Envestnet Case Study (Part 1)

As mentioned before, I need to study more TPAMs to get a broader view of their offerings. Today I will increase the sample size to 2 by looking at Envestnet.

     > Our open architecture platform encompasses a broad range
     > of institutional-quality research, investment products,
     > and advisory resources. The Envestnet Platform gives you
     > the tools to conquer complexity and drive your success.

I imagine “platform” to include pull-down menus with various funds available for investment. FAs can choose these for clients, which means the FAs would be overseeing the investments. The TPAMs actually pull the trigger on trades at the exchanges, which is where the action truly takes place.

Under “portfolio solutions” are listed three investment management companies: American Funds, PMC, Franklin Templeton. Looking closer, they list roughly 20 sets of portfolios (it’s a bit dizzying!) that all include a PMC component.

The website explains:

     > Whether you’re an independent advisor, a broker-dealer or
     > an institutional investor, Envestnet | PMC provides you
     > with all the experience and solutions you need — from
     > comprehensive manager research to portfolio consulting and
     > portfolio management — to help you improve client outcomes.
     >
     > PMC performs rigorous due diligence on an extensive
     > universe of investment vehicles to identify best-in-class
     > managers: those we consider able to outperform their
     > benchmark over a complete market cycle.
     >
     > Our team applies qualitative due diligence and quantitative
     > expertise for manager selection and ongoing monitoring.
     >
     > PMC provides in-depth consulting for advisors and
     > enterprises. We guide advisors through the various decisions
     > involved in building an optimal portfolio.
     >
     > PMC consultants also help enterprises design and monitor
     > wealth management programs and ensure fiduciary
     > responsibilities are consistently met.
     >
     > PMC combines specialist asset managers and PMC capital
     > markets intelligence to create advanced mutual fund wrap,
     > unified managed account, and separate account portfolios.
     >
     > Through a multifaceted, collaborative effort between
     > portfolio, consulting, and research teams, PMC delivers
     > a robust selection of solutions to fit the needs of almost
     > any investor.

One could get caught up for weeks to months trying to understand all the intricacies here.

Ultimately, though, I think all of this is well-written boilerplate that could apply to most any IA. Despite its apparent uniqueness and eloquence, flip a coin and choose an IA.

To better understand their investment expertise, I navigated to a video about quantitative portfolios and factor enhancement. Next time I will focus on the meat and potatoes of this presentation.

Delving Further Into TPAMs (Part 2)

Today I continue with a recap of my understanding of TPAMs thus far.

I initially understood TPAMs to be investment experts just like pharmacy benefit managers that handle the drug benefit for health care insurance companies. The phenomenon of compounded investment returns is strong reason why investing deserves a dedicated manager whereas financial advisors (FAs) may be too busy with other activities (e.g. raising assets, financial planning) to do this efficiently.

TPAMs are therefore the embodiment of intellectual capital (i.e. “experts”) required to provide a more optimal form of investment management than a plain vanilla approach one could learn from reading a book. The realization that these are “people like me” got me thinking this might be my niche…

…except maybe they’re not.

I now think I was holding the bar too high. My “significant improvement” terminology refers to subpar—not optimal— performance that, admittedly, still trounces the alternatives (e.g. savings accounts, CDs, or cash under the mattress). For this reason it is good even though it has traditionally struck me as bad (see here, here, here, and here).

I struggle with the reality that TPAMs might provide garden-variety investment offerings. As experts, why not chase performance a bit when bolstering annualized return by a single percentage point can result in a vast wealth increase over the course of decades? But as I have discussed, performance considerations are often omitted completely, which leaves us with that significant improvement.

TPAMs may be better described as specialists than experts. An expert is “a person who has a comprehensive and authoritative knowledge of or skill in a particular area.” To me, this implies quantitative analysts, financial engineers, and/or statisticians: none of which are necessarily employed by TPAMs. Regardless of performance [which is conveniently omitted anyway], constant involvement with investment activities results in familiarity and automaticity that makes them quite valuable.

