From the December 2007 issue of Investment Advisor • Subscribe!

Future Talk

Is third-party portfolio management the next wave?

Every now and then you get a glimpse of the future--when you're presented with a new fact or idea that causes other bits of information floating around in your brain to tumble into place, forming a clear picture of where things are going. I had such an experience at the Thornburg Wealth Management Conference here in Santa Fe this October. That conference is always good for me, both because it's a local event, and I get to spend a few days with some of the smartest wealth managers in the country. I usually find nuggets for at least a column or two.

This year, I was confronted with two new facts that, when combined with two notions I already held, caused a slight, but significant, realignment of my worldview. The first was that a surprising (to me, anyway) number of advisors are now offering some kind of healthcare services to their aging client bases. In fact, in a survey of the attendees we conducted for the open forum session I moderated, 85% of the advisors said they offer healthcare services. Granted, the 30 or so advisors present represent a pretty small sampling, and as I said, they tend to be on the cutting edge of the profession. Still, 85% is such an overwhelming number that it leads me to believe that many of you are offering healthcare services, too.

The second perspective-altering fact came from Thornburg Securities president Ken Zeisenheim, who's been in the industry as long as I've been covering it, and has been a great source of insight and information to me over the years. Ken pointed out that in response to the FPA's victory over the SEC on the so-called Merrill Lynch Rule, the Wall Street wirehouses are enabling their brokers to avoid the fiduciary duty of investment advisors by having them sell third-party portfolio management services. A classic example of the law of unintended consequences.

The Competitive Threat

Wall Street, of course, has tried package management before: in the form of ridiculously loaded wrap accounts, which proved uncompetitive even to the unsophisticated public eye. But this time, as they say, things are different. The New York marketing mavens have come up with a far more attractive formula: Third-party portfolio management by major institutional money managers and global private banks, firms that most clients couldn't get to manage their money unless they had a lot more money. Ken's question was: what will independent advisors do to compete with that?

So combine these now-available money-managers-to-the-wealthy and new healthcare services needed by older clients with two other items that we already know: While numbers of clients and revenues are up, profit margins at independent advisories are being squeezed (by employees, technology, and new, costly services) like never before; and, at least in my opinion, independent advisors don't charge enough for their services to begin with. What you get is a vision that to compete with Wall Street, cut overhead costs, increase fees, and support new healthcare services, independent advisors, too, are going to have to turn to third-party portfolio management.

Now, before you go off on a rant about another layer of fees, high-priced products, client stealing, and the fact that you can manage portfolios as well as anyone, let me make a confession: I've always thought third-party portfolio management was a dumb idea for independent advisors, too. In fact, when the late, great Lynn Hopewell told me over ten years ago he was turning his client portfolios over to a third-party manager, I have to admit I thought he was going 'round the bend. But as in so many other ways, it turns out Lynn was just ahead of his time.

I'm not saying someone else can manage your client portfolios better than you can. I'm suggesting that just like answering the phones, executing trades, and writing financial plans, screening mutual funds and monitoring their performance might not be the best use of your time. Hiring someone to do those things might not be the best use of your resources, either. In an era when employee costs are rising faster than profits or revenues, it's time to take a hard look at all the labor-intensive tasks performed by advisory firms to see if they can be effectively outsourced to someone else. I know it's hard to hear, but portfolio management, as probably the most labor-intensive task handled by you or your staff, shouldn't be a sacred cow.

Charging What You're Worth

I'm also saying that you don't charge enough, and this might be a pretty painless way of effectively raising your rates. This is another notion I've resisted for years, but have finally come around on. Here's why: In my view, independent financial advisors offer their clients two invaluable services that they can't get anywhere else: 1) you protect your clients from the financial services industry, which, while it may be occasionally well-meaning, still has at the core of its agenda separating your clients from some portion of their wealth; and 2) keeping your clients from making dumb mistakes like not investing regularly for the long-term, not carrying enough insurance, jumping in with both feet into every investment fad they hear about from their golfing buddies, or pouring most of their retirement savings into the local sushi restaurant. How much is that worth? Much more than 1%.

However, I know that one of the most difficult things advisors do is to bring themselves to charge enough, or even just to charge more. So it occurs to me that a good solution to this dilemma might be to outsource your client portfolio management. Yes, the additional 50 basis points or so will be borne by your clients, effectively raising "your" fees to a more reasonable level. Of course, you won't actually get that increase, which may cause you to question how this is going to help your margins. But work with me here: Although your revenues won't actually go up, by not having the expense of hiring people to create, monitor, adjust, and execute trades in client portfolios, your expenses will go down, probably way down, so your bottom line (the part you take home) will go up.

What's more, if you're not managing portfolios yourself, you'll suddenly have a lot more time to recruit new clients, follow up on some of those referrals you've been ignoring, spend more time with your existing clients, have plenty of time for new clients, write a book, or play more golf. All of which will generate more revenues or give you time which you'll probably feel is even more valuable. Although one advisor whom I won't name (but lives on the Big Island in Hawaii) lamented that "if he didn't manage client portfolios, he wouldn't have anything to do," I'm guessing most of you could make good use of a big hole in your weekly schedule.

So call me crazy (it's been done before), but using third-party portfolio managers just might offer a better business model for independents advisors. Less work, lower overhead, and more time to grow your practice can be powerful benefits. What's more, it takes you out of the performance loop, and further onto your clients' side of the table: if performance is weak, or outside of your investment policy statement, at one or more of your third-party managers, you can always fire them, and get someone else. Far better to monitor performance than to live by it.

The Caveats

Which brings me to the catch (you may have noticed, there's always a catch in financial services). As with many of the outsourcing solutions that independent advisors are using today, if you partner with the wrong one, the result can be far worst than if you'd just continued to do it in-house. Here are a few things to consider when looking at third-party portfolio managers:

1. The clients need to be yours, not theirs. Because they take discretion over the portfolios, some management services feel the clients are theirs, communicating with them directly, and making it far harder, if not impossible, to fire them. In my view, if a third-party manager isn't a service clearly offered through your practice, you're just asking for trouble. All client contact, and explanations for all changes in client portfolios--or not changing them--should come directly from the advisor.

2. The cost has to be reasonable. The temptation of third-party managers is to charge some ridiculous amount of money for their expertise, perhaps because they do too much work with wirehouse brokers. Even though their cost is part of that "higher fee" which you are well worth, there are limits. Maybe in another ten years or so, I'll change my tune about this too, but 200 bps seems the upper limit on financial advice, and 150 basis points more reasonable.

3. You need to have some involvement in the investment process. The problem most advisors have with management services is that they lose the ability to have input into the investment process, and to customize client portfolios. Both are important aspects of the services that advisors are offering their clients. Obviously, portfolios need to meet each client's specific needs, and just because you're not managing the portfolio, doesn't mean you don't have good ideas or responsibility for what's in them. I think advisors would have more comfort with third-party managers if they had more input to the management process.

Bob Clark, former editor of this magazine, surveys the advisory landscape from his home in Santa Fe, New Mexico. He can be reached at

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