sellers or vice versa. In most cases, these potential deviations are ameliorated by the fact that there are authorized participants, who can work directly with ETF providers in the primary market, to create or redeem entire baskets of ETFs, and effectively earn an arbitrage profit if/when ETF prices deviate too materially from their intrinsic value. However, in the event that the underlying securities become less liquid – e.g., if the broader markets are under duress – this ETF liquidity mechanism can potentially break down, which introduces the potential that ETFs could trade at a dramatic discount (or premium) from their intrinsic NAV for an extended period of time. As a result, it’s not sufficient to just look at factors like daily trading volume and bid-ask spreads when evaluating the liquidity of an ETF; it’s crucial to look at the liquidity of the underlying holdings as well, or risk being caught up in a liquidity squeeze that results in the ETF trading at a big discount to intrinsic NAV if a significant market event causes sellers to head for the exits and the authorized participants find the underlying holdings are too illiquid to facilitate redemptions and arbitrage the discount away.
How DFA Is Putting Its John Hancock On The ETFs Category (Brooke Southall, RIABiz) – Dimensional Fund Advisors (DFA) is the second-hottest name in passive investing right now (second only to Vanguard), but unlike Vanguard has only been able exclusively to financial advisors, and exclusively via mutual funds. But in a newly announced (though technically just an ‘updated’) partnership, DFA will now be working with John Hancock to roll out a series of 6 new ETFs that will be built using some of DFA’s “dimensions” (i.e., the factors like small-cap and value, as well as profitability, that DFA overweights to create its uniquely-styled investment approach). Notably, while the new offerings will include a large-cap ETF, a small-/mid-cap ETF, and four sector funds (in consumer discretionary, financials, healthcare, and technology), it will not directly blend together comprehensive three-factor solutions, nor implement some of DFA’s unique trading and tax management strategies, which in theory helps to keep its mutual funds unique to the advisors who use them. The new ETFs are also expected to be more expensive than DFA’s own mutual funds, where the former will cost as much as 35-50bps but DFA mutual funds are as little as 8-10bps.
2015: The Year Of The [RIA] Mega-Deal (Diana Britton, Wealth Management) – According to industry consultant David DeVoe, the RIA space has hit record levels for merger-and-acquisition deals and the average size of deals are bigger than ever. The first half of 2015 saw a total of eight “mega-deals” for firms that had more than $5B of AUM (compared to just one such acquisition in the first half of 2014 and two in the same period in 2013). More generally, the total number of RIA transactions for firms with over $100M of AUM were up 84% in the first half of the year, with 61 transactions. And even when the mega-deals are excluded, the average deal size is getting bigger, up to $877M of AUM on average for 2015, compared to $656M in 2014 (and $679M in 2013). Also notable in the industry M&A trends in a shift in buyers – which in the past several years, RIA buyers have primarily been consolidators and other RIAs, lately private equity firms and banks are picking up the buying pace (at 17% and 10% of deals, respectively, compared to 0% and 5% for those buyers last year). Ultimately, DeVoe suggests that the rising pace of activity is reflecting of both the growing interest of well-financed buyers coming into the wealth management space, and also the industry’s demographics that have an ever-growing number of advisors (and large advisory firm owners) approaching retirement age and looking for a transition.
No Slowing RIA Growth (Jerry Gleeson, Rep) – Notwithstanding the competitive pressures and potential regulatory changes, the RIA channel is the only one that has grown (and continues to grow) since the 2008 financial crisis. This year, Cerulli Associates projects that independent and dual-registered RIAs combined will reach 23% market share, rising further to 28% by 2018. While the RIA share is still smaller than wirehouses, which are estimated to hold 36% of industry assets, the gap is closing, and wirehouses are actually down from almost 42% back in 2007. The shift from wirehouses to RIAs – both in terms of client assets, and brokers who “break away” from wirehouses to the RIA channel – has been accelerated by companies that have formed to help advisors outsource compliance and back-office functions (from HighTower to Dynasty Financial Partners). Though ultimately the growth of RIAs is not just a story of advisors shifting channels; organic growth at RIAs has been strong as well, with almost half of the 71% rise in RIAs revenues since 2009 being attributed to attracting new clients and new assets from existing clients. In 2014 alone, a Pershing Advisor Solutions study found the average RIA had a median growth rate of 21%, of which 12% was attributable to organic growth. Ultimately, it seems that perhaps the greatest threat to RIA growth is competition from the new RIA alternative – the robo-advisor – though already many of those platforms are shifting from being competitors to technology solutions for independent RIAs to use with their clients instead.
