Tapping Advisor Technology Thought Leaders: Michael Kitces, Part 2

Jul 15, 2014

This is the second of two blog posts covering my conversation with Michael Kitces. In this one we pushed into the current trends of financial planning. You can read the first post here. Kitces Headshot

To give you a sense for how Michael operates, our conversation was conducted while he was on a long drive. In total, we chatted for about two hours, during which he became more and more passionate. I only hope there weren’t many other drivers about, as a lot of brain power was focused on the phone, so there cannot have been much left for the road.

The power of the advisor
Michaels feels that advisors do not know how much power they have. In the early days, brokers would sell investment products like stocks, bonds, and insurance. This has evolved into a role of providing advice. A good outcome of this is the split of responsibility between choosing specific investments from the overall financial planning. However, there remains a conflict, as advisors through their planning are still really good at selling product. What the advisor suggests, the investor in many cases buys. In the more mature medical profession, they have split this up so that a doctor cannot be paid by the drug company to recommend their drugs. They would be too effective a sales channel for drug companies with the ensuing conflicts of interest.

Fiduciary ascent
This type of conflict continues to drive the ascent of the Fiduciary. There is a movement to become more and more objective, supporting the growth of organizations such as NAPFA and FPA, as well as CFP certification. Michael thinks that most advisors will become fiduciaries, and as a result, the competition will become intense. Think of it: wire-houses are becoming fiduciaries and they have budgets that can fund huge sporting event adverts. Now, that is competition.
What’s more, consumers are becoming more active and pressing for transparency and value. There has been industry sentiment that the 2008 crash led to a mild drive for regulation; that has since died down. Au-contraire, Michael retorts; think of the Great Depression. The stock market cratered in 1929 and in 1933 and 1934, tighter regulations were passed. Following that history, we are due for a round of regulation in 2019, which Michael is cautiously optimistic will happen.

On the hot topic of robo-advisors, Michael felt that robos do the front and the back of the portfolio management process really well. At the back-end of the process, they have created rebalancing and portfolio management that is easy for the investor to understand and manage. In the front-end, they have created excellent, intuitive user interfaces that allow investors to master complicated financial concepts without having to understand the gory details. However, in the middle, where the decisions are made about what to do and why, the human advisor still has a significant advantage. This could lead to a successful combination, a technology-augmented advisor which he has named the “‘cyborg advisor.” (For more description on that, read http://www.kitces.com/blog/the-advisor-of-the-future-is-not-human-nor-robot-but-cyborg/. )

Rebalancing and rise of the TAMPs
The robo-advisor threat is exacerbated by the fact that although advisors have had good rebalancing systems available to them for at least a couple of decades, a lot are still not using them. It is only recently that the number of advisors who rebalance passed the thirty 30% mark. This is one of the reasons that Turnkey Asset Management Providers (TAMPs) have seen such a growth over the last few years, as these back-end services are a basic part of their package. Michael hypotheses that robos have created a “Rebalancing 2.0;” a new generation of rebalancing that can be accessed directly by investors.

Demise of the passive investment advisor
A theme coming out of recent robo-advisor press is that life is going to become difficult for the advisors who have created their business only on investment recommendations. Your average investor is now more financially literate than previous generations, and they have many websites that can guide them on portfolio construction.
Michael’s amended version of this theory is that good active investment advisors will always have happy clientele because the ROI of an advisor who is delivering alpha is easy to sell. However, now that more performance information is readily available, it is also true that the active investment advisor who consistently delivers alpha is a fairly rare bird. Michael’s feeling is that investment advisors who rely on passive investments will have a tough time showing their value.

This led us to the future of advisor fees. There are a few scenarios.

  1. For the passive investment advisor, it is likely that they will feel fee compression (see previous section).
  2. Fee transparency will become the norm. In turn, this will mean that advisors will have to be able to show 75 to 100BP of value in much clearer ways than they do today.
  3. This last scenario is maybe more questionable. Will advisors be forced to unbundle fees? Maybe. If an advisor is driven to a Chinese menu of fees, some services, such as say 25BP for commoditized basic investment management, are clear value. However, financial planning pricing is in its infancy. Will an investor pay for it upfront without understanding the value? Will they recognize that it is an ongoing service and pay an ongoing 25BP fee for it? It is unclear. If unbundling occurs, it is likely that most advisors will feel fee compression, as the investor decides which services they will consume and which they will do for themselves.

Multi-generational hype
A recent PCW survey found that 98% of children who inherit wealth leave their parent’s’ financial advisor. There is much gnashing of teeth amongst advisors on how to reduce this percentage. Michael thinks this is overblown. His feeling is that advisors should not chase the money; instead, they should chase the target clientele with whom they specialize. He writes more on this topic here: http://www.kitces.com/blog/why-its-a-bad-idea-for-most-advisors-to-pursue-their-clients-next-generation-heirs/. An analogy is nursing homes – they do not try and expand their clientele to younger people; they sell effectively to the elderly and tailor their services accordingly. Then when nursing home residents die, they find new nursing home residents; not the children of the former residents. Michael suggests that if an advisor has a good niche of Baby Boomer clients, they should not worry that they have an aging clientele, they should engage more of them.

Outsourcing options are now plentiful. There are good solutions for both technology and investments (both active and passive). Therefore, advisors have the opportunity to focus almost exclusively on clients. Michael feels that in this environment, advisors should stop looking for excuses not to outsource! With a focus on clients, it allows advisors more time for strategically honing a value proposition and developing differentiated services to match.

Michael is opinionated on any financial planning subject, and you get the feeling that on each topic, he has iterated many times as issues have evolved and as his knowledge has deepened. He then airs his informed opinions in a way that most anyone can understand. It is a powerful combination.
You can access Michael’s website at www.kitces.com, which outlines his services. You can also subscribe to his blog, Nerd’s Eye View at www.kitces.com/blog.

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Raef Lee

Raef Lee

Raef Lee is the technology contributor for Practically Speaking and also serves as a managing director for the SEI Advisor Network.

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