Realizing that both FAs and TPAMs sometimes provide these garden-variety, mediocre investment returns represents the next step in my understanding. This significant improvement still represents substantial value for the end client.*

Regardless of skill level, I think TPAMs can realize economies of scale that [partially] offset their cost. Perhaps they get better commission rates or personal handling of high-volume trades (since they aggregate capital across many FAs) to reduce slippage compared to typical electronic execution.

I still need to study more TPAMs to get a broader view of their offerings.

I should also do a post on what I perceive to be “garden-variety” or “plain vanilla” offerings.

Also left for discussion is whether “you get what you pay for” with regard to [optimal] investment management (hedge funds).

* Repetition is one way I convince myself of things.

Delving Further into TPAMs (Part 1)

Last time I did an exhaustive job of presenting official definitions for IA and IAR along with unofficial uses for the term “financial advisor” (FA). Today I want to review the case for TPAMs.

I use “FA” to mean those who interact with the end (retail) client. FAs provide financial planning services. Legally, FAs are IAs even though they may outsource the investing altogether.

TPAMs are IAs that do not typically associate with the retail client. I can understand this from a cost perspective. By avoiding the public, they can reduce labor and focus all their time on developing and executing trade strategies. In addition, most retail clients can get sufficient information from their FAs because they lack a complex financial understanding that would demand response from the expert (TPAM).

I fail to understand why TPAMs would avoid retail clients as a matter of policy, however. I should be allowed to communicate directly with those who will be exercising trade discretion over my capital. This is why I frown on First Ascent. Consider some analogous situations in other industries. If I have a question about a particular food then I am not limited to speaking with the grocery store manager: I call the manufacturer directly. If I have a question about a particular plane flight then I can speak directly with the captain and first officer as I disembark. If I have a question about a surgery then I am not limited to speaking with the medical assistant: I speak with the surgeon directly. I have even interacted directly with a program developer when having tech issues, which is a main reason I recommend AmiBroker.

If I am going to work as a TPAM then I need to understand what the average TPAM offers. I can then decide whether it makes sense to enter the fray. This was part of the plan when I started blogging about these things.

When evaluating a FA, it might make sense to consider the “investing chain.” Each intermediary requires a small management fee as compensation for services rendered.

Equally or more important to intermediaries is the skill and/or strategy applied. Will it be a plain-vanilla/garden-variety approach (e.g. Investing for Dummies) or will it be a deeper application of intellectual capital (e.g. quantitative analyst, programmer, statistician, etc.)?

I will continue next time.

Financial Investment Advisor Representative, Defined

I hope Wheel of Fortune fans in the audience will appreciate the “before and after” format of the title. Today I will discuss definitions of financial advisor, investment advisor, and investment advisor representative.

I alluded to the terminology confusion here. According to Investopedia:

     > An investment advisor (IA) is defined by the Investment Advisers Act
     > of 1940 as any person or group that makes investment recommendations
     > or conducts securities analysis in return for a fee, whether through
     > direct management of client assets or via written publications. An
     > IA who has sufficient assets to be registered with the SEC is known
     > as a Registered Investment Advisor, or RIA.

With regard to spelling, “investment adviser” was utilized by Congress under federal law. “Investment advisor” seems to be a more popular form within the securities industry. Either are acceptable and at times they are used interchangeably.

     > IAs… [often] have a level of discretionary authority, allowing them
     > to act… [on behalf of] clients without having to obtain formal permission
     > prior to… [acting]. However, discretionary authority must be formally
     > provided by the client [in advance].

You could hire me to trade securities in your account the same way I trade for myself. You would be granting me discretionary authority to do this. I must be licensed in order to get paid, however.

     > An investment advisor (IA) can be either an individual or a company.
     > If you are providing investment advisory services as an employee of
     > an IA, you are actually an investment advisor representative (IAR).

