Enjoy the current installment of “weekend reading for financial planners” – this week’s edition starts out with a concerning warning that regulators appear to be shifting from “just” fining firms to actually requiring them to admit public guilt and make an example of individuals; while on the plus side, this may be good pressure on some firms to clean up their act, it also raises fears for advisory firms that making (too many) mistakes could cause them to become an example case as well. We also lead off with two interesting articles on the current independent broker-dealer landscape, including the activity of the big firms at the top, and what the small firms are doing to try – to varying degrees of success – to stay competitive amidst a competitive environment and rising regulatory/compliance costs.
From there, we have a few practice management articles this week, including a great reminder from Roy Diliberto of the reasons why some advisory firms have incredibly high (98%+) retention rates, an interview with Financially Wise Women advisor and social media activist Brittney Castro about how blogging and social media have helped to grow her practice, and a look from industry commentator Bob Veres at the emerging new trend in advisory business models: monthly retainers.
We also have a few investment-related articles, from a fascinating look at how in the long-run markets can still have better very-long-term returns in high valuation environments that low-valuation ones (e.g., the 30-year return starting in 1929 was actually higher than the 30-year return beginning in 1980!), to a discussion of whether advisors aren’t giving enough acknowledgement to the value of bank CDs as a fixed income investment in today’s environment (given the penalties to ‘break’ a CD to reinvest at higher rates is a much lower effective duration than bonds with similar yields), and some recent research on risk tolerance finding that while risk tolerance is relatively stable, investor perceptions of risk do appear to shift with the market environment in a dangerous fashion.
We wrap up with three interesting articles: the first provides tips from advisor and blogger Barry Ritholtz about how to “curate” your own feed of investment and financial information to manage the firehose of information available today; the second is a discussion from Bob Seawright lamending the lack of clear “best practices” on financial advice and the incredible inconsistency from one advisory firm to the next (which in turn can lead advisors to unwittingly fall back to delivering advice based on their biases); and the last is a look at how the rise of software is beginning to threaten many professions (not just financial planning), and how “robo-advice” of all sorts – from medicine to law to financial planning – may change the role of professionals in the coming years.
And be certain to check out Bill Winterberg’s “Bits & Bytes” video on the latest in advisor tech news at the end! Enjoy the reading!
Weekend reading for June 21st/22nd:
Forget Fines, Regulators Want Public Scoldings – This article by Joe Duran of United Capital in Investment News calls out a notable new trend in the regulatory environment: while in the past, regulators have typically coerced (large) financial settlements from institutions that behaved badly, while allowing them to avoid admitting public guilt, this is less and less the case. Instead, we’re seeing a rise of regulators not only applying significant fines, but requiring companies to publicly admit guilt as well; witness, for instance, the recent Credit Suisse AG incident where the company had to not only pay $2 billion in fines for assisting U.S. citizens to avoid taxes, but the company also had to publicly acknowledge its guilt. Similarly, SEC Chairwoman Mary Jo White has recently noted that “If an enforcement program is to have a strong deterrent effect, it is critical that responsible individuals be charged.” In other words: watch out, there are more public examples coming from the SEC as the regulatory pendulum swings. While thus far, this kind of increased focus on admitting guilt and holding individuals (publicly) accountable hasn’t come down to the level of individual RIA firms, it may become more of an issue particularly for RIAs as the number of firms grow, and there are more new entrants who may have less skill and experience in being compliant. Accordingly, Duran cautions that advisors should focus more than ever on staying compliant and within the spirit of the rules, but being proactive on awareness and disclosure to clients, recognizing that the more various ways that you offer solutions to clients the greater the risks may be (so only focus on doing what you can execute well), and be certain that you can demonstrate that your firm is truly monitoring and self-policing itself effectively (so the SEC doesn’t feel like they need to do it for you!).
