Lack of Performance Reporting (Part 5)

Today I continue discussion of a July 2014 blog post by Jason Zweig.

Zweig addresses how financial planning activities like tax reduction, estate and retirement, [life and long-term-care] insurance, debt management, and asset protection provide value. I alluded to this here and I wonder if a failure to separate these fees enables advisers to “go cheap” with the investment expense (as mentioned in a previous footnote).

Zweig continues:

     > [While financial planning] benefits often can’t be quantified… that
     > shouldn’t exempt advisers from reporting results that can be… like
     > investment returns.
     >
     > Even so, most financial advisers remain reluctant to calculate their
     > results. Jonathan Pond, president of Jonathan D. Pond LLC, a financial-
     > advisory firm… that manages approximately $230 million, says he
     > worries that the SEC would second-guess any such numbers, raising the
     > potential for regulatory reprimand [emphasis mine].
     >
     > “As a result, we absolutely do nothing as far as putting out performance
     > data,” he says. “It will be a cold day in Hades before we put that sort
     > of thing in a brochure.”

I find this shocking and very similar to a 2016 financial adviser discussion about not including inferential statistics in articles.

     > If a prospective client is curious about track record… Pond [says]
     > he will find two existing clients whose situations are comparable.
     > Then his staff prints out portfolio holdings for each, removes
     > the personal identifying information and sends the documents to the
     > prospective client—who is then free… to look up the past
     > performance of each holding separately online.

This sounds like a cheaper alternative to GIPS compliance.

     > Most investors probably won’t even go that far, says David Spaulding,
     > head of a firm… that measures investment performance. “In a relationship
     > business, many clients just say, ‘Why would I ask about numbers? This
     > guy clearly knows what he’s doing.’ So nobody brings it up.”

Salesmanship trumps performance. Put another way, rapport acts as a smokescreen.

With regard to SMAs, which I have mentioned in Parts 1 and 4, Zweig quotes David Fried of Fried Asset Management:

     > “If an adviser says that every client is different, then how can he
     > realistically be an expert on investing in all those different ways?”
     > Mr. Fried asks. “And if they aren’t all different, then the adviser
     > must have a few core strategies, and then the return for each of those
     > can be reported.”

This sounds like a powerful argument to me.

Zweig recommends anyone in the market for a financial adviser ask for a written performance record:

     > That shouldn’t be just the results of a single client, a cherry-picked
     > handful of lucky stock picks or market calls, or a short-term snapshot
     > that starts… at the beginning of an epic bull market.
     >
     > It should instead present a composite of how large numbers of clients’
     > portfolios fared over multiple time periods—say, the past one, three,
     > five and 10 years, after all fees…
     >
     > If enough clients start asking, advisers will have to apply the same
     > scrutiny to their own performance that they claim to apply to funds
     > and other investments.

Powerful argument indeed!

Barrier to Entry (Part 3)

Based mainly on performance and cost requirements, I perceive a high barrier to entry into the asset management (AM) arena whereas James Osborne of Bason Asset Management largely disagrees citing the ease of passing a licensing exam.

Osborne mentioned “holding oneself out as an IAR” whereas I discussed barrier to entry as an IA. He is talking about working as an employee of an IA firm and I am talking about establishing the IA firm.

Trump cards are available to melt away any barrier. For example, becoming an IAR may be even easier in the case of someone who has befriended an IA principal. Friendship can shortcut résumé and interview requirements. With regard to the IA, AUM and/or a strong ability to sell can shortcut the cost/performance barrier by minimizing expenses (as a %).

After all my exploration into hedge funds, IAs, and TPAMs, I have often been amazed that getting into AM could be as easy as spending the money to set up an entity. To me, this is a gamble I will not take because I fail to see the road to assets. Access to enough HNW individuals is all I really need to launch this business.

Requiring a more advanced credential like an MBA or CFA might be the only way to satisfy Osborne. I would argue that even these credentials do not focus on investing performance, which would be necessary to satisfy me. The MBA curriculum at some of the best business schools has one trading course and a second available as an elective.

Another explanation for our differing perceptions of barrier to entry could be the discussion of separate sub-industries. I think raising assets and the business of [minding] investing [performance] (e.g. first paragraph here) can (should?) be mutually exclusive as advisers in the former sub-industry often outsource to the latter.

I get the impression that most professional investing incorporates a plain-vanilla,* plug-and-play approach offered by many robo-advisers and large firms. These firms have marketing muscle and/or economies of scale capable of choking out new startups like me considering a higher fee structure to make efforts worthwhile. Once again, enough sales/marketing panache and/or the right connections would enable me to trump the barrier.

