The Changing Role Of Financial Advisers

October 05, 2009

The nature of the financial adviser marketplace has changed. And that means that some investors should probably change their financial advisers.

A decade ago, the task of most mainstream financial advisers was relatively simple. They formed relationships with clients, developed a straightforward wealth-building plan, invested their clients’ money in a portfolio of mutual funds and tried to make sure that their clients didn’t do anything stupid while the market did the work.

To me, that last piece was always the most valuable. Having someone or something in between you and your money is often a good idea. A good adviser can dissuade you from acting on impulse, either rushing to buy the “next big thing” or rushing to sell something that has under-performed. In both cases, it usually saves you money in the long run.

For most advisers, however, the task of actually managing money was secondary. The best portfolios are almost always boring, and a decade ago, boring meant a simple split between U.S. equities and
bonds, perhaps with some international equities thrown in. Some advisers would tilt their portfolios toward small caps or value, and a few on the bleeding edge would sprinkle in emerging market exposure.

Advisers who wanted to try to beat the market bought actively managed mutual funds. By and large, they used relatively simple metrics like trailing performance and manager tenure to pick one fund over another.

Those days are over. ETFs have changed the game, in two important ways.

First, they have broadened the universe of asset classes that an adviser can consider. An adviser today must do more than just choose between U.S. stocks, foreign stocks and
bonds. They have to decide whether to weight emerging markets in line with their share of global market cap (11 percent) or their share of global GDP (24 percent). They have to choose whether to add international bonds to a portfolio or stick with the
U.S. fixed-income market. They have to decide if commodities and currencies have a role in investor portfolios, and whether TIPS make more sense than Treasuries.

These decisions were possible in the good old days too, of course, but they were more difficult to execute, and often concealed behind the boardroom door of an active mutual fund manager.

Trickier Role

ETFs have opened up a hundred targeted areas of the market to advisers, all one trade away, all cheap. This has made the adviser’s job a hundred times more complicated as a result.

(I feel this pressure myself. I’m considering adding international fixed income as a new asset class to my streamlined 13.65 basis point ETF portfolio. It would be the first major change to that portfolio since I designed it in 2007. More on this in a future blog.)

The second change is even more fundamental. With ETFs, the burden of generating returns has shifted away from mutual fund managers and squarely onto the shoulders of the individual adviser.

Whether they use all ETFs or a sprinkling of ETFs, mutual funds and single stocks, the best advisers now embrace the idea that the fundamental driver of returns is a portfolio’s asset allocation policy. The chief goal of the underlying instruments in the portfolio is thus to provide exposure to an asset class or theme that the adviser wants to tap into, not to try to beat an underlying benchmark by a percentage or two.

I suspect that over the next few years, we’ll see the average fee charged by mutual funds decline as their services become less valuable, and they are forced to compete head-on with the one-two punch of good advisers with efficient ETFs at their disposal. Meanwhile, the average fee charged by financial advisers may go up, or at least stay stable, as their services become more valuable.

For investors, this means that the choice of adviser is becoming increasingly important. As I’ve said before, your cousin Charlie is no longer good enough.

There are some excellent financial advisers who will choose to outsource their portfolio management using model portfolios, and focus on client services; that’s legitimate, as long as the model portfolios they use are thoughtfully designed and carefully implemented.

But it doesn’t change the fact that the adviser’s role in generating portfolio returns is growing. And that means the value that you ascribe to picking the right advisers should increase as well.



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