Unlocking Real Value Blog

Recent studies by two research firms confirm that the growth trend in retail investment alternatives is poised to continue:

• Cerulli Associates predicts that alternative mutual funds will represent 14% of the industry’s assets in the next 10 years, up from the current 2%; and
• Strategic Insights expects liquid alternatives to reach $490 billion by 2018, up from $237 billion at the end of August.

Those surveyed include managers, investors, advisors and industry executives. Cerulli also found that 25% of advisors they spoke to plan to increase their allocation to alternatives. What the implications of this growth?

The Good – investors will have more of a variety of funds from which to choose. Presumably, as the growth in retail alternative investments continues, so will the education process, of both advisors and investors, as will transparency. But I have commented before that I am worried about the growth of alternative investments in the retail space, because many investors have no idea what they are actually investing in. Advisors are also at risk if they don’t take the time to truly explain how hedges fit into a portfolio.

The Bad – while assets are forecast to increase significantly over time, up until now the proliferation of new funds has outpaced this growth. In 2012, for example, 101 alternative mutual funds were launched. While this number has abated this far, to around 30, I fear that this could be an example of the industry creating the demand – rather than the demand leading to product development. Some industry executives already see an alternatives fatigue setting in.

The Ugly – this trend proves to be the next bubble and further deteriorates investor confidence in advisors and the industry as a whole. The ugly word “derivatives” comes to mind – is the product development world getting ahead of itself again in creating innovate products that investors (and advisors) don’t really understand and may not truly need? Will investors balk when their hedged portfolios underperform in years such as 2013 and they fire their advisors, without ever giving their portfolios the opportunity to outperform in down markets?

My hope is that the many mistakes of the past will not be repeated, and that I am being overcautious. My fear is that I am right.

What do you think?

Advisors constantly struggle with the question of how to price their services. Rarely do you go to an attorney or physician who offers to discount their fees; so why should advisors? The answer is quite simple – they shouldn’t. But underlying this answer is the assumption that the advisor has clearly articulated his/her value added from the beginning of the relationship and follows through as the relationship develops.

This concept is often referred to as pricing your value. For example, should fee-based business be priced differently than commission business (for “hybrid” clients) that utilize both services? The answer depends on what services you are providing. If commission clients are getting many of the same services – such as asset allocation advice and quarterly reporting – on that portion of their business, the answer is yes; if they are not, the answer is no.

PriceMetrix, a leading industry pricing service and think tank know for the quality and depth of their research, recently released a study on whether or not advisors price the fee-based and commission portions of their hybrids differently – is one discounted as a loss leader for the other? The results showed that the answer is basically no – most advisors show consistency in pricing – either higher or lower than average; only 21% of advisors seemed to price the two kinds of services differently.

(The study included data from hybrid households with investment assets between $500,000 and $1 million and come from the PriceMetrix database that includes nearly 500 million transactions and over $3.5 trillion in assets.)

These results are encouraging in that they hopefully reflect that advisors are consciously deciding that they are worth their fee, regardless of the type of transaction. In the event that these results are just a coincidence, it’s worth mentioning a few golden rules of pricing:

• Advisors should clearly articulate to new clients their value added proposition and casually remind them of their commitment and follow through on an on-going basis;
• Fees and how they are earned and charged should be discussed upfront – if clients have to bring up fees before you do, you are probably going to be on the defensive for the duration of the relationship; and
• The type of investment – fee-based v. commission – should be irrelevant in pricing because you want to be seen as a solution provider rather than simply an order taker.

I’ve read a number of interesting articles/reports lately that merit a mention – and could help lead to business-building ideas.

1) Referrals – a recent study by Prudential about referrals indicates that while clients think it takes 4.8 years on average to build up enough trust to make referrals, most advisors think that such trust is built in half of the time – just over two years. Perhaps advisors need to be a little more patient! The good news, however, is that while clients believe that referrals have a lot of social risk, more than half of the people surveyed have made referrals, and another third said that they would.

2) Fee-based compensation – According to Cogent Research LLC, two-thirds of industrywide compensation will come from asset-based fees by 2015, up from 59% today. The study included 1,700 financial advisors with an average of just over $100 million under management. The likely biggest loser from this continuing and growing trend – actively managed mutual funds.

3) Advisors too focused on baby boomers – a recent Cerulli Associates report (conducted in conjunction with Phoenix Marketing International) warned that advisors are focusing too much of their time on baby boomers, just at the time when these investors are going to be retiring and entering the spend-down phase of their lives. Simultaneously, fewer than 20% of investors under the age of 40 feel that they are getting enough attention. Advisors, by ignoring these younger investors, could miss out not only from the growth in assets of these investors as they become more successful, bus also from the more than $2,3 trillion in investible assets estimated to be transferred via inheritance between 2026 and 2030.

4) Wirehouses face continued threat from RIAs – the Aite Group, in a new report, indicates that independent shops and discount brokers should continue to benefit from their ability to tailor customer experiences more easily than wirehouse advisors. While there is no denying the continued growth in market share of wirehouse competitors, I for one still believe that a wirehouse advisor can be successful and create a very good client experience – they just have to work a little harder at it! (According to the story, RIAs boosted assets last year by 18.2%, discount brokers by 12% and the wirehouses by 8.2%.)

I was asked to comment on the results of an Ignites (A Financial Times Service) poll of financial services employees and their thoughts on retirement. About 84% of respondents say that they are saving enough for retirement, although 52% said that while there current savings rates are sufficient, they still feel that they should be putting more money aside.

This contrasts to a recent Gallop poll which found that 46% of non-retireed Americans do not feel that they will have enough money to retire comfortably.

First, why are we in the financial services industry so much more comfortable with our outlooks for retirement? To quote from the article:  “As Andy Klausner, founder and principal of AK Advisory Partners says, “You would expect fund industry employees to be more tuned in to retirement and saving for retirement than the average person simply through their day-to-day exposure to the issues.

“Even if they aren’t directly involved in the products, for example, they are certainly more aware of the advertising and marketing that their firms do. This goes for all [fund industry] employees,” he writes in an e-mail response.

Additionally, fund firms themselves are taking an active role in helping their employees prepare for retirement. One way that firms, such as Invesco and Vanguard. accomplish this is by making their employees eligible to participate in their 401(k) plans from the day they start employment, rather than requiring a waiting period.”

Secondly, however, why do we feel that we should still put away more? I think there are a number of reasons: 1) people are living longer than ever before, so the fear of outliving your savings, no matter how large it may be, is great; and 2)  to quote from the article again: “A number of factors can hinder professionals from saving enough, Klausner acknowledges. For example, living costs usually are higher in the large cities where financial services firms tend to be located, such as New York. Plus these professionals may not be seeing their compensation rise as quickly as it did before the 2008 financial crisis, he says.”

Any thoughts to add?