* I perceive the unfortunate consequence to this “dumbing down” of available options for non-accredited investors to be a
   lack of meaningful outperformance.

Barrier to Entry (Part 2)

I want to continue the discussion about barrier to entry into the AM industry by presenting a contrary viewpoint.

In February 2015, James Osborne of Bason Asset Management posted the following in a blog:

     > For roughly a decade a huge shift has been moving the financial services
     > industry away from commissioned brokers associated with a wirehouse or
     > indie broker/dealer and to Registered Investment Advisors who work for
     > a fee. Without a doubt, this is a good thing. The conflict that comes
     > with commissioned advice is unnecessary, and investors deserve better…
     > There is a downside as this shift takes place when it comes to training
     > and licensing. The requirements to be a broker… pass the Series 7 exam.
     > Let’s be clear: the Series 7 isn’t exactly like passing the Bar or
     > graduating from medical school. It’s more like cramming for a few days
     > or weeks before a freshman year final exam. To pass the Series 7 you

Funny!

     > at least have to be able to define stocks, bonds, mutual funds and
     > options. It’s not much, but it’s a start…

This describes my 2014 experience in preparing for and passing the Series 65.

     > To be… an Investment Advisor Representative… the only requirement…
     > is to pass… the Series 65. The Series 65 exam is roughly half as long
     > as the Series 7 exam, and… much less technically challenging.

     > So we find ourselves in a world where the only barrier to holding
     > oneself out as a competent fiduciary advisor is a few hundred dollars
     > in state registration fees and a 3-hour exam. I can’t imagine anyone
     > intentionally designing a system where we are trying to make it easier
     > to be a fiduciary advisor than a stock broker, but that is where we are.

     > If we as Registered Investment Advisors want to be taken seriously as
     > professionals, we have to raise the barrier to entry. Potential advisors
     > should have a much broader knowledge base before practicing. The CFP
     > and the CFA are a great place to start…

How about a Pharm.D.? It’s much more expensive!

     > Unfortunately, the CFP board has taken steps to lower the barrier to
     > acquiring the CFP marks rather than raising it…

As opposed to general “financial planning,” I want to focus on improving investment performance.

     > Whether the solution comes from regulators forcing the administration of
     > a much more challenging entry exam or the industry raising the bar for
     > advanced designations, something needs to give. If a representative is
     > going to hold out as a fiduciary advisor under an RIA, the public should
     > be able to be reasonably assured that this person is competent to give
     > advice in the client’s best interest. I am not sure that is the case today.

I will try to resolve some of these differences in viewpoint next time.

Barrier to Entry (Part 1)

GIPS compliance and verification leads me to perceive a high barrier for entry into the asset management (AM) industry.

The first barrier is significant expense unless one has ample AUM awaiting management. GIPS compliance and verification may not cost $40,000 but it could cost half that. In addition would be expenses of setting up the IA, getting licensed, legal documentation, accounting, hiring a compliance firm, and perhaps contracting with a prime broker. Many of these are recurring expenses, too. I could easily see $40,000 per year total. If I charge a 1% management fee then I’m in the red until I build to $40M AUM* (taxes not included).

The second barrier is solid investment performance–probably necessary to attract institutional money. Developing a strategy with an impressive long-term Sharpe ratio is difficult. Most people in the financial industry have limited or no trading experience. The best trading minds with whom I have associated come from outside the industry and while some are capable of generating good (time-limited?) performance, the vast majority retains full-time jobs. Alternatively, they may be of retirement age. The former cannot afford the expenses mentioned above. Neither the former nor the latter have enough knowledge [or desire] about what it takes to enter the industry.**

Given the prohibitive cost and the performance requirement, some cheaper companies provide third-party verification of model returns that I doubt institutions would find credible. These are priced for individuals who, like me, are probably associated with limited AUM potential. One inexpensive service with which I have communicated has a simple “one account/one model” requirement. One could open multiple accounts with a brokerage, trade different strategies, and then just have the most profitable account verified to come out smelling like a rose. I doubt the big institutions would risk their reputations by outsourcing to TPAMs who have used inexpensive verification services like this. Sometimes you get what you pay for.

For all these reasons, I perceive the barrier for entry into AM to be quite high. Those with access to high-net-worth individuals (e.g. financial advisers in the business of raising assets) do not have the expertise to generate solid performance (hence the demand for TPAMs). Those able to generate solid performance don’t have enough knowledge about and/or desire to enter the industry or access to enough assets to make the expense worthwhile.


* It would cost less to sell my services to existing IAs as a TPAM or sub-adviser.
** I feel like I’ve done more research into wealth management than most retail traders.

