Google outsourcing investment management, and you will receive 49 million results. Many of these orient towards financial advisors who wish to shed that responsibility. Investment management has long been part of the service offerings of financial advisors. Why would a financial adviser pay someone else to make investment decisions on behalf of their clients? There are at least four reasons.
Investment management requires a commitment of resources
Making investment decisions for paying clients is difficult. It requires knowledge, preparation, and consistent application to do well. Hiring credentialed experience such as Charted Financial Analysts (CFA) requires money and talent. Training a team and developing repeatable processes requires time and dedication. Whether the financial advisor favors individual stocks, mutual funds (MF), or exchange-traded funds (ETF), the sheer breadth of available choices is staggering. There are now as many MFs and ETFs as there are individual stocks. Resources dedicated towards investment management are resources taken away from other parts of the business.
Investment management does not allow the financial advisor to differentiate themselves
Deciding to devote resources to investment management is only the start and does not guarantee success. MFs and ETFs performance is measured and monitored daily, letting you see how they compare to their respective benchmarks. Advisors utilize those same MFs and ETFs to construct model client portfolios, but besides client and advisor, who measures and monitors their active investment choices? No one.
The problem is that there exist no standardized measurements of how their models perform. Most client portfolios are customized to meet the needs of the client, typically an attribute. However, this also means there is no clear benchmark, weakening accountability for the financial advisor as an investment manager and diminishing the ability to differentiate themselves. Investing acumen is difficult or impossible to measure, leading to the third reason.
The advisor concludes investment management is a commodity
Nothing could be further from the truth. This myth stems from the misrepresented debate between active and passive stock-picking. Accepting this storyline at face value led many financial advisors to believe there was no possibility to add value for clients through investment management. Yet, it was something they had to offer. The solution was to pay someone else to handle the task so the financial advisor could devote more time to client service and business generation. In truth, the active/passive investing debate was about the costs of investing. There is nothing passive about investing. Every action you take or avoid is the result of an active decision.
More time for client servicing
When a financial advisor outsources their investment management, the thinking goes, they will have more time for other tasks. More time for servicing existing clients. More time to prospect for new clients and grow the business.
The drawback for clients
But outsourcing has drawbacks for clients in particular. When advisors decide to delegate their investment management responsibilities to other organizations, it leaves them exposed. In those cases, a financial advisor cannot know nearly as much about the portfolio they are paid to manage. Such as why certain assets were added to or deleted from the portfolio? After all, someone else made the decision.
Clients pay their financial advisor to help manage their financial lives. Rather than clients using financial advisors as investment management wholesalers, why not go directly themselves? Finally, over 90% of financial advisors still charge fees based on an AUM model or assets under management. But if the financial advisor delegates investment management to a third party, why pay a financial advisor as if they alone were managing your assets?
The lesson for clients is to ask questions about your financial advisor’s business model. Understand how it works, who is doing what, and be confident of the value received for fees you pay.