According to the Uniform Securities Act, an IAR is:

1. An individual employed by or associated with an investment advisor.
2. An individual employed by or associated with… [an IA] who makes any recommendations or otherwise gives investment advice regarding securities, manages accounts or portfolios of clients, determines which recommendation or advice regarding securities should be given, and/or provides investment advice.
3. Anyone who holds herself or himself out as providing investment advice and/or receives compensation for such.
4. Anyone who supervises employees who perform any of the foregoing.

I could create an LLC, a C-corp, or an S-corp for whom I, personally, would work as a representative (IAR).

#3 also defines an IA. One further detail may differentiate the two:

     > Look Out! If a person meets the above criteria for IAR he or she
     > must register with the state.

An IA may or may not have to register with the state depending on AUM and in what states its clients reside. An alternative to registering with the state is registering with the SEC. Specific rules are beyond the scope of this post.

I have been using the term “financial advisor” (also spelled “adviser”) to describe those interacting with the end (retail) client. This is not an official criterion, however. Investopedia says that financial advisor:

     > is a generic term with no precise industry definition, and many
     > different types of financial professionals fall into this general
     > category. Stockbrokers, insurance agents, tax preparers, investment
     > managers and financial planners are all members of this group.
     > Estate planners and bankers may also fall under this umbrella.

Nothing is official with regard to “financial advisor” whereas IA and IAR are legal terms. This explains much of the confusion.

     > A financial advisor provides financial advice or guidance to customers
     > for compensation. Financial advisors, or advisers, can provide many
     > different services, such as investment management, income tax prep.
     > and estate planning. They must carry the Series 65 license to
     > conduct business with the public; a wide variety of licenses
     > are available for the services provided by a financial advisor.

Other licenses include Series 7, Series 63, and Series 66. The 7 is administered by the Financial Industry Regulatory Authority (FINRA) whereas the North American Securities Administrators Association (NASAA) oversees the 63 and 66 exams.

The licenses pertain to people (i.e. IARs) rather than business entities (most IAs). My 2014 Series 65 license expired because I did not get state-registered as an IAR within two years. I now have to retake the exam to be paid for financial advice or discretionary trading services.

     > What may pass as a financial advisor in some instances may be a
     > product salesperson, such as a stockbroker or a life insurance agent.

I have referred to “glorified salespeople” multiple times.

First Ascent Case Study (Part 3)

I was analyzing the TPAM First Ascent when I got majorly sidetracked on the matter of performance. Today I want to get back to First Ascent for the purpose of understanding where I might fit in with regard to asset management.

I do not see performance reporting on the First Ascent website. In an attempt to learn about the value they provide, I looked at some other tabs. One of First Ascent’s portfolio descriptions reads:

     > Each Global Explorer core is the foundation of the portfolio and provides
     > broad diversification among global securities markets. Each core consists
     > of low-cost exchange-traded funds (ETFs) that track domestic and
     > international stock and bond markets.

This could simply be a basket of ETFs easily purchased by a retail trader.

     > We may add satellites to a portfolio to complement the core. Satellites
     > may consist of actively managed mutual funds or passively managed
     > index funds or ETFs.

This sounds like more ETFs or mutual funds that any retail trader could purchase.

     > Satellites give us the possibility to add value for clients through
     > active managers.

So the TPAM outsources some of its work to a fourth party? It makes sense to me that advisers might outsource asset management to third parties who focus exclusively on investing (e.g. executing trades, studying strategies and techniques, developing systems). I would not expect TPAMs to outsource for the same reason, though. They are the outsourcing.

     > The goal of adding a satellite is to benefit from… a skilled manager,
     > or specialized strategy that may improve returns, create a new
     > source of diversification, or offer additional downside protection
     > within the portfolio.

The outsourcing having to outsource is a contradiction in terms that makes little sense to me. Furthermore, each intermediary must take a cut in order to be profitable. I would expect more intermediaries to serve as a drag on performance.

