Writing on wall for traditional advisers
Rise of mutual funds ordained wave of change
Having been in the investment industry for the past two decades, I have witnessed many interesting changes.
It started with the introduction and subsequent growth of mutual funds. This new product brought the excitement of the stock market from Wall Street to Main Street with the average investor now finally being able to own a well-diversified portfolio of stocks and bonds.
Investors didn’t mind paying the high fees, which were often embedded or hidden, as 2.5 to three per cent seemed low when compared to interest rates that were in the mid to high single digits at the time.
This highly profitable product spawned a plethora of independent investment firms, and those that were able to generate strong returns prospered and grew into firms that today have billions of assets under management. Even those managers who didn’t have distribution channels could partner in a subadviser capacity with those who did, because the fees were large enough to share.
At the same time, multitudes of small to mid- sized specialty firms including hedge funds were formed offering mandates to high net worth clients willing to pay even higher fees for exclusivity and torqued up performance.
Then the Walmarts and Amazons of the investing world came along.
Barclays, State Street and Vanguard all began offering exchange traded funds ( ETFs) as a low- cost alternative to mutual funds. As market efficiency has improved due to the greater number of participants and more equal access to information, it has become all the more difficult for the higher-fee, active mutual fund managers to beat their passive benchmarks.
While many of these fund managers have finally responded by slashing their fees, it hasn’t stopped the flow of money into ETFs. It has now reached the point where mutual fund firms have capitulated and begun launching their own lineup of ETFs — but it may already be too late.
The investment industry as a whole morphed into a l ow- margin manufacturi ng business with rising administration and regulatory costs and rapidly falling management fees. Therefore, looking ahead, only those with size, scale and distribution will be able to prosper.
In particular, the multiservice Canadian banks have been stealing market share in this environment by moving toward their own manufactured in- house investment products while at the same time layering on and cross- selling higher- margin, premium services such as insurance, lending, and other banking offerings.
However, the writing is on the wall for those traditional investment advisers on the grid because as the investment offerings become more commodified and brought i n- house, the banks will slowly take ownership over their clients. As a result, the advisers are being transformed towards a salaried relationship manager model which makes tremendous economic sense in today’s low-margin environment.
Then there are the independent investment firms with large subadviser relationships who are really exposed. This is because the money generated by fees simply isn’t enough to go around anymore, meaning many of these firms will face massive fee compression, or worse, be internalized thereby losing the business altogether.
The boutique managers with specialty offerings charging a two per cent management fee and 20 per cent performance fee aren’t safe either. We think that unless they begin slashing their fees they could be replaced by ETFs that are currently providing similar mandates at only 0.5 to 1 per cent with no performance fee.
The one area outside the banks and ETF providers not facing disruption is in those providing an i nvestment service and not a product. This includes a more holistic “risk-planning” approach including tax, insurance, financial and investment oversight which are much harder to commoditize. While technology currently exists to help with asset allocation, rebalancing and client reporting, we have not yet seen anything that can replace the direct-to-client interface in regards to oversight and planning.
In conclusion, as an investor it helps to get an understanding of the options available and where t he i ndustry is headed. While newer investors will be directed toward a single ETF solution, as they grow they will require more planning and oversight services especially when it comes to navigating greater conflictsof- interest and cross- selling by those who are consolidating positions in this dynamic environment. Financial Post Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary- based private client and institutional investment firm specializing in discretionary risk- managed portfolios as well as investment audit and oversight services.