The Price Of Independence (Mark Tibergien, Investment Advisor) – It has become increasingly popular in recent years to become an “independent” advisor, yet Tibergien notes that as the advisory industry becomes more complex, the very nature of what “independence” really means is murkier than it once was. Is it about being an independent business owner? Or independent in your ability to select technology and platforms? Or independent in your ideas and recommendations from clients? Or simply independent of any direct supervision? Even across this span, “independence” can get murky. If a firm is independent owned, but its ownership includes passive investors that you work for, to what extent are you really working and operating ‘independently’ versus being accountable to the advisory firm shareholders/owners? Or what if your “independent” firm simply gets bought or merged into another independent firm – are you still “independent” at that point? Another challenge around independence are the various programs that “independent” platforms and custodians offer – from integrated technology solutions to client referral programs – that may in practice limit your ability to move clients elsewhere or adopt other technology solutions, which again raises the question of whether your independent firm working with an independent provider is really independent at all. In fact, a growing number of conflicts-of-interest between many independent firms and their providers are threatening independence altogether, from proprietary managed account solutions to special deals on transaction costs. Ultimately, the point isn’t that advisors must be “purely” independent or that one type of independence is better than another, but simply to reflect that how “independent” an advisor really is may be a far more nuanced evaluation than it once was, which matters both for the advisor who really prizes independence, and also in how to properly communicate the advisor’s “independence” (or lack thereof?) to a prospective client.
Endorphinomics: Working On Happiness (Bob Clark, Investment Advisor) – Advisory industry business consultant Steve Moeller recently published a new book entitled “Endorphinomics: The Science of Human Flourishing“, which explores the common challenge that many advisors face: they end out investing themselves so intently into their businesses, that by the end they build a large and profitable and “successful” business but suffer personally in the process, from health issues to family issues and more. In fact, as Moeller began to study the issue, he found that “successful yet miserable” people are all around, especially in the advisory world, where the industry focuses so heavily on money that it’s hard as an advisor to not fall into the “having more money [and a bigger/more successful business] will make me happier” delusion (e.g., one famous survey found that the average American said he/she needs about 40% more income to be happy… a response that was sadly consistent regardless of what the person was actually making already in the first place!). Ultimately, Moeller focuses the discussion on the science of what actually makes us happy, and how to live a life that keeps our endorphin levels high and live a “flourishing” life. And notably, while Moeller’s book is written nominally for advisors who are ‘stuck’ leading successful yet miserable lives, the book’s guidance is arguably just as relevant for most of the clients we advise, too!
Seats At The Big Kids’ Table (Richard Wagner, Financial Advisor) – While financial planning continues to be on the rise, Wagner laments that from the broader societal perspective, financial planning still doesn’t really have a “seat at the big kids’ table” when it comes to issues like public policy and society’s views about our relationships with money. For instance, notwithstanding the CFP Board’s address on K Street in Washington DC, the reality is that financial planners are rarely ever involved in substantive policy discussions in Washington, and lawmakers don’t ask for the input of financial planning experts before making new laws or setting new policy around financially-related issues for Americans. While the financial services industry more broadly does often have a seat at the table in government policy issues – along with academia – it is more commonly to represent the industry’s interests, not to advocate on financial planning issues for consumers. Ultimately, Wagner suggests that the perspective we have as financial planners really would be unique and valuable – because we really do sit across from real-world individuals dealing with real-world financial challenges, amidst an ever-changing world as technology and longevity continues to redefine our notions of ‘work’ and ‘retirement’ in the first place – and that the progression to ‘earning’ a seat at the big kids’ table is a hallmark of our path to becoming a bona fide profession in the first place.
Fees Vs Commissions: Why An Old Debate Is New Again (Bob Veres, Advisor Perspectives) – Veres suggests that the emergence of robo-advisors is forcing the industry to revisit the ancient fees versus commissions debate, but in new and interesting ways. The biggest distinction is that historically, the commission was defended as being essential to serving the middle market, where an AUM or standalone fee just couldn’t produce enough revenue to support an advisor; yet with robo-advisors squarely targeting the middle market with an AUM fee – and an especially low one at that – it raises the question of whether this historical defensive ground for commissions still holds. Similarly, the growth of robo-advisors on an AUM model into the middle market undermines the historical criticism that fee-only advisors work ‘exclusively’ or primarily for high-net-worth clientele; whether it’s robo-advisors serving consumers directly, or existing RIAs adding in robo-technology to serve smaller clients, the potential that RIA minimums may soon drop precipitously also undermines the historical criticism that ‘fees don’t work in the middle market’ (not to mention the growth of standalone fee-only advice firms serving the middle market like Garrett Planning Network and XY Planning Network). And of course, all of this is happening in the midst of an environment where commissions really are in decline across the industry, as more and more advisors shift to RIAs, the volume of load-based mutual funds has declined significantly, and commission-based insurance appears to be on the decline as well. While in the case of the latter, the decline of commissions has been slower – and as long as almost all insurance products have some kind of commission load built in, arguably consumers aren’t ‘harmed’ as the product will have the same cost either way – Veres still makes the case that as the industry shifts ever-more towards fees, more no-load products will emerge (just as occurred in the investment space). The bottom line – while the fee vs commission argument has existed a long time, growing technology tools to allow fee-compensated advice to the middle market, a widening base of no-load products, and a clear industry-shift in advisor compensation where commissions are declining and fees are on the rise, suggests that while the transition is slow, the future of the financial planning profession really does appear to be centered around fees, not commissions.
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.