Financial advisors and investors in Canada could benefit from the introduction of a few key features from the United States’ financial advisory system; namely, the registered investment advisor (RIA) model, the ecosystem that supports it and the turnkey asset management program (TAMP).
The RIA model has become an increasingly popular option for advisors south of the border. The traditional broker/dealer advisory channel, similar to Canada’s big bank-owned brokerages, has been steadily declining since 2014 and now sits at about 600,000 members. Meanwhile, there are now 30,000 RIAs in the U.S. and recent year-over-year growth in this category is in excess of 20 per cent.
There are three key reasons why advisors in the U.S. are choosing this route. Independence – or the ability for advisors to choose how to run their operation, free from the sales quotas and conflicts of interest that a broker/dealer imposes – is the prime benefit of the RIA model for advisors. The fiduciary standard to which all RIAs are held follows closely. (Yes, advisors in the U.S. want to be fiduciaries and many look to become RIAs to operate in their clients’ best interests.) The third benefit is simple economics.
Under the RIA model, advisors retain the fees they charge; there’s no override, grid or other friction on advisor earnings. Although this approach means advisors need to pay all their business costs, an entire secondary ecosystem of vendors has sprung up to support the RIA model.
RIAs can select their preferred tools, link them together with a few clicks of the mouse so they can exchange information – and not pay an arm and a leg to do so. Case in point: XY Planning Network, a service provider for younger RIAs, meets all of an advisor’s essential technology needs starting at just US$421 a month.
A recent InvestmentNews survey showed that RIAs’ earnings before owner compensation – what the advisor gets to take home – averaged 65 per cent on firms earning around $500,000, with top performers hitting rates as high as 90 per cent. For any advisor with an entrepreneurial bone in their body, the economics of this approach are hard to pass up.
The potential benefits of the RIA model, which is similar to the portfolio manager registration category in Canada but with some core differences, are not limited to advisor gains. In the U.S., the advisors’ higher profitability per client household has led to lower client households per advisor ratios, which in turn leads to more time, attention and advisory services per household – and thus better outcomes for clients. There’s also increased demand for advisors, which, coupled with imposed supply limitation, creates opportunities for new advisors coming into the market.
Another key difference between the U.S. and Canada is how RIAs handle portfolio management. A growing trend is to outsource portfolio management to a TAMP. Although TAMPs vary in how they operate, in general, an advisor opens a client account with a custodian and then the TAMP is given discretionary authority over the account and runs the portfolio. Thus, the account remains on-book for the advisor, but expert portfolio managers manage the portfolio. The use of TAMPs allows advisors to focus on financial planning and on nurturing the client relationship.
To become an RIA, an advisor must obtain a Series 65 licence by passing the corresponding examination. In Canada, to become a portfolio manager, an advisor must hold the chartered investment manager or chartered financial analyst designation and complete four years of oversight/apprenticeship experience. In addition, each portfolio manager operation must have its own internal chief compliance officer (CCO). Both the oversight and CCO requirements are obstacles for prospective portfolio managers.
Thus, there’s an opportunity to open up a different channel for discretionary portfolio management in Canada through outsourcing. Securities regulations don’t limit the delegation of management, so why not create a new licencing arrangement that would allow the outsourcing of portfolio management to an exchange-traded fund, a mutual fund, separately managed account providers, or a TAMP – if the platform was made available in Canada.
This new registration category could waive the experience requirement for portfolio managers if they outsourced all asset-management functions; this approach could create better results for clients as it would put investment discretion in the hands of managers with more experience and better resources.
A second potential change is even simpler: allow the outsourcing of CCO duties to an independent third party. This move would also serve clients’ best interests in that single-person and small portfolio manager shops would no longer be responsible for their own oversight, which is a clear conflict of interest.
These small differences, which could come to fruition through the adoption of an RIA-like model, could have a big impact on Canada’s investment industry and unlock a virtuous cycle, just as they have in the U.S. They would result in lower overhead, which would lead to greater per-client profitability, greater levels of service per client – and all would be enforced by the requirement to act as a fiduciary.
Jason Pereira is partner and senior financial consultant at Woodgate Financial Inc., a financial planning firm under the IPC Securities Corp. umbrella in Toronto. He is a three-time winner of PlanPlus Inc.’s Global Financial Planning Award.