FP50: Big Changes At The Top – This article highlights Financial Planning magazine’s annual survey of independent broker-dealers, and the trends underway in the IBD environment. The big news in the IBD world over the past six months has been the entrance of Nicholas Schorsch, the (non-traded) REIT magnate whose series of IBD acquisitions of Cetera Financial and others have put RCS Capital at the #3 spot for IBDs ranked by revenue, well below LPL and Ameriprise but just above Raymond James and AIG Advisor Group. More broadly, the reality is that the IBD environment has already been consolidating, with some predicting that in just a few more years the IBD environment may be down to just 10-or-so major players, and a smattering of tiny “mom-and-pop” firms, though even IBD consolidators are concerned because the acquisition prices that RCS Capital paid has to-be-acquired firms asking for more than what most other buyers seem willing to pay at this point. In addition, the sheer breadth of IBDs – and advisor business models – that exist arguably still means there’s room for a lot of players, and some IBDs have been branching ever further outwards, such as offering more hybrid or dual-registered options for advisors who want to have an RIA offering as well, and branching into different markets (as some like Wells Fargo and Commonwealth go ‘upmarket’, and offers like Lincoln and RCS move ‘downmarket’ towards the mass affluent).
Facing The Challenges – This article from Financial Advisor magazine highlights the environment for smaller broker-dealers in the current advisory landscape. In recent years, smaller broker-dealers have struggled with growing regulatory and compliance costs, low interest rates, and a highly competitive environment in which they lack economies of scale to do the fundamentally same thing (“process the business”), but are now increasingly trying to compete by differentiating on the level of personal service they can provide because they don’t have a large “stifling bureaucracy” infrastructure. This seems to be especially appealing to more experienced advisors who are comfortable in their practices and just want to run their businesses and mostly be “left alone” by their broker-dealers. Nonetheless, many smaller broker-dealers who can’t at least reach a “mid-sized” tier (and scale to manage compliance/regulatory costs) are either exiting the industry or consolidating, and the number of broker-dealers has fallen significantly from 4,720 just five years ago to only 4,142 as of this spring. In addition, low interest rates mean firms don’t earn much while holding client cash, and declining variable annuity sales as insurance companies cut back on their products have also slowed activity; there is also concern that many IBDs have been active with non-traded REITs and Business Development Companies that are illiquid (if they end out having performance issues, the associated legal and regulatory fallout could be the end of many smaller broker-dealers). The shift to fee-based business is also creating challenges, and many IBDs are trying to adapt by forming relationships with investment providers that will allow the B/D to earn some administrative and revenue-sharing fees, or even building in-house solutions that allow the B/D to keep more of the available revenue for the offering. The recruiting environment is also getting more competitive, as large IBDs offer transition packages up to 20%-30% of 12-month trailing production, and smaller IBDs can’t afford the cost. For many mid-sized IBDs, the sweet spot seems to be getting large enough to have some scale to be viable, but remain small enough to create the “homey” personal service that appeals to advisors unhappy at larger firms.
Why Clients Keep Financial Planners – While much is written about why clients fire financial advisors, in this Financial Advisor magazine article Roy Diliberto looks instead at why it is that clients keep financial planners, and why some firms continue to maintain near-100% retention rates while others need a steady flow of new clients just to replace the 10%-20% who leave every year. The key tips and insights for firms that do well retaining clients include: 1) elite firms do a good job communicating realistic expectations, and what they can and cannot control (e.g., diversification may reduce volatility, but can’t eliminate it, and there will be market declines from time to time, so don’t promise you can make the pain of losses go away!); 2) good planners keep clients from making foolish decisions they later regret (e.g., if the client calls in 2009 and says ‘please sell everything’ they may later blame the advisor for not talking them out of it!); 3) they are passionate about planning – all planning issues – not just investing client assets, and thoroughly cover all the key aspects of the planning world; 4) they follow a financial planning process, and follow it consistently for all clients, and don’t accept “investment-only” clients at all; 5) they focus heavily on a deep discovery process that really gets to know their clients, beyond just their numbers and investment portfolio; 6) they do a good job executing the simple but critical administrative tasks (e.g., really return calls promptly) and be certain that your staff are empowered and rewarded for doing so.
