How a streamlined investment process helps advice businesses succeed
What does the client of today value from an advice business?
In addition to strong performance outcomes and competitive fees, they expect quickly executed advice, free-flowing information and empowerment from their adviser.
But in the current landscape of increasing resources required for regulatory scrutiny and compliance administration, running a profitable practice is increasingly challenging for advisers of today.
Advisers are drowning in paperwork, emails and compliance expectations, and completing records of advice (ROAs) for multiple client accounts means rebalancing or tactical changes can take weeks or months to complete.
“With regulation and compliance here to stay, advisers will have to make a choice between using human capital for technical demands or to nourish client relationships,” says Sherise Mercer, head of Macquarie Virtual Adviser Network.
“The question that’s repeatedly being asked is how can the back office be streamlined through technology or outsourcing so the front-line adviser can focus on the client and making sure their needs are met?”
Advice practices that will thrive are those with a clear recognition of what clients want and how they can serve them. This begins with streamlining the investment process.
What we’ve seen over the past couple of years is advisers seeking efficiency and scale. Efficiency and value to clients are inherently interwoven in the current regulatory environment.
Ultimately this is a shift in the way you do business and in your value proposition to clients.
Efficiency through technology
In light of these conflicting demands on resources from clients and regulators, Josh Persky, a portfolio strategist for BlackRock’s Multi-Asset Strategies Group, is seeing more advisers interested in technology they can use to offer actively managed, multi-asset class portfolios without the paperwork burden.
“The ETF model portfolio is the first step towards a more standard and holistic investment strategy that uses technology to improve client outcomes,” says Persky.
“Advice practices are learning this is a way to significantly reduce their costs, while retaining what clients value most. It’s about leveraging technology to build scale and reduce costs.”
By replacing unique client portfolios composed of perhaps many dozens of managed funds with a carefully selected model portfolio range matched to risk profiles, advisers can expect to shift their client facing/admin time ratio from 60:40 to 80:20.
Potential fee savings are equally compelling, reducing an average advisory fee of 1.09 per cent to as little as 0.33 per cent for actively managed, multi-asset class strategies, using an exchange traded fund (ETF) based model portfolio.
A business revolution
When chief executive Brett Taggart recognised his time-poor advisers were struggling to deliver expected standards of client service, he knew Australian Financial Advisory Solutions (AFAS) needed a significant change in strategy.
He had been proud of the company’s identity as skilled assets managers, delivering tailored risk-adjusted performance for each client through asset allocation.
But following sweeping regulatory change, the AFAS team were required to issue hundreds of ROAs every week just to make bulk changes to client portfolios.
“If you do one change, that’s 300 customised documents to send out,” says Taggart. “You make the change, issue the documents and have a team of people doing the compliance. That’s a huge cost to the business. I can send money all around the world with the click of a button, but we were still sending clients a paper document which they had to sign and send back. It doesn’t make sense.”
Like so many advice businesses, AFAS had reached the crossroads referred to by Mercer: do you invest in becoming an asset management specialist or in building client relationships?
It was an easy choice for Taggart who couldn’t justify channelling so much labour into compliance activities that add no value to the client experience or bottom line. So he began investigating options to reduce the compliance workload, without sacrificing performance.
“We had to find a way to plug into that asset management capability,” says Taggart. “We recognised we needed to use ETFs rather than managed funds given the speed of transactions and the cost.”
The success of this new approach for AFAS can be seen clearly in the numbers: over a six-month period, the firm has been saved from sending more than 700 ROAs and won back hundreds of hours for their clients.
A holistic, robust investment solution
Cost and time savings associated with less administration are significant for any business.
But advice firms are also looking for a scalable investment process that delivers on their two most important goals - maximising risk adjusted returns and ensuring due diligence and accountability for every portfolio and transaction.
Recognising the need for a holistic, robust solution that can deliver on these goals, BlackRock has developed its own model portfolios.