The website suggests First Ascent only communicates with financial advisers. I am suspicious of a company that will not communicate with the end client. Are they trying to hide something? Much of what I can see echoes tenets of passive investing, which leads me to expect performance that falls short of the major indices. Given their surprisingly cheap fee structure, this is probably a plain vanilla, garden-variety offering of the sort discussed last time.

Beating the benchmark over the long haul is a very difficult proposition even for professionals. Doing this cheaply seems unlikely because of the significant intellectual capital required.

Subpar performance, as I have discussed, is not a reason to avoid because that can still represent significant improvement.

Opacity, on the other hand, leaves the door open wider to the possibility of fraud. From what I can tell, this is unfortunately what the First Ascent website gives us and this is something I would avoid.

Asset Management in 2018 (Part 2)

Today I continue presenting my perspective on asset management in 2018.

On one hand, as someone who has devoted the last 10 years to learning about the mechanics of trading and investing I think the lack of performance reporting is an outrage. I feel strongly that anyone worth their salt as a trader should disclose performance, aim to maximize it, and be open to performance scrutiny. Shouldn’t we all be aiming to get better?

On the other hand, even if GIPS compliance and verification were commonplace, most potential clients probably wouldn’t understand the detailed statistics anyway. Leaving performance out of the consideration and paying hefty fees for mediocre returns remains acceptable because this still represents significant improvement in beating the pants off a savings account or cash under the mattress. As a bonus for those fees, financial advisers do much more than just [supervising] the investments.

Most advisers use selling techniques to connect with potential clients, to establish trust and rapport, and to raise assets regardless of investment performance. Despite a gut reaction to call this despicable, given the significant improvement I can’t say this is bad for the everyday client.

I am reminded of skill-oriented activity proficiency as described in Michael Mauboussin’s 2012 book The Success Equation. Mauboussin argues most people attain acceptable skill level in day-to-day activities (e.g. playing a sport, driving a car) after about 50 hours of training/practice. People then plateau and are perfectly content to remain. Elite performers advance beyond natural plateaus through deliberate practice. This involves hours of concentrated/dedicated repetition along with timely and accurate feedback (e.g. from a coach or teacher) to detect and correct errors. Deliberate practice is laborious, time-consuming, and not much fun, which is probably why few people become true experts or champions.

With regard to investing, clients generally settle for the plateau. Whether anyone realizes it [due to the lack of performance reporting], most money managers fail to beat the market.* Their plain-vanilla investment offerings generate subpar performance that still represents significant improvement. Despite the persuasive pitches that appeal to compassion, tenderness, and sensibilities, these offerings are essentially the same no matter how much they assert a sincere desire to custom-tailor a plan for individual uniqueness.

Flip a coin and choose an IA.

One other phenomenon that obscures lackluster returns is the mature bull market that continues into 2018. Aside from a few short benders, equities have rallied higher for the last 5-6 years. Layperson clients either have their heads in the sand or are happy when profitable. Most strategies have been profitable. This satisfies the casual observer for whom discontent only arises when investments lose money.

Beyond the widespread existence of poor financial literacy, I certainly believe a category of client exists that aims higher and wants more. This is the client who realizes that even in times of plenty, outperformance is important as a means to buffer against the inevitable losses that will occur when the market turns sour.

These are the people who invest in hedge funds.

These are the people who seek something more akin to optimal asset management rather than the garden-variety mediocrity.

This is beyond the scope of most financial and investment advisers.

This is where I might fit in.


* I may blog on this at some later date.

Asset Management in 2018 (Part 1)

The last few months of blogging began as an attempt to figure out where I might fit into the asset management landscape. I have since discovered an industrywide lack of performance reporting that may or may not be a serious issue.

That people seeking professionals to invest money do not scrutinize performance history strikes me as a telltale sign of poor financial literacy. Many people may seek IAs because they believe “this is just what you do” when you have idle capital. And perhaps people assume that as clients, any IA will work in their best interest to achieve maximal returns. With performance reporting optional, people probably have little understanding what criteria they should consider when selecting an IA or what parameters to monitor when tracking an IA.*

Part of me sees performance oversight as evidence of brainwashing. Poor financial literacy is probably as good an explanation and a much less paranoid one (think Occam’s razor).

