Lawrence Cook lists five reasons why he believes keeping investment in-house is a drain on advisory businesses
Some financial advisory businesses have traditionally considered it important to have an in-house investment proposition.
Yet this form of working can increase the chance of firms becoming inefficient, exposed to worrying risks and unattractive to potential buyers.
While there are plenty of examples of forward thinking financial advisers choosing to remodel their businesses and outsource non-core functions, some retain an emotional attachment to old ways of working.
Some fear change, believe they will lose control through outsourcing, deem themselves too busy to make any adaptation or, quite simply, enjoy picking funds.
However, this approach can threaten the long-term strength of firms.
Here are five ways in-house investment propositions can drain advisory businesses.
1. Squeezing profit margins
Profit margins can easily be eaten away by the operational cost of delivering an advisory investment proposition.
Regular reviews and changes to the portfolio can require significant administrative capability: writing to clients, following up with them and actioning their responses.
Further administration is required to keep track of those clients who do not respond and whose portfolios cannot, therefore, be changed.
2. Exposed to unnecessary risks
There are several risks businesses face in running their own advisory portfolios, the first being key person risk.
Often a small number of people are relied upon to complete the research, construct portfolios and make decisions about portfolio changes.
Absence through sickness, holidays or other reasons put the proposition at risk and, therefore, the service delivery to clients.
If the adviser is relying on external research to support its advisory investment model the risks are similar, but there is also the added due diligence risk of the third party supplier.
Many research companies are themselves very small operations and not well resourced.
3. Struggle to achieve scalability and attract buyers
Adding more clients to a model using an advisory investment solution means proportionately more administration.
As businesses grow, they become increasingly difficult to manage - increasing costs and stretching management control and oversight.
This also makes them less attractive to potential buyers.
Any buyer will want to buy something that is easily managed. An advisory investment solution is not so easily administered beyond a relatively small scale.
A buyer will want to be able to look at whole segments of clients and know that their risk requirement and suitability is matched by the investment portfolio.
As many clients will end up with a portfolio not matched to their ideal, this cannot be easily achieved with an advisory investment solution.
Sudden changes in investment markets may require lots of portfolio changes at an asset class and fund/stock level.
This is impossible to do quickly and efficiently for all clients in an advisory solution which is, therefore, a less attractive proposition to a buyer.
4. Client outcomes and ongoing suitability
With the impact of administration burden and inconsistent responses from clients, IFAs are left with a number of client portfolios that differ from what was originally intended.
Over time, clients with a similar risk requirement will get quite different portfolios and investment performance and potentially different outcomes - this is in direct conflict with the wishes of the regulator.
5. Damaging client retention prospects
From time to time, investment markets are contrary and do not deliver what is required or expected. From time to time investment managers do not perform.
Both of these factors have the potential to damage client satisfaction. If the client feels the IFA is responsible then this threatens client retention.
An IFA focusing on financial planning can sit on the same side of the table as the client holding investment managers to account and adjusting plans according to the behaviour of investment markets.
A firm using an advisory investment solution that doesn't deliver is then potentially conflicted - if it doesn't perform, do they sack themselves as portfolio managers?
To mitigate against the five areas highlighted here, many advisory firms are working with discretionaries.
By using the services of a discretionary manager all this administration - plus the costs and risks that go with it - are removed or refocused on activities than generate more revenue.
Failure to make tough decisions about the traditional approach to investment can stop firms from achieving their true business potential.
Lawrence Cook is director of marketing and business development at Thesis Asset Management
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