More than ever it's imperative financial advisors provide transparent cost structures and conflict-free, unbiased advice when recommending client portfolio solutions.
Since the Department of Labor's final rule on qualified accounts, pressure is now mounting on other industry regulators to produce their own versions of a fiduciary wealthcare standard to extend to the much larger non-qualified world. As a market opportunity there are fundamentally two areas in which an advisor can differentiate themselves boldly before these agencies enact their rules: The first is cost transparency; the second is performance evaluation. Taken together, clients will have a clear understanding of whether or not they're being served efficiently and productively by their financial advisory relationships.
But how would an advisor go about achieving this?
The first step is to take a good long look at your client accounts. Then, ask the tough question: How have I been or will I be compensated (directly or indirectly) by these assets? This compensation is beyond any asset-based fee or commission one may earn from the account's market value or trading activity and includes other financial or non-financial compensation associated with those assets.
For example, a mutual fund or separately-managed account manager that, in the spirit of partnership, sponsored an advisor to host a dinner, seminar, golf outing, or other related marketing event or effort, provided a form of remuneration.
Such remuneration is so ubiquitous that most advisors view this support as a means to survive in the business, especially during their early or lean years. However, the landscape is changing and new potential rules (already under discussion at Finra and the SEC) could find the entire money management wholesaling contingent receiving severance packages before too long.
If you're a financial advisor, why wait?
Start behaving as if the new world order has already taken hold and use it as a service differentiator that messages your proactive elimination of even the appearance of conflicts of interest.
I've heard the arguments regarding how this kind of activity is not creating a conflict for every client in every situation and I don't particularly disagree. But the regulatory movement is afoot nonetheless. Begin adaptation now so that in five or so years when the new rules take effect, weaning off the money managers' teat won't result in the ruin of ones practice.
And when it comes to cost transparency, there's a tremendous amount of fees not properly disclosed to clients.
Of course, every firm has their ADV delivery requirements, but who knows of a client that actually reads those documents?
A common area of fee-layering takes place in managed account programs, whether TAMP, WRAP, or other platforms, in which mutual funds are utilized as managed account holdings. Rarely do clients fully understand that there are two layers of cost: one visible in the quarterly statement in a line-item called "advisory fee;" the other cost implicit within the mutual funds themselves.
I often audit portfolios managed at major firms and routinely discover a $1,000,000 portfolio costing a client more than 2% due to the aggregate of these two fee layers. If any advisor believes this area will go unaddressed by the regulators, think again. It's one of the easiest areas of cost transparency improvement and will most likely require a client signature on fee acceptance.
In the second main area of differentiation, advisors can adhere to a standardized performance reporting routine.
Establishing an agreed-upon benchmark or set of benchmarks that can get both advisor and client on the same page during quarterly or semi-annual reviews is a best practice. Ultimately, clients should be in a position to judge independently whether they've had success or failure with their advisor.
Did they take more risk than the broader market to achieve greater returns? That's okay.
Did they earn far less than market returns but also took far less risk? That's okay too.
The principle is that the client's portfolio performance experience is consistently framed through an understanding of risk and return. This is critical to showcasing the advisor's value proposition or detriment.
Technology will continue to support an advisor's choice to highlight this area and regulators may find future influence on these report types as well.
Standardized evaluation tools will never be a panacea, especially when a client's level of education in modern portfolio theory, strategic asset allocation and asset correlation is considered.
The best advisors not only provide performance data but go further to educate clients regarding the nuanced importance of various metrics. After all, this is precisely why clients want to hire a financial advisor in the first place: they believe a professional can add greater overall value (financial and intellectual) than going it alone.
As advisors evolve, the industry can prove them right.