GIPS Compliance and Verification

Today I will continue discussing my phone conversations with Sean Gilligan (Longs Peak Advisory Services) last November about GIPS compliance and verification:

• GIPS compliance is required by many firms for models under purchase consideration.
• Unified managed accounts (UMA) have come into favor lately as opposed to wrap accounts. Instead of sending a client to me, I communicate the trade model (perhaps even buy/sell signals) to advisers who do the trading and pay me a percentage of (their stated) AUM for the model.
  

• One approach to marketing is to get approved by platforms like Evestnet that serve as portals (another intermediary added to the investing chain) to various TPAMs. Institutional advisers would likely require firms under consideration to be GIPS compliant.
• Investment management firms seeking GIPS compliance have usually identified a platform(s) onto which they want to be featured. The platform (as suggested above) requires its participant advisers to be GIPS compliant and verified. Some platforms have a minimum AUM requirement, which is important to know in advance.
• Institutions sometimes search investment manager databases (e.g. Mercer, eVestment) to find potential investment managers. They often include GIPS compliance as a search criterion.
• Gilligan suspects options are more in demand than I may think because most institutions have increased their allocation to alternative investments* over the years.
• GIPS compliance is established for a firm rather than a single strategy or account. This prevents people from choosing only well-performing models/accounts to be presented.
• Every discretionary account must fit into an existing GIPS-compliant composite even if different strategies are implemented. This explains how SMA performance could be standardized (and subsequently verified).
• People with a good strategy will often contract with Raymond James or LPL Financial; if GIPS compliance is the only hurdle then it would be well worth the expense.
• An institution looking to invest with me would prefer to be a small percentage of my total AUM. Just because I can execute a strategy with $1M doesn’t mean I can do it with $10M or more. Therefore, I will likely have to build my book from smaller accounts (not my ideal scenario).

Next time I will start to discuss the barrier to entry given all these considerations.


* Alternative investment is a broad category. I’d be interested to research this more.

Lack of Performance Reporting (Part 4)

Today I resume discussion of Jason Zweig’s July 2014 blog post:

     > “It’s baffling to me,” says Tim Medley, president of Medley
     > & Brown, a financial adviser in Jackson, Miss., that manages
     > $575 million and publicly updates its performance monthly
     > online. “The advisory business has grown dramatically, and
     > I would have guessed that by now a lot more advisers would
     > be posting their rates of return on their websites.”

“Baffling” echoes my “no-brainer” sentiment.

     > Mind you, every client opens and closes accounts at different
     > times, in a variety of investments, with various levels of

This is suggestive of my historical perspective of separately managed accounts (SMA), which I “perhaps erroneously” believed to be justified in omitting performance reporting.

     > risk. But that doesn’t mean an advisory firm can’t calculate
     > the average return it earns for its clients. Every investor

In other words, my inference was indeed erroneous.

     > in a given mutual fund also is unique, but all mutual funds
     > report their past returns in the same standardized format.

Kenneth Winans, in the article discussed last time, also discussed a standardized format:

     > Any advisors who actually have a performance record worth
     > boasting about can prove they make money in bull markets
     > and keep it in bear markets, too. Doing so simply requires
     > getting a Global Investment Performance Standards (GIPS)
     > verified performance record. A GIPS record is a full disclosure
     > of investment performance results adjusted for risk using
     > a standard methodology, allowing for comparison among
     > different investment managers and benchmarks. Numerous
     > disclosures are also mandated, such as whether performance
     > is calculated before or after fees. GIPS standards are set
     > by the CFA Institute, which administers the well-respected
     > Chartered Financial Analyst program, to give “investors
     > the transparency they need to compare and evaluate
     > investment managers.”

Winans believes all investment advisors should have their performance GIPS verified.

To find out more, I contacted Sean Gilligan of Longs Peak Advisory Services. He spoke with me about the process and cost.

He also discussed verification:

     > Verification is the review of an investment management
     > firm’s performance measurement processes and procedures
     > by an independent third-party verifier. Specifically,
     > verification assesses whether the firm has complied with
     > all the composite construction requirements of the GIPS
     > standards on a firm-wide basis. It also tests whether
     > the firm’s policies and procedures are designed to
     > calculate and present performance in compliance with the
     > GIPS standards.
     >
     > Third-party verification brings additional credibility to
     > a firm’s claim of compliance and supports the overall
     > guiding principles of the GIPS standards: fair representation
     > and full disclosure of a firm’s investment performance.

Verification is that “expensive accountant” and thanks to Sean Gilligan, I now know who some of these companies are.

