There's a revolution brewing in financial advice. It's good news for investors, but not such glad tidings for Canadian banks.
The Big Five are counting on "wealth management" – the business of delivering financial and investing advice to clients – to help fuel earnings growth in the years ahead. However, the path to those higher earnings is likely to be more challenging than in the past as technology introduces new rivals and helps cut the cost of obtaining investing advice.
One of the most striking examples of the new technology comes from Vanguard Group Inc., the U.S.-based fund and ETF giant. It is experimenting with offering low-cost counsel to U.S. clients through webcam chats with real advisers, supplemented with other online tools. Vanguard figures it can deliver regularly updated financial plans and other advice to people who have at least $100,000 (U.S.) for an annual fee of only 0.3 per cent of their assets, a tiny fraction of what most advisers now charge.
A pilot version of the program, known as Vanguard Personal Advisor Services, has been introduced quietly in the United States over the past few months, and a broader roll-out is planned next year. The company says it has no plans to bring a similar offering to Canada. Still, if the program is successful in the U.S., it's hard to see why Vanguard or someone else wouldn't deliver a Canadian version at some point.
Vanguard, in particular, has the size – think $3-trillion in assets under management worldwide – to achieve economies of scale and disrupt the traditional model of dispensing financial advice. While so-called robo-advisers such as Nest Wealth and WealthBar already offer to build portfolios at low cost primarily through online tools, the additional attraction of the Vanguard offering is its ability to link up a client with a human being who also happens to be a qualified financial planner.
Whether Vanguard ever does go ahead with a Canadian version, the domestic market seems ripe for an offering of this type. Financial planning, as often practised in Canada, consists of building balanced portfolios that can be reasonably expected to deliver returns of 5 to 8 per cent a year over the course of an economic cycle, before fees are deducted. The problem is that fees usually chew up a couple of percentage points or more of that return – in effect, diverting roughly a third of the potential reward from a client's portfolio into an adviser's pocket.
Advisers can potentially deliver value in this scenario by helping to keep clients on track and thwarting their natural impulse to jump into hot stocks or sectors. Advisers can also provide advice on tax planning, insurance issues and other complex issues.
But, all things considered, fees still seem ripe for reduction, especially at a time when low bond yields are depressing the outlook for future returns. Slowly but surely, index funds and ETFs are gaining fans by promising to deliver market returns at the lowest possible cost.
The battle for lower fees is nothing new. For more than a generation, finance profs have been lecturing students about how unlikely it is for an investor to beat the market. The numbers show that "passive" strategies that merely track market indexes at low cost produce better results, on average, than expensive "active" management that attempts to select tomorrow's market winners. To anyone in money management, the benefits of cheap indexing strategies are old news.
But it has taken a long time for the message to leak out to the general public. At the same time, a flood of new talent and effort devoted to finding good investments has made it tougher and tougher for even the hardest working, most brilliant manager to uncover opportunities ahead of her colleagues.
Charles D. Ellis, a famed U.S. money manager, summed up the case nicely in a recent article in the Financial Analysts Journal: "The increased efficiency of modern stock markets makes it harder to match them and much harder to beat them – particularly after covering costs and fees."
A new study of the Canadian market by Stephen Foerster and Alessandro Previtero of the University of Western Ontario, Juhani Linnainmaa of the University of Chicago, and Brian Melzer of Northwestern University concludes that financial advisers succeed in having their clients take on more risk – but all the benefit of the higher reward from that additional risk, and more, winds up being devoured by fees.
For now, those fees are often veiled from a client since they are typically deducted before results are reported. But recent regulatory changes, such as the Client Relationship Model 2 introduced by the Canadian Securities Administrators, will make an adviser's fees and other charges more transparent to users as new disclosure rules roll out over the next couple of years. Banks and other institutions that deliver advice are already adjusting their business models to reflect the new realities.
If advisers are delivering value, their clients should be satisfied when they see what they're actually paying for that advice. If not, expect a greater interest in the new wave of technological alternatives.