Investment Management: Practice Management Implications

By Jaco Jordaan, CFA, CFP^®, ChFC
Senior Portfolio Manager
H.D. Vest Advisory Services

For CPAs, there are really only two reasons to get into the wealth management business: helping clients and adding revenue to the overall business. Idealists may argue that helping clients is the more important point, however, unless you are financially independent or willing to do a little pro-bono planning, ultimately it comes down to the bottom line. Increasing your revenue and ultimately helping your clients to gain their own financial independence – that’s the big picture goal for most practitioners. But as you start down the road of actually ‘doing’, there are complex decisions to be made including staffing, systems, remaining independent or affiliating with a partner, licensing, marketing, menu of services, and a myriad of other decisions.

One of those decisions regards whether the do-it-yourself approach or the outsourcing approach to Investment Management is better for the long term growth of the practice (revenue goal) and which approach is more appropriate for clients (helping clients goal).

In order to properly evaluate the decision, it is important to define the components of a thorough investment management process. Following is a description of the investment management process I utilize at H.D. Vest Advisory Services^SM (HDVAS) and what I believe to be the key components. As you review these elements, think about how you execute them in your practice, how much time you or your staff spends on each, systems costs, and whether you can provide reasonable execution to achieve a consistent experience across your client base.

Components of the Investment Management Process:

1. Portfolio construction
2. Investment Implementation
3. Operational Implementation

Portfolio Construction

Building portfolios requires developing an outlook for the different asset classes. Under a traditional Markowitz based portfolio optimization approach, this requires making assumptions for the expected returns, expected risk (standard deviation of return), correlations, and suitability constraints. Massaging the optimizer will provide a baseline for standardizing portfolios which can be turned into a long term strategic portfolio. Building the assumptions requires research. Will you simply use historical returns? Are historical returns reasonable of the next market cycle? What about an inflation plus risk premium approach? Should correlations be weighted for recent history? Should risk be adjusted so that asset classes are Sharpe ratio equivalent? A tactical overlay to the base portfolio requires ongoing market and economic research to identify short term dislocations and determine whether it is prudent to opportunistically trade on the information.  For our portfolios, HDVAS has assembled an Investment Policy Advisory Board consisting of various industry experts including investment strategists and economists. This provides an opportunity to develop and debate assumptions, and to review current portfolio positioning. Having an advisory board ultimately helps to build portfolios that are not biased by one person’s opinions.

Investment Implementation

The portfolio construction process simply identifies where to gain market exposure; it does not tell you how to gain that exposure – which investment vehicles to use. Determining which investment vehicles to use requires a robust due diligence process.

Following are some of the items a due diligence process could cover:

1. Quantitative Data – returns, risk, portfolio composition, holdings based analysis, returns based analysis, tracking error, alpha, beta, Sharpe ratio, geographic exposures, fixed income data such as duration and credit quality, etc.
2. Qualitative Information – investment philosophy, manager experience, style drift, selling discipline, analyst team, overall management structure, cost, compliance concerns, etc.
3. Manager Overlap – how does the investment fit in or overlap with investments currently held or being considered for the portfolio.
4. Monitoring – periodic review of the investment thesis by reviewing quantitative data and qualitative information.

In addition, there is constant innovation in the products available to financial Advisors. This requires monitoring the marketplace and staying ahead of investment vehicle trends.

Operational Implementation

After having designed a portfolio, including the identification of investments to use, there are the operational aspects of actually managing the portfolio. There are three main events that can trigger trading in the portfolio:

1. Cash Management – new accounts that have to be invested and systematic contributions or distributions.
2. Portfolio Shifts – trading required to implement a change in the base portfolio, such as a change in fixed income target duration or an overweight to international equities.
3. Portfolio Rebalancing – these trades result from market movements that necessitate realignment with the model portfolio.

To properly manage multiple portfolios requires systematic procedures to execute on these three events and provide a consistent and compliant client experience.

Practice Management Implications

The opportunity cost of the do-it-yourself approach is primarily time. It takes time to do the economic research to develop capital market assumptions and model portfolios. It takes time to conduct due diligence on investment vehicles. In fact, an internal survey of Advisors who successfully implement a do-it-yourself approach revealed Advisors are spending 15-25 hours per month, on average, on investment research. It takes time to manage portfolios. It may be easy to manage a single portfolio, but if your practice consists of 60 or 100, how many hours or days does it take to trade through all the portfolios? Do you have the time and systems available to rebalance all 100 portfolios within a timely manner that treats all clients fairly?

And the biggest question of all – does a do-it-yourself approach add value in terms of risk adjusted performance that accrues to the client? Can you reasonably expect – as the acting CEO of your company who is charged with managing staff, meeting with clients, developing plans for clients, completing tax returns or bookkeeping for the core business, and other aspects of running your business, not to mention having a personal life outside of work – to be able to consistently outperform professionals who are focused exclusively on investment management?

Or, would it make more sense to outsource investment management to your home office, to a turnkey asset management program, or to a fund family while you focus on growing your relationship oriented practice by helping clients with the 8 Wealth Management Issues^SM?

           
           - Investment Management
           - Cash Flow and Debt Management
           - Family Risk Management
           - Retirement Planning
           - Education Planning
           - Legacy Planning
           - Business Planning
           - Special Situations Planning

There is empirical evidence to support building a relationship oriented practice versus an investment management oriented practice. According to CEG Worldwide research, wealth managers (which fits our definition of a relationship oriented practice) earn an average of $881,000 per year, while the average investment generalist earns only $279,000.¹ Beyond the empirical data, we know that the more services a client receives from a single Advisor, the stickier that client becomes, which boosts the practice revenue retention rate.

As you look to the future of your practice, consider the points above and quantify the dollar value of time spent on investment management functions which could be outsourced. If, in your analysis, you believe you can grow revenue more by becoming a comprehensive planner, then evaluate outsourcing opportunities. If, in your analysis, you do not believe that is the case, then at a minimum, develop systematic procedures and standardized portfolios to maximize the efficiency of your practice.

¹ “Can We Talk,” John J. Bowen, Financial Planning Magazine, July 1, 2008