Lack of Performance Reporting (Part 3)

I pick up today discussing Kenneth Winans’ Forbes article about the lack of performance reporting among financial advisers.

Winans has his own theory on this matter:

     > Perhaps Wall Street hides its mediocre investment performance
     > because it’s been overcharging investors. Bloomberg News
     > writes: “The White House under President Barack Obama
     > estimated that Americans lose $17 billion a year to conflicts
     > of interest among financial advisors. Wall Street lobbying

Some overcharging may be due to conflicts of interest (e.g. steering a client toward a fund that offers a nice commission when a comparably performing ETF is available for which the advisor would not get compensated). Other overcharging is simply a result of fees being “too high,” which is a subjective assessment. If you hire someone to manage investments then it’s going to cost more money. Performance may also trail what you could otherwise do yourself. The latter requires time and effort to learn, however, which few people want to pursue. This is especially true since average returns from an investment professional are far better than what a layperson can expect from savings accounts, CDs, or bonds.*

     > groups dispute that math—and they’re right to do so. The
     > actual dollar amount is probably much higher.

This is vitriolic sarcasm because he doesn’t provide any evidence to support the latter claim.

     > Making matters worse, beyond soaking Americans with high
     > fees, 8% of advisors at the average firm have a record of
     > serious misconduct.

This is close to the 7% number I reported here.

I find it ironic that when I went to Kenneth Winans’ IA website (on November 16, 2017), the link to view his track record brings up “the page you’re looking for does not exist.” As a second data point, though, their management fee for growth investments ranges from 0.98% (for over $5M) to 1.38% (down to $250,001).

Let’s move now to Jason Zweig’s blog post from July 11, 2014 entitled “Financial Advisors: Show Us Your Numbers.” Zweig says mutual funds and ETFs publish performance and according to Charles Rotblut of AAII, you are justified in asking to see the track record of any adviser looking to sell investing services. Zweig writes:

     > While some financial advisers who cater to individual
     > investors are willing to calculate and report their own
     > average historical returns, the vast majority still
     > don’t—and probably won’t until investors smarten up
     > and start demanding it [emphasis mine].

I will continue with Mr. Zweig’s post next time.


* Full disclosure: I hope to get paid for doing this one day if I can demonstrate a clear record of outperformance.

Lack of Performance Reporting (Part 1)

I am learning some things as I investigate the wealth management industry in an attempt to find my niche. One of the big eye openers is a lackluster effort given to performance reporting.

Before learning about sub-advisers and TPAMs, I had a vague understanding of the adviser role in wealth management. I thought both financial and investment advisers managed investments. I knew mutual funds and ETFs were often used. I thought advisers often sold their own companies’ funds. I had a vague understanding that some funds published misleading performance data. I knew some advisers did not publish performance data and I believed these were the “separately managed accounts,” which [perhaps erroneously] made sense to me.

I had never directly researched “performance reporting in the wealth management industry” and am now surprised to discover that this may be an inconsistent phenomenon.

To explain how this occurs, I envision a process like the following. People with savings hire advisers to invest for them. These advisers coordinate multiple financial planning activities such as retirement, taxes, estate/legacy, life insurance, and annuities. Most time is spent on these other activities and the lack of investment performance reporting—essential for suitability evaluation—goes completely unnoticed. Alternatively, investing may be cursorily discussed because it gets outsourced to a TPAM. Either way, investing fails to get needed attention but clients remain satisfied overall due to other financial planning services of which clients may not have even been previously aware.

Kenneth Winans wrote a 2017 Forbes article entitled “Wall Street’s Secret: Advisors Sell Performance, Yet Hide Their Track Records” where he gets right to the crux of the matter:

     > …the American culture… love[s] taking the measure of things,
     > even when they’re hard to quantify. We like to know exactly how
     > good our doctors, accountants and lawyers are at what they do,
     > trying to rank them against their peers. Oddly, however, when
     > it comes to performance data from the average financial advisor,
     > finding hard numbers is like trying to nail jelly to a wall.

Like I said, First Ascent you are not alone…

     > Worse still, it’s nearly impossible to get client references from
     > IAs that reveal how they’ve performed. In an industry full of
     > type-A personalities, you’d think they’d want bragging rights.
     > Instead, Wall Street’s dirty little secret is that most investment
     > pros don’t have performance records. They prefer to talk about
     > how attentive an advisor is, whether he or she returns calls
     > quickly and can refer you to a good accountant or an estate
     > attorney. But we can get that type of information ourselves on
     > Google without having to pay 1% of all our savings annually.

I will discuss this further next time.