If recent headlines in which some large broker-dealers are paying out millions or even hundreds of millions of dollars in regulatory fines, restitution or awards to investors aren’t enough to keep firms, reps and advisors awake at night, the impending effects of new regulation just may be.
Firms will need to be able to point to their due diligence process and show that it is robust. This underscores the urgent need for deep due diligence. Is an in-house chief investment officer the answer? Or is it better to outsource this critical function?
Some would argue that the financial crisis alone was enough for many wealth management firms to feel the need for increased due diligence. And the best of firms are re-thinking their due diligence process, not simply on the securities level, but “strategically,” according to J. Gibson Watson III (left), president and CEO of Denver-based Prima Capital, a firm known for its deep research bench and due diligence on SMAs, mutual funds, ETFs and alternatives.
“We have seen firms of all shapes and sizes questioning their best practices—how they render advice to clients. They are questioning the construction of their wealth management platform,” Watson said. Some of the questions they are asking now, Watson says, include these:
- “Do we have too many managers? Too few?"
- “Do we have investment quality?”
- “What about alternatives? Should we be including alternatives on our platform and, if so, what type?”
- “What about asset allocations—are our clients’ portfolios adequately diversified?”
- “Do we need to introduce additional asset classes, and if so, which ones, and how do we do it?”
“Given the compression we saw in asset values coming the through the credit crisis, and the focus on not only top-line revenue growth but bottom line margins, the argument for outsourcing that chief investment officer (CIO) function is better than ever.” It is, Watson argues, a “sound strategic decision to outsource that responsibility to experts in the field.”
Being the “outsourced CIO for big banks and broker-dealers” is a “core part of business” for Prima Capital, says Watson. But his firm has recently added a group of modular offerings for smaller firms, including the one or two-person RIA.
Prima Capital is helping client firms to put in place “best practices for due diligence.” Watson says one of the main areas where due diligence is headed is a focus on the “qualitative” aspects of due diligence rather than the “quantitative.”
How Is This Research Different?
Before the crisis, Watson explains, wealth managers “relied on Morningstar’s star ratings and historical returns to select managed investment products to recommend, but now, advisors, brokers and individual investors alike appreciate the value of the qualitative due diligence.” It’s not just the returns over time, that are important, he says, but
the culture and “qualitative aspects of the asset management firm to manage that portfolio; the quality, the sustainability and the repeatability of that investment management process; the quality and the credentials of the people that are actually managing those portfolios; and the stay-in-place factors that are really behind those people.”