Imagine that today’s regulatory models are gone – no SEC or FINRA to worry about – and we are inventing a new model to create and distribute financial products and services. Most people would agree that we certainly would not do it the way it’s done today. We “manufacture” financial products as if they were widgets, and distribute them through intermediaries as if they were groceries, with the “recipes”—the actual planning and advice—given away as a value add.
Don’t believe it? Think about this elemental question: How do you get paid? Basic business sense decrees that the aspect of your business that brings in revenue is the heart of your value—and right now, financial planning and advice is rarely the key revenue creator. If you are paid according to assets under management, you’re placing the value of your services squarely on your ability to select and monitor financial products. And if you’re paid per transaction, you’re being paid for providing access to a financial product. The rest is value-add—even if you think of it as the most important aspect of your service model.
What Do You Sell?
Today, we have an opportunity to alter our value chain. From the perspective of the end-client, the process of procuring financial products, from whole life insurance to liquid alts, is changing and the industry should be proactively changing with it. Investors as well as advisors should benefit.
Historically, manufacturers built products and owned the distribution, controlling both access and the sales process. This was the case in the life insurance industry, where employee-agents were the sole vendors of products created by the firm. The linkage of manufacturing and distribution created some risk, of course—resulting, for example, in the vanishing premium class action suits of the 1980s. Control begat liability.
In the case of mutual funds, the asset management firms, i.e., the product creators, prescribed the selling process, providing collateral material replete with Ibbotson charts, profiles of typical clients, asset allocation models—basically everything needed to present the product to consumers. The approach was based on transaction fees, with advisors giving away the planning and advice. It was rather an antiquated model, but one that enabled the manufacturer to retain influence, with the advisor or broker/dealer as intermediary.
The notion of a product serving a role as part of the financial plan did not emerge until much more recently: More and more, planning and advice have become the service, and product simply an implementation solution. But business models have not kept up.
How Many Middlemen?
With changes in both investor and advisor preferences, the manufacturer is now the intermediary, along with everyone else who gets in the mix. Thus, the critical question has become “Who is adding value?” People are taking a piece of the pie that may not need to be cut. There is at least one too many intermediaries in the supply chain, and it’s time to look at where the redundancies lie.
Sustaining Success Notwithstanding the Self-Inflicted Headwinds
The hard truth is that if all an advisor is doing is marking up someone else’s work, e.g., charging for asset management while simply reselling a model and adding their own “advisory fee” (aka additional dealer mark-up), where’s the value? It may be how the advisor gets paid, but it’s not how the client benefits from the interaction with the advisor.
There’s a disconnect with regard to business models in general. We’re still attempting to utilize century-old schemes in terms of the way products are constructed, to support an advice model that didn’t exist when they were designed. Before the 1970s, when clients could not trade securities without a broker, the industry could reasonably charge for access to products and information. Retail clients couldn’t get data or access on their own.
Forty years later—despite no-load mutual funds, discount brokers, online investing, banking and insurance purchases, and now robo-advisors—the same business model still exists, just with different prices. Because regulation hasn’t caught up, we’re in a “workaround world,” dealing with questions like “Can fee-only survive?”
In some ways those who are fighting regulatory changes are circling the wagons to preserve the irrelevant.
But this is just a fix to try to take the existing framework and extend its useful life. It still doesn’t put the client and the advisor together and reduce the influence of everyone else in order to lower the client’s cost of ownership.
Walmart or Amazon
Financial products don’t require a lot of shelf space. They would do fine in a virtual environment where you could construct your own custom products and be channel/business model agnostic. So does a product manufacturer need to own, or even lease, distribution? Or require a gatekeeper, such as a platform, to provide access?
The professional financial advisor holds the best position within the financial services ecosystem because that is the role closest to the client. Everyone else in the supply chain will wield less power over time. When data is flowing freely, as it ultimately will, and basic tenets of the financial plan and asset management are commonly known, the real value will be in the support of the behavioral element of client decision-making—the role played by the advisor. This will be the power seat as financial products become commoditized.
One possible model is for advisors to deliver the products; another model is robos. As the robos evolve, along with consumer preferences, someone will probably leverage their technology to further commoditize basic investment management, leaving the advisor to handle the human element: the motivation, discipline and courage required to create and stick to a financial life plan, and the flexibility to adjust that plan as life circumstances change. What will this mean in terms of access and cost? If you could unbundle the cost of distribution from the product, with the investor paying explicitly for advice, how might this affect actual investor returns?
The Good Old Days for Advisors are Coming
I really believe that the good old days for advisors are in the future. The intermediaries that are not adding significant value, those who are simply marking up and distributing someone else’s intellectual capital, are at risk going forward. The real value proposition for clients lies in the advisor who acts as a catalyst to get them to think about their future and take appropriate action. That advisor will command fees appropriate to the value he or she provides.
The compensation model won’t necessarily be AUM fees, nor embedded within a product. As the industry matures into a profession, like accountants and attorneys, there will still be a variety of ways for advisors to get paid—but they will be paid for their expertise and guidance, not for products. The unbundling of compensation, in the form of distribution allowances, from product and explicit payment for professional services is coming. I don’t know whether it will happen in three years or 30. But it will be driven, in part, by technology and in part by client preference. Advisors who earn their keep will do quite well and those who are cogs, marking up others’ work, will be forced to go somewhere else.
Who Will Advise the Advisors?
The service providers that want a preferred relationship with advisors will be those that help advisors meet their business goals. Five or six years ago, providing a range of technology applications was sufficient to gain an advisor’s loyalty. Now, custodians, broker/dealers and platforms need to offer the “so what” element—what does a given application/integration mean for the advisor and how can they use it most effectively to create value for end clients and, ultimately, for the business.
There is still plenty of opportunity. Think about the mass affluent who are paying the most and can least afford it. Until someone breaks through and creates a model that demonstrates value for the client, with complete transparency, we will continue to muddle along with the current anachronistic model. Hopefully someone in the game today has the motivation to grab the opportunity and create disruptive innovation. But if the industry doesn’t step up, the government will continue to insert itself. Whether it’s ugly or very ugly, it will certainly be disruptive.
Matt Lynch is the Managing Partner of Strategy & Resources, LLC, a financial services consulting firm