Amy McIlwain & Brittney Castro Talk Social Media For Advisors – This article from the Financial Social Media blog is an interview with Brittney Castro of Financially Wise Women on her success with blogging and social media. For Castro, the attraction to social media was both as a powerful opportunity to market her business, and also because her target niche – entrepreneurial women – were actively using it as well (so it was a good opportunity to connect to them, going to where her target clients are). From the compliance side, Castro notes that some broker-dealers provide more compliance freedom and flexibility than others, though now she operates as an RIA with even more control; for those who have to navigate compliance challenges, Castro suggests the key is strong communication with the compliance department about what you’re trying to do (as many/most compliance departments “have no idea what advisors are doing on social media” but with some education and relationship-building you can get compliance on your side to help navigate the regulations). In terms of time commitment, Castro notes that she spends a significant amount of time on social media and digital marketing (10-20 hours per week), but she considers that social media time to be her marketing time and notes that her results have been commensurate with her efforts, with leads for new prospective clients coming in through her website every week. Castro has created an editorial calendar of content to keep her on track, and uses Hootsuite to schedule some tweets and posts, though it took 6 months of steady social media and blogging work before she ever saw her first client from her efforts (and as a result, she suggests to start small, pick one thing to focus on, and build from there). Notably, though, Castro points out that “success” and social media ROI is more than just new clients; building her brand and credibility are important as well, and can have other valuable intangible (and eventually tangible) results, such as a new revenue stream she has from hosting a show after the production company saw her on YouTube and Twitter.
Advisors: New Fee Model Taking Over? – This article by industry commentator Bob Veres looks at an emerging new business model trend in the advisory business, especially amongst young advisors: charging retainer fees purely for advice, often in the form of a monthly subscription fee just like other monthly bills (cell phone or TV service) that fits the client’s cash flow. Thus far, the model has been largely mocked, yet Veres notes this was the similar path that the assets-under-management (AUM) approach went through in the 1980s and 1990s, where the new non-commission model was first mocked, but is now being imitated widely. Yet Veres sees the model gaining momentum, as advisors increasingly outside investment management to third-party platforms to focus solely on the financial advice itself. Ultimately, Veres sees 5 key implications to this new model: 1) it may threaten existing AUM firms, as it aligns fees more closely to the comprehensive planning service than just the portfolio; 2) it allows advisors to build connections to clients at a younger age (and then keep them in the long run, cutting off the pipeline for more established firms down the road); 3) the model is efficient enough to widen the pool of would-be clients (i.e., at lower minimums); 4) advisors may be able to service a larger number of clientele; and 5) if existing firms don’t accommodate this model that younger advisors want to adopt, the firm may lose young advisors who leave to go do it on their own.
Who’s Afraid Of 1929 – This blog article takes an interesting look at the returns that followed the crash of 1929. Certainly, the immediate aftermath of the crash was quite ugly, due both to the Great Depression itself, and what are now viewed as a series of mis-steps by the Federal Reserve at the time that exacerbated the problem. And arguably, the poor short-term returns weren’t entirely unpredictable, as in the year leading up to the start of the crash, the yield curve was inverted, profit margins were at record highs, and the Shiller CAPE (market P/E ratio) had gone parabolic – on top of the actual economic downturn that began to occur and financial panic that ensued. Yet in the end, as the article shows, the long term returns from the crash of 1929 peak were still remarkably good; while the 10-year real return was an ugly -1%, the 30-year real return from the peak was actually a healthy 7%, which was actually higher than the 30-year real return starting in the fall of 1980! In other words, the 30-year real return from the top in 1929 was better than the 30-year real return from near the bottom in 1980 (notwithstanding how powerful the returns of the 1980s and 1990s were), despite a drastic difference in valuation measures like Shiller CAPE and Tobin’s Q. A similar result occurs when looking at returns in excess of the risk-free rate of the (respective) times. Ultimately, the outperformance of the 1929-1959 period appears driven by both stronger corporate performance (real EPS growth was better in the earlier period), and favorable dividend reinvestment rates (dividends in the early parts of the 1929 cycle got reinvested at cheaper prices). The bottom line: over very long time periods, other factors play a far more important role in long-term returns than “just” market valuation, so high valuation is not necessarily a reason to abandon a buy-and-hold strategy to pursue good long-term returns. (Michael’s Note: While valuation measures like Shiller CAPE are not a strong factor in predicting 30-year returns, they are a strong factor in predicting 10-year returns, which does matter for retirees taking ongoing withdrawals from a portfolio and who are exposed to the associated sequence-of-return risk.)