The issue shocks me because I stress performance. Defining, understanding, and optimizing performance through system development are what I do. If I were not able to outperform as a trader then I would have gone back to work as a pharmacist.

Hiring an IA to generate subpar returns is much better than socking wealth under a mattress or in a bank savings account. I believe the significant improvement between paying a hefty management fee to an IA and not being invested at all is far greater than the improvement between optimal asset management and industry-standard [conventional] asset management. And given the havoc wreaked by financial fraud over the decades, perhaps it’s not so bad to settle for subpar returns with someone you can feel good about as opposed to taking chances with a black box sight unseen.**

I will continue next time.

* For those who do this. Some clients don’t even open monthly statements.
** Especially if fraud is more common with entities not personally known, which may not be the case.

Lack of Performance Reporting (Part 12)

Today I conclude this blog series with Jaime Levy Pessin’s 2011 WSJ article “Advisers’ Little Secret: Their Past Results.”

     > Charles Schwab’s website recently started to include performance…
     > for… [portfolios including] a choice of three preset investment
     > approaches… primarily made up of low-cost ETFs… Schwab… is
     > considering posting… numbers on its site for other portfolios…
     > managed [in a similar manner] for broad groups of investors…

This is another example of granularity and a window into the way robo-advisers (or certain TPAMs) might report performance.

     > In June, MyPrivateBanking started discussions among its members—
     > both investors and money managers—aimed at developing a Charter
     > for Ethical Wealth Management that would include a call for easier
     > access to advisers’ performance results.

While this sounds promising, I get no internet hits for “Charter for Ethical Wealth Management” beyond Pessin’s 2011 article.

     > BrightScope… is aiming to do the same with advisers’ performance
     > results. Last month the company started discussions with a
     > committee of IAs about ways to standardize performance reporting.
     > BrightScope also hopes to raise awareness of the performance issue
     > among investors, many of whom never ask to see advisers’ track
     > records.* “Our goal is to use consumer awareness to compel advisers
     > to play ball,” says… BrightScope’s chief executive [emphasis mine].

I have a call into BrightScope to get an update on this.

I hope BrightScope did press forward and I hope they succeed because I believe those looking for investment management are well-served by screening for encouraging past performance. The alternative is to sell people based on things like a good story, charisma, and rapport—none of which necessarily have anything to do with the ability to make money grow.

* Tenth and final reference to small demand for performance reporting and/or lack of performance reporting in the industry

Lack of Performance Reporting (Part 11)

Today I continue discussion of Jaime Levy Pessin’s 2011 WSJ article “Advisers’ Little Secret: Their Past Results.”

     > Andrew Tignanelli [of MD based Financial Consulate] says… complying
     > with GIPS is “quite intense for the average small… advisory firm…”

This is another reference to GIPS expense as a barrier to entry.

     > As of now, his firm has chosen not to provide performance information
     > publicly, although he does make it available to prospective clients
     > who ask for it, which he says happens infrequently… [emphasis mine]

To me, this details much of what is wrong with the industry. If you’re a client looking for an asset manager then performance should be near the top of the selection criteria. I continue to be amazed to discover this may not be the case.

     > Mercer Bullard, a law professor… points out that the SEC requires
     > disclaimers… explaining that past performance doesn’t guarantee
     > future returns. But, he says, some firms worry that any form of
     > performance reporting could be viewed as a promise. That concern,
     > he says, “necessarily suppresses the use” of such numbers.

Jonathan Pond seemed to be worried for similar reasons. In addition to not stating it as a promise they are including a disclaimer that explicitly says it’s not a promise. So why worry? A securities attorney might be able to speak to the frequency with which advisers get sued for this and whether they lose any such cases.

