In his August column for Investment Advisor entitled “What Will Become of Us?” Pershing Advisor Solutions CEO Mark Tibergien posed several questions regarding the future of investment and financial advice and potential challenges (from Amazon, from custodians, and from the Securities and Exchange Commission and Financial Industry Regulatory Authority) that might emerge. He went on to offer a few predictions.
Mark is correct to point out that evolution will continue in the financial and investment advice space, and perhaps even accelerate. The pace of change will vary over time, and it will be affected by new competitors and regulatory developments.
The following are my own predictions of the future changes that will likely occur in the financial and investment advice profession — and how these shifts will impact registered investment advisors, in particular.
Between the dangers posed by the SEC’s Reg Best Interest to broker-dealer business models, as well as the substantial increase in consumer’s knowledge of, and demand for, fiduciary advice, the investment advisor profession will continue its strong growth in the years ahead.
1. Large RIA firms will become larger.
Especially as founders of existing, smaller RIA firms continue to age and seek exit strategies. Some larger RIA firms will merge. Other large RIAs will be bought out by private equity investors. A few will go public.
But new small RIAs will be formed, due to the ongoing entrepreneurial spirit of many investment advisors, paired with their quick ability to adapt to new technologies, and the continued development and emergence of high-quality software platforms for smaller RIAs.
2. Margins for RIA firms will be reduced.
No surprise here. After reasonable officer compensation is paid, expect margins to fall to 10%, from their current level of about 20%, for wealth management firms.
3. Small RIA firms will eschew outsourcing portfolio management, but will begin to rely upon independent consultants for investment strategy due diligence and for mutual fund/ETF/other pooled investment vehicle selection.
Paying an outside investment manager basis points to manage a portfolio will diminish over time, when just mutual funds and ETFs are utilized in portfolios.
Instead, smaller RIAs will begin to embrace independent firms that provide research (for a flat fee each year) into investment strategies, portfolio design, and investment product selection.
Independent and objective academic research and back-testing of investment strategies, with forward-thinking analysis applying predictions of the macro-economic environment and incorporating testing for the impact of severely negative macroeconomic events, will result in the expert portfolio strategy/product due diligence that many RIA firms need today. The smaller RIAs will then implement those strategies themselves, aided by ever-better portfolio management software.
4. RIAs will pay a fixed annual fee for access to custodial platforms, plus per-account fees.
This is inevitable as other sources of custodian income (revenue sharing payments from funds, payment for order flow and revenue from cash held in low-interest accounts) are discontinued due to new legislation, regulation or enhanced fiduciary due diligence.
5. Fiduciary standards will emerge from the SEC and DOL, in a strongly applied manner, under a new administration.
The foundations for this push are already present, including:
A.) A keen knowledge among policymakers of the importance of the fiduciary standard;
B.) The substantial coalition of dozens of consumer and other groups that support the fiduciary standard;
C.) Greater knowledge of just what “fiduciary” means and what a bona fide fiduciary standard requires (especially when a conflict of interest is present);
D.) A desire to walk back the current SEC’s strongly criticized “Regulation Best Interest” (the title of which is deceptive);
E.) The desire to occupy the fiduciary space at the federal level, as continued competition emerges from more states moving to impose their own fiduciary standards; and
F.) Greater endorsement of, and less opposition to, the fiduciary standard as more and more Certified Financial Planners exist, bound by their voluntary acceptance of a stricter fiduciary standard than the SEC currently requires.
The “incidental advice” exemption for brokers from the application of the Advisers Act also will be substantially narrowed. All this is a question of “when,” not “if.” And, once instituted for a couple of years, this new era of “fiduciary investment advice” will be very difficult to unwind.
6. This will drive more firms and advisors toward fees paid by the client rather than fees derived from products.
A.) There will be a realization that it is nearly impossible to properly manage a conflict of interest, in order to keep the clients’ best interests paramount to the interests of the financial advisor. It is better to avoid conflicts of interest where possible.
B.) Fees will reflect the level of service and expertise applied, and will be “reasonable.”
C.) While levelized commission platforms will emerge, questions will arise concerning whether even a reduced 3% or so commission is “reasonable compensation” under a fiduciary standard, when so little advice is provided.
D.) All ongoing (even intermittent but often) investment advice eventually will become subject to the fiduciary standard; only quite limited “sales exceptions” and “education exemptions” will exist.
7. Asset managers’ fees will continue to decline.
A.) The annual expense ratio of mutual funds and ETFs will decline.
B.) 12b-1 fees will disappear — if not by regulatory fiat, then by pressure arising from an ever-increasing number of fiduciary advisors who understand that 12b-1 fees add no value to a mutual fund’s shareholders.
C.) Other revenue sharing payments will cease.
D.) Soft dollar payments by funds to brokerage firms will either disappear by federal legislation, or will diminish under pressure from fiduciary due diligence.
E.) Greater focus will emerge on the internal transaction and opportunity costs within funds and ETFs.
F.) ETFs will gain greater market share, in part due to lower transaction costs (as they affect continued fund shareholders), and in part due to the tax-efficiency of equity ETFs. (However, Congress may seek again to change the tax rules in this area.)
G.) Sharing of securities lending revenue with the investment advisor or its affiliates will be banned.
H.) As alternative sources of revenue dry up for fund companies, the annual expense ratio (AER) for mutual funds and ETFs stabilize, but at lower average AER levels than are present today.
8. “Flat annual fees” — whether paid in quarterly installments or via monthly subscription services — will become more prevalent.
Asset-based fees will continue, but will decline. Forward-thinking RIAs will bifurcate fees, charging robo-advisor like low AUM fees for investment portfolio management, while charging flat annual fees for ongoing financial planning.
9. Technology will continue to lower portfolio-management fees.
The “robo-advisors” who are not yet profitable (as many still are not) will disappear or merge (or they will be acquired by a profitable hybrid-model firm). Advisors know “robo-advisor” services are just a great integration of technology, with a slick web interface.
Technology integrations will continue to get better. While larger RIA firms have deeper pockets to review and implement technology solutions, smaller RIA firms will continue to see software emerge for their use at substantially less cost.
10. Mutual funds and ETFs will continue to see increased use for a period of time, but then portfolios of individual securities will become dominant.