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.

First Ascent Case Study (Part 2)

Since an ethical mission statement is not what enables First Ascent Asset Management (a TPAM) to offer such a low flat-fee structure, I am looking for another explanation.

A closer look at the website explains its low operating expenses. It claims to have outsourced technology infrastructure maintenance and back office functions, which can be 25-33% of the typical overhead. It shares a co-working facility rather than leasing a posh downtown office. It conducts most interactions over the phone, Internet, or website to spare travel expenses. It uses videos to introduce/sell itself to advisers. It doesn’t do expensive broker-dealer conferences.

The implication is its low flat fee is justified by these enhanced efficiencies but I think the comparison can be misleading without identifying the customers. First Ascent is a TPAM that caters to other IAs. Many IAs cater to retail clients. Retail clients will not always be sold through frugal means because significant competition from other IAs exists to get their business. I believe wealthier clients want to be treated well. They want a quarterly luncheon update or a physical office where they visit trusted advisors in person. First Ascent’s clients do not need all this, which is probably what spares the expenses.

Maybe First Ascent charges lower fees because it provides a lower-quality product than other TPAMs. Looking at its content on investment portfolios, I see platitudes that serve as boilerplate marketing:

     > Diversification. Global diversification can improve performance and control risk.
     > Objectivity. We put the interests of clients first. We avoid conflicts of interest.
     > Balance. We balance our understanding of history and research with real-world experience.
     > Elegant Simplicity. Leonardo Da Vinci said, “Simplicity is the ultimate sophistication.”
     > Low Cost. Controlling costs and expenses allows clients to keep more of what they earn.
     > Discipline. Our well-defined process allows us to better navigate both good and bad markets.
     > Patience. Success in investing takes time. We are willing to wait for our ideas to bear fruit.

It provides some historical content including renowned names in the space (e.g. Harry Markowitz, James Tobin, and William Sharpe): more boilerplate, basically. It mentions two portfolios that may be implemented at multiple risk levels and are available in tax-sensitive versions, which is nothing proprietary.

With regard to performance, I see absolutely nothing! Although past performance is no guarantee of future results, this is an insult to the financially savvy that can still learn much from trade statistics.

Unfortunately, First Ascent is not alone when it comes to omitting performance details. I will discuss this more next time.

First Ascent Case Study (Part 1)

My last career saw insurance companies “carve out” (outsource) drug benefits to pharmacy benefit managers. Having a dedicated investment manager aside from an adviser busy with many other activities therefore makes a lot of sense to me.

I have [derivatives] expertise from my years of learning, backtesting, and trading [options]. I have also studied trading system development and critically analyzed many writings on the subject. I have discussed strategies with other traders and shaken up related concepts every which way to better understand them. I feel I approach the investment arena with something a bit more advanced (e.g. “alternative”) that has a good chance to outperform.

After learning about TPAMs and sub-advisers, my initial thought was that these are people/entitles like myself.

To explore this, consider First Ascent—a TPAM whose adviser perspectives I described in my last post. They charge a flat fee of $500 per account. This is 0.50% for a $100,000 account, 0.13% for a $250,000 account, 0.05% for a $1M account… dirt cheap, in other words! This level of compensation would be unacceptably low for me.

Viewing a video on the First Ascent website from CEO Scott MacKillop suggests some complicating factors. The end client still gets charged by the custodian, financial adviser, and any relevant mutual funds or ETFs. I don’t know whether the custodial fee comes through First Ascent or the adviser. The financial adviser fee is typically a percentage of AUM. Mutual funds charge multiple fees and ETFs have an expense ratio. All these different expenses coming from different places make it difficult to ensure an apples-to-apples comparison because the total fee schedule is highly variable and hard to completely identify.

MacKillop says:

     > If you ask me why other asset management firms haven’t done what
     > we’re doing, I’d tell you I have a pretty good guess but you’d have
     > to ask them. Each business is different and maybe they’d have
     > a good explanation. I’d love to hear what they have to say.

The First Ascent mission stresses doing what’s best for their clients, building the best portfolios, and investor education: “If we do all of that well then low fees and low expenses can really make a difference.”

While all this sounds like tough, persuasive talk, my impression is that the [vast?] majority of IAs could say pretty much the same thing. I doubt any of this is truly a marketable advantage.

If it’s nothing about the pitch then what allows First Ascent to charge such a low, flat fee?

I will explore this further next time.

Outsourcing Asset Management (Part 1)

This wealth management domain into which I am trying to break is quite elusive. I have been told repetitively how “unique” and “impressive” my story is. Yet I still have no job offers, nobody asking me to sign up, and no road map to a future. At least I have gained a bit more clarity with the concepts of “TPAM” and “sub-adviser.”

Further research into these concepts crystallizes some suspicions not directly identified thus far. For a while I have believed financial advisers to be mainly salespeople. The very existence of sub-advisers and TPAMs supports this belief. While fiduciary duty means putting client interests ahead of the firm, non-trading activities like marketing and raising assets do the opposite because they help the IA business move forward without contributing to client investment performance.

Mac MacKillop at First Ascent Asset Managers (a TPAM) writes about how advisers conceptualize outsourcing. One advisor described himself as a coach drafting players for different positions. His job is to find the best player (TPAM) to accomplish a certain job (investment objective) and to hold that player accountable (hire/fire). Another advisor described himself like a general practitioner (GP) charged with caring for the client’s overall [financial] health. He makes referrals to specialists (TPAMs) with expertise in particular areas (investment objectives) just as a GP refers patients to vetted oncologists or surgeons. He described finance like medicine where nobody has the time or resources to expertly manage all facets.

MacKillop interviewed another advisor who said:

     > I explain that I cannot do both the planning and provide
     > the level of due diligence and research required of a
     > prudent investment manager, so we hire people who
     > specialize in that area.

One advisor’s perspective emphasized conflict elimination:

     > I tell them that by bringing in managers who are
     > specialists in their area I put myself on the [client’s]
     > side of the table… I get to stay objective and help
     > my client hold the managers accountable rather than
     > trying to explain away my own performance.

The implementation of external managers makes good sense for opening doors to dedicated strategies, funds, or alternative investments that may be in the client’s best interests.

I will discuss outsourcing prevalence in another blog post.