     > Some advisers may not publish performance numbers… says Susan John…
     > chairman of the National Association of Personal Financial Advisors…
     > A financial adviser who manages money but also helps with retirement
     > and estate planning… may be less likely to provide performance…
     > “because each client will have a specially tailored portfolio…
     >
     > …[at] Merrill Lynch… advisers construct portfolios for clients “based
     > on their individual attributes,” says a spokeswoman for the firm.
     > “In this context, we do not believe aggregating the performance of a
     > group of clients would yield a meaningful result.”

See my previous comments about how GIPS can account for this, about how granular categories do seem viable, and about how this might just be an excuse to avoid the expense especially when most clients [surprisingly] may not ask for it anyway.

     > Medley & Brown LLC… addresses the disparity in client types by
     > posting two broad, 10-year rolling performance charts on its website:
     > a “growth” composite, which includes portfolios with less than 18% of
     > the account in cash and bonds, and a “balanced” composite, which
     > includes portfolios with 18% or more in cash and bonds.

This is one way to define granular categories.

     > Because of the cost and labor involved in adhering to GIPS, Medley &
     > Brown is not GIPS-compliant, says Tim Medley, a principal…

This baffles me because as of mid-2017 (note: Pessin’s article is from 2011) online databases do not suggest Medley to be a small firm (see Tignanelli’s comment above).

I will conclude next time.

Lack of Performance Reporting (Part 10)

I am going to conclude this blog series by discussing “Advisers’ Little Secret: Their Past Results,” an August 2011 Wall Street Journal article by Jaime Levy Pessin.

     > You can comparison-shop for almost anything online. But probably
     > not if you’re an individual looking for an investment adviser—at
     > least not if you want to compare advisers’ performance.

Along with the long list of links I included in Part 8, here is another affirmation of the title for this blog series.

     > While the performance of mutual funds is published daily and
     > [while] investment firms that cater to institutional investors
     > are expected to publicly document their results, such reporting
     > is rare among advisers who work with individual investors.

This reminds me of Dave O’Brien’s statement about “hawking a product.” I simply disagree because GIPS provides for performance reporting either way.

     > Many money managers do offer performance numbers to
     > prospective clients who ask for them in face-to-face meetings.
     > But that doesn’t make it easy to shop around… Steffen Binder,
     > managing director of MyPrivateBanking, a Switzerland-based firm
     > that provides information… for clients of private banks and
     > wealth managers… [says] “in today’s world, publishing
     > information on the websites is the gold standard of disclosure.”
     >
     > Why the lack of such basic information? After all, posting results
     > would be “a clear advantage for good performers.” Mr. Binder notes.
     >
     > Regulatory and legal concerns are a major hurdle. Advisers don’t
     > want to be accused of promising too much, and avoiding that pitfall

This surprises me and seems quite reminiscent of the adviser perspective on why financial publications don’t include inferential statistics: “‘significance’ is a term that may implicitly overstate findings to a degree that may mislead unsophisticated readers, putting the writer/magazine at risk.”

     > can be expensive. Also, some advisers say the diversity of the

GIPS is expensive.

     > portfolios they put together for their clients makes it difficult
     > in many cases to provide performance measures that would be
     > relevant to many prospective investors.

As discussed last time, GIPS can account for this.

     > The SEC doesn’t require IAs to publish performance information.

I think it should.

     > It does offer guidelines for what can and can’t be included in…
     > [advertised performance]… advisers aren’t allowed to pick only
     > their best clients or… best time frames… in order to pad the
     > results. Results also need to be displayed net of fees.

GIPS accounts for all this.

     > Steven Stone… of… law firm Morgan, Lewis & Bockius LLP, says…
     > [although] GIPS rules are clear, there are still many judgment
     > calls… such as which accounts to include in a composite… often
     > firms attempting to achieve GIPS compliance hire a consultant or
     > lawyer to help with the process, he says, and that can get pricey.

Is cost the only downside to GIPS?

I will continue next time.