The Best Fixed-Income Investment – This Morningstar article notes the paucity of yield in today’s short-term (ETF) bond funds; short-term T-bills pay zero, short-term multi-sector funds pay perhaps 2%, and the biggest short-term bond ETF (Vanguard Short-Term Bond Fund) yields just a little more than 1%. Yet ultimately, the article points out that the best solution of all may be none of these; instead, today’s unusual combination of low interest rates, tighter regulations, and competition amongst banks, mean that the best fixed-income deals right now may be in the highest-yielding bank CDs. For instance, Synchrony Bank (a subsidiary of GE that was previously GE Capital Bank) and also Barclays now offer a 5-year CD paying 2.25%. This is not only an appealing fixed-income yield, but an even more appealing one on a risk-adjusted basis, given that the bank CD has FDIC coverage up to $250,000 (which in turn is backed by the full faith and credit of the U.S. government, which puts it on par with government bonds), and even when adjusting for the early withdrawal penalties (180 days of interest for Barclays, 270 days for Synchrony) the CDs have the equivalent of a duration of only 1.7 (though the penalties are capped, so if rates spike significantly, the effective duration is even lower!). Of course, if rates fall further, the bank CDs will not enjoy the price appreciation of a typical bond, which is part of the trade-off for the “above-market” yield and limited downside duration. Nonetheless, given that a 2.25% in Treasuries directly would require buying a 7-year bond (with a duration of 6.5!), and a 2.25% in investment-grade corporates would still have a duration of almost 4 years (and some credit risk), the bank CD (not brokered CD, but direct with a bank) is arguably quite compelling. And as the article points out, this incredibly appealing yield from banks isn’t just a mirage or bank stupidity; it’s because banks have opportunities to get sticky bank business, the potential to cross-sell higher margin products, the opportunity to effectively raise capital at low cost (to the bank), and to some extent banks count on the fact that savers often don’t actually liquidate and reinvest bank CDs even when rates do rise.
Do Large Swings in Equity Values Change Risk Tolerance? – This article from the Journal of Financial Planning studied changes in risk tolerance scores (using FinaMetrica risk tolerance tools) from 2007 to 2012 and compared them to stock market prices and valuation levels over the time horizon. The results found a very high correlation (070) between the absolute price of the S&P 500, and reported risk tolerance scores. Similarly, the results also found a high (positive) correlation (0.73) between risk tolerance scores and P/E ratios, suggesting that investors were more risk tolerant when valuations were high and less risk tolerant when valuations were cheap (despite the actual investment implications of P/E ratios, which would suggest the opposite should be the case!). However, across the time horizon, it’s notable that the standard deviation of the S&P 500 over the time period was 17.27%, while the standard deviation of risk tolerance scores was a mere 1.86%, suggesting that while risk tolerance and market prices may move in tandem, the actual change in risk tolerance scores may not be significant enough to actually lead to a materially different recommended asset allocation (though to the extent tolerance changes occur, they appear to be most dramatic during market declines). Nonetheless, there does appear to be some linkage, although it’s not entirely clear whether the results indicate that risk tolerance scores actually move with market volatility, or whether risk perception is the greater issue and FinaMetrica may simply be a not-quite-perfect measure of risk tolerance in the first place.