These portfolios are designed to provide institutional-quality asset allocation across a range of client risk profiles. Not only does this offer a cost-effective path to seeking outperformance, it also provides a documented, consistent and compliant investment process for every client.
A framework for total performance management
Long-term investment policy
Selecting appropriate strategic asset allocations for different risk profiles is the cornerstone of a long-term investment policy as demonstrated by Brinson, Hood and Beebower in their 1994 paper Determinants of portfolio performance.
It is these choices that ultimately determine total portfolio return.
A considered, research-driven asset allocation should take into account characteristics of each asset class (i.e. cash, domestic equities, international equities, Australian Fixed Income, Global Fixed Income & AUD Cash), and use a robust framework to forecast expected returns and volatility.
Assumptions and forecasts must be continuously challenged with sensitivity analysis and stress scenarios, and constraints applied according to the results. These strategic asset allocations act as a benchmark for any tactical decisions made within the model.
Model Portfolios Allocations
Tactical asset allocation
With a quarterly rebalancing process, our portfolio construction approach seeks to systematically capture return premiums while managing both risks and implementation costs.
We seek to achieve this by focusing on three core philosophies:
- Return – fundamentally based, top-down macroeconomic analysis
- Risk – use of proprietary portfolio and risk management systems designed to produce diversified portfolios that only take compensated risks; and
- Cost - trading costs integrated into portfolio construction using our own transaction cost models.
There’s no shortage of research supporting the performance benefits of tactical asset allocation, none more so than for value investing across individual equities.
Fama and French are credited with the definitive study demonstrating the value effect, and work from Asness provided evidence that this value effect applies to many global asset classes beyond US stocks.
This concept of relative value across asset classes is central to BlackRock’s model portfolio tactical asset allocation. The graph below highlights the potential benefit of a relative value investment approach by comparing 10-year returns for the S&P 500 Index based on original valuations.
This clearly shows that the more attractive the initial valuation, the better the 10-year return potential.
It’s worth noting returns charted here are long-term. Relying solely on a value-centric investment approach ignores the potential for shorter-term underperformance and this is why medium and short-horizon indicators should also be taken into account.
Implementation
With these long-term investment policy and tactical asset allocation insights in mind, we can narrow down the field of investment vehicles to use for implementation.
We generally find that using ETFs within a well-defined portfolio role makes for more cost-effective, liquid and efficient use of active risk budget in an invested portfolio.
As many ETFs were specifically designed to serve as building blocks for market betas or factor tilts, they are natural candidates for implementation.
Considerations for use of ETFs in model portfolio implementation
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ETF Provider
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Exposure
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Structure
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Cost
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Portfolio Monitoring
Limiting losses associated with market declines ranks high on the list of objectives for managing a model portfolio.
That’s why it’s so important all steps of our framework are highly systematized.
Relying on a clear and well-defined process for asset allocation and overall risk management, our model managers are free to focus their attention on potential risks not flagged by typical indicators.
We do use detailed risk analytics and stress testing capabilities.
However, results from these tools can benefit from a human understanding of the current market context. Computer modelling can only rely on historical data to stress test a portfolio and cannot be expected to respond to a novel scenario in the same way a human can.
Our investment process includes monthly investment committee meetings, where team members from research, portfolio management and investment strategy review performance, exposures, sensitivities to market betas, stress testing and value at risk analysis.
Summary
In the context of pressure on advisers to deliver value to clients and assurance of transparency, integrity and compliance to the regulator, model portfolios have strong appeal.
But whether advisers are building their own portfolios or using a model approach, the critical issues to address remain the same:
- What is the best way to build a portfolio that adds investment value?
- Will the portfolio have a chance of recouping the fees associated with investing and financial advice?
- What type of process is more likely to result in a portfolio with better client outcomes? and
- How best to implement, monitor and ensure compliance for model portfolios for each client.
Alex Zaika is head of wealth for BlackRock’s iShares business in Australia.
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