One aspect of my financial advisory practice that astonishes fellow advisors is that my team outsources the day-to-day responsibility of managing clients’ assets to mutual fund companies, exchange-traded fund providers and investment-counsel firms.
For advisors who see their value proposition as “beating the index,” that revelation is a difficult one to grasp. The reason we’ve chosen this path is very simple. We know – and are not afraid to admit – when we cannot add value.
Consider the following:
- The market is fundamentally a zero-sum game. For you to make money, someone else must lose that upside – and vice versa.
- For years, academic studies of empirical data have demonstrated that generating alpha consistently is extraordinarily rare. In fact, there are questions about whether it’s even possible.
- Looking at three widely recognized studies conducted by Vanguard Group Inc., Morningstar Inc. and Envestnet on how advisors generate value, not one points to portfolio management or securities selection.
So, how can advisors best handle the tasks of security selection and portfolio management?
If you don’t believe we can add excess return via alpha, security selection is easy as it becomes a portfolio-management decision regarding which indexes and indexation methodologies to include.
However, if you wish to seek alpha, then security selection becomes much more challenging. What behavioural, informational, executional, technological, or speed advantage can the average advisor access to extract gains from others?
The answer? None. We get our information at the same time as the public. By then, the institutional players and the algorithms have consumed and processed the data already. What hope does an advisor, or even a small team of advisors, have when faced with teams of certified financial analysts and data scientists who command enough money to move markets?
That’s no exaggeration. Michael Lewis wrote in his 2014 book Flash Boys: A Wall Street Revolt that 200 financial institutions had signed up to use a proposed fibre-optic cable line that runs from Chicago to New York at a total cost of US$2.8 billion before the cable was even done being laid. That’s because it would shave 0.0003 seconds off the time required to relay Chicago futures data to traders in New York.
Algorithms can trade on this information before our individual, non-networked brains have even had time to process a single number on a screen. And if you need yet more proof, listen to Patrick O’Shaughnessy’s podcast, Invest Like the Best, in which he interviews some of the most sophisticated money managers in the world. Their competitive advantages versus those of average advisors and investors are so staggering that Mr. O’Shaughnessy often jokes he should have called the podcast This is Who You’re Up Against. Thus, the only real choice if you’re an advisor seeking alpha is to hire the best-armed and proven people you can find – or consider not seeking alpha at all.
When it comes to portfolio management, the case for outsourcing is equally compelling. Every major financial institution offering one-ticket mutual fund or ETF portfolios has a management team supporting them – and each of those teams has access to more people and resources than any advisor.
Consider the example of the multi-asset management team at Mackenzie Investments, which boasts a team of four portfolio managers, seven analysts and an economist – four of whom used to work as portfolio managers for the Canada Pension Plan Investment Board. All have access to a significant number of active and passive mandates and work off multi-million-dollar custom technology consoles. What hope does any advisor have of adding more value than a team like that?
Case in point: one full-service dealer challenges its advisors to demonstrate they can do a better job than its in-house asset-management arm. Advisors are asked to pick the account of just one client who has a balanced mandate – one the advisor feels they have done an exceptional job with – and then compare it to the full retail priced balanced Series A class fund.
To date, the challenge has been conducted 100 times. The result: 99 advisors underperformed the fund, 85 of whom by more than one percentage point. Only one advisor has beat it – and that case is arguably a statistical anomaly. Even if that advisor outperformed the reference portfolio, the real questions are: By how much? And would that advisor have been able to deliver even more value through financial planning and other non-investment-management activities?
There is a real difference between advice and investment management. Advice is a very broad term encompassing many services that can add value to clients’ lives. Such services include comprehensive financial planning, ensuring suitability, asset location, tax management, behavioural coaching and other factors that require the one-on-one assistance we all claim to provide and on which we pride ourselves.
So, don’t bring a knife to a gun fight. Well-resourced teams whose primary focus is on managing client investments are in the best position to handle the investment-management component. Instead, focus on the areas in which you can really have an impact and make yourself indispensable to clients.
For advisors who think this puts us at a disadvantage when speaking to prospects, think again. My team wins prospects over more often than not thanks, in part, by pointing out that combining qualified, outsourced professional investment management with personalized, one-on-one advice is a winning formula.
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.