Curate Your Personal Investment Resources – This article by blogger and finance commentator Barry Ritholtz shares some of his own resources used to keep up the latest news and ideas in the world of investing, which is becoming more and more difficult as the sheer volume of news, data, and media grows every year. So what should you do? Ritholtz has 7 tips: 1) Follow bloggers who “curate” lists of the best content out there, to help shortcut your own process of finding content (trusted curators include Ritholtz’ own Top 10 Reading List for Bloomberg View, Further Reading from FT Alphaville, Real Clear Markets, Abnormal Returns, and Next Draft; 2) Use technology that lets you capture articles to (re-)read later (Ritholtz uses Instapaper); 3) Use browsers with multiple tabs open (Ritholtz keeps the Wall Street Journal, NY Times, Bloomberg, and more open so he can quickly scan websites for notable headlines; 4) Use an RSS client (e.g., Feedly) to follow blogs and authors for their latest content; 5) Join Twitter and find people you enjoy following who share useful information; 6) as you find writers whose content you like, keep up with what they’re writing on an ongoing basis; and 7) when you find people who do a poor job on content/recommendations/information, ‘quarantine’ them out of your information filters so you’re not distracted by their bad information again! Ultimately, it takes time to cultivate and develop and “curate” your own information flow, but the end point is the potential for a significant increase in information-gathering productivity!
The Advice Business Needs A Serious Fix – This article by Bob Seawright in Research Magazine laments the unfortunate reality that in the world of financial advice, there are startlingly few best practices established about what is the right advice in various client situations. As a result, we tend to succumb to our biases, defaulting to recommendations and solutions that fit whatever service or product we have for sale, and often not even realizing that our advice may be far less objective than we realized. For instance, ask 10 doctors whether a splint is an appropriate solution for a broken leg, and you’ll get remarkably similar responses; ask 10 financial advisors about whether an annuity is an appropriate solution for a broken retirement or the role that active management should play in a broken portfolio, and there’s far less consistency! This is exacerbated by the fact that because individual circumstances and preferences vary, it really is difficult identify the true and “right” answer sometimes. Nonetheless, the bar to obtain licensing as a financial advisor is shocking low, so it’s no surprise the analysis and conclusions of many “advisors” often lacks rigor and defaults to their natural biases (which may then be amplified by the conflicts of interest in some compensation models). The bottom line: when your only tool is a hammer, every problem looks like a nail, so the solution for the industry is that we really need to train ourselves on a wider variety of tools and techniques and best practices to work with in the first place.
Robot Doctors, Online Lawyers And Automated Architects: The Future Of The Professions? – While the advisory world has been abuzz over the past few years about the rise of the “robo-advisors”, the potential for technology to threaten professions has been occurring in other fields as well, especially since a recent study found that much of the ways that software has replaced jobs in recent years is not amongst low-wage manual jobs but fairly well paid positions in traditionally middle class careers (e.g., administrators, travel agents, bookkeepers, and secretaries), and being a “knowledge worker” is not necessarily a safe domain. Instead, the expectation is that professions will begin to break down into their component parts, where some aspects may be streamlined and/or fully automated but the human remains for the rest. For instance, architects will likely remain (it’s hard to imagine a computer unleashing much architectural creativity!), but the tools available online make small architecture firms more competitive (and able to be collaborative) and leaves large firms with less of a size advantage. In medicine, technology devices are increasingly becoming effective diagonisticians (in fact, there are groups trying to create a working Star-Trek-style tricorder!), and may even someday do relatively complex surgeries, but we still need the human touch to help guide us (and already have a shortage of doctors). Similarly, lawyers will remain relevant, but software can (and already is) streamlining many of the more mundane, routine tasks, allowing fewer lawyers to serve far more people, but also bringing down costs that opens up legal advice to a wider market that can’t afford it – arguably a path that financial planning may someday follow as well!
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!