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Five Types of Risks Advisory Firms Face

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Managing risk for advisory firms can be a tricky business. Many advisory firms are small enough and different enough from the mega-sized banking, insurance, brokerage or other financial services firms that a lot of the research or traditional “wisdom” about managing risk just doesn’t apply–it’s focused on the behemoths. So when an entity comes up with risk-management research focused squarely on advisory firms, we pay attention.

While many smaller firms focus most sharply on portfolio and market risks–for good reasons–there are other threats wealth managers need to be aware of and control. SEI Advisor Network, based in Oaks, Pennsylvania, has released a white paper, “The Risk Dynamic,” about the specific risks advisory firms face and the tactics advisors can employ to mitigate them. The paper identifies five types of risks for advisory firms: infrastructure, organizational, fiduciary, reputation and client. “The five risks are not a surprise…the different economic climate makes these risks more important,” to wealth managers, according to SEI’s Head of Advisor Solutions, Kevin Crowe. He notes that advisors request time and again that SEI, “tell us what we can do about it.”

Fiduciary risk is clearly at the forefront of advisory firms’ thinking when it comes to risk, especially with legislation proposed that could change the regulatory landscape for both RIA firms and broker/dealers whose reps give advice. While RIAs have been bound by fiduciary duty since the Investment Advisers Act of 1940, there is pending legislation that would mandate that B/D reps who provide advice to clients act as fiduciaries toward their clients. If they must have the same fiduciary duty to clients as investment advisors have, B/D reps and executives will have to find the path to the fiduciary standard–and it’s vastly different from the suitability standard they currently operate under.

“Take the investment process–there’s clearly a proliferation of products an advisor can use. Can they have expertise in all of them and apply a consistent process to evaluating them and implementing them at an investor level? That seems like a difficult task,” Crowe asserts. One way advisory firms can mitigate some of this kind of risk is to partner with a firm than can help with that. But, he cautions, “you have to be careful who your partners are–you still have fiduciary responsibility to choose that wisely.”

From a fiduciary perspective, a “consistent investment approach is a very tangible thing,” Crowe explains. For advisory firms, the “best way to allocate your time is spending it with your existing clients and business development activities, as opposed to doing things that can be done away. As an example–trying to be an expert in every investment product out there or trying to do portfolio management in a number of different ways. What we see from a risk perspective is, a consistent approach which has a consistent implementation is a real strong tool.”

Another way advisory firms can control fiduciary risk is to, “understand the type of account client’s assets are kept in,” says Crowe. For instance, brokerage accounts have, SIPC “insurance because the assets are not always kept there…they’re lent or used in different ways.” Another approach would be keeping client assets in “a custody account. They’re not [loaned], they are kept separate from the custody organization’s assets…so of the organization disappeared, the assets are still there.”

The white paper outlines three distinct types of strategies that advisory firms can implement to address risk: “Process-oriented Strategies address inefficiencies throughout the firm on a systematic level,” according to the paper. “Management-oriented Strategies,” seek to “balance the demands of the profession,” with running the firm, “like a business and not like a practice.” The third leg of this stool is “Communications-oriented Strategies.” Communications can “ultimately have the greatest effect on a firm’s bottom line,” so making this a priority, with structure, can be extremely valuable. Crowe advises wealth managers to put these risk mitigation strategies to work for their firms in “small steps.”

Comments? Please send them to [email protected]. Kate McBride is editor in chief of Wealth Manager and a member of The Committee for the Fiduciary Standard.


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