EMBRACING CHANGE AS OPPORTUNITY. Harness the Power of the Robo-advisor in Your Practice

Transcription

1 EMBRACING CHANGE AS OPPORTUNITY Harness the Power of the Robo-advisor in Your Practice

2 Key Takeaways Advisory firms and their investment professionals may need to embrace new technologies in order to meet clients on their terms. But embracing technology does not mean replacing human advisors. Robo-advisors are widely expected to continue gaining market share among investors with accounts below $100,000, may potentially make inroads among investors with accounts between $100,000 and $500,000. Investors are seeking greater value from their financial advisors along with a clearer understanding of services provided. The role of advisor planning platforms and their ability to streamline the goals-based process cannot be underestimated. Combining the human touch of an experienced financial advisor with the logic, fee transparency, methodology and accessibility offered by a robo-advisor platform can be a powerful combination for an advisor s practice model. 2

3 The overriding challenge for advisors today is that they often need to meet the distinct needs of two different types of clients. Older clients are increasingly focused on retirement solutions and the best way to pass their legacy on to the next generation. Meanwhile, that next generation is looking for adaption and innovation from its advisors, including access to the latest technology, innovative products and client-customized solutions. State Street Global Advisors Channel Name Goes Here 3

4 Embracing Change as Opportunity Robo-Advisors, the web-based, low-cost investment management services making headlines in recent months, have quickly become one of the fastest-growing players in the retail investment world. Their disruptive innovation has put some human players in investment advisory business on the defensive. Still, while traditional full-service providers should be taking note of this accelerating growth, the robo-advisor phenomenon can also be viewed in a positive light, says Brie Williams, Head of Practice Management at State Street Global Advisors. Advisors can incorporate some of the same robo elements that have driven that sector s growth into their own business models, including algorithm-based management of model ETF portfolios, she says. In doing so, advisors can leverage efficiencies while enhancing the value of the personal guidance they can deliver. An Industry in Transition The rapid rise of robo-advisors is just one piece of a larger trend that is reshaping the advisory industry, driven in large part by an ongoing generational shift. As Baby Boomers (born ) age, they are moving from the asset accumulation to the distribution phase of their lives. Coming up behind them are Generation X (born ) and Millennials (born ), who are in the middle or early part of the accumulation stage. The overriding challenge for advisors today is that they often need to meet the distinct needs of two different types of clients. Older clients are increasingly focused on retirement solutions and the best way to pass their legacy on to the next generation. Meanwhile, that next generation is looking for adaption and innovation from its advisors, including access to the latest technology, innovative products and clientcustomized solutions. While each generation has a slightly different approach to investing, financial planning and working with financial advisors, there is also plenty of common ground among them. In 2014, State Street s Center for Applied Research asked investors: In the future, do you think that technological advances in providing financial advice will better serve individuals with regard to value and cost than financial advisors? It found that more than three-fourths (76%) of Millennials respondents checked yes, and that even a slim majority of boomers (54%) took the same view. Generation X respondents came in right between the two, with 67% agreeing with the idea. 1 Figure 1: By the Numbers How different generations want to engage with their advisors I prefer working face-to-face or over the phone when making investments 54 % 50 % 49 % Millennials Generation X Baby Boomer Source: State Street Center for Applied Research Survey Analysis 2014; Question asked: What is your preferred communication mode? (I prefer to use remote or online channels for making investments/i prefer working face to face or over the phone when making investments) n=2,880 individual investors. 4

5 TALKING TO YOUR CLIENTS ABOUT FEES For many clients and prospects, an attractive element of roboadvisor platforms is cost (albeit not a trump card). If an investor believes he or she can get the same quality of service for one-fourth or less of the price currently paid to a human advisor, the decision isn t complicated. But our recent study 2 reveals that only 33% of investors say they completely understand the fees they are being charged. And even when they know how much they are paying, they don t know if it s reasonable particularly if they don t understand the value they are receiving. Most clients are value-conscious, says Joshua M. Brown, a New York City-based financial advisor at Ritholtz Wealth Management, but they don t always know what that means. Often investors are more focused on beating an investment performance benchmark than achieving long-term goals. Portfolios are now free valueless, Brown says. Advice, on the other hand, is invaluable but only if it s delivered with meaning and when it counts. This is the challenge. This is how advisor fees are either earned or not. So it s up to the advisor to explain the value clients are receiving for their fees. State Street Global Advisors (SSGA) s research on the topic of communicating value and discussing fees shows that when clients understand what they re paying for and the value they are receiving in return, they are significantly more likely to agree with these statements: The fees/commissions my advisor charges are fair. My financial advisor provides objective advice without regard to the fees or commissions I pay. Based on my recommendation, a friend or family member has become a client of my financial advisor. There is no right or wrong fee structure. It s all about how advisors operate within their fee structure, says Michael Stevens, Managing Director, State Street Global Advisors Global SPDR Group. The following are best practices that can help your clients appreciate the value of your services and be less tempted by the allure of low-cost robo platforms. Assess clients financial literacy. A high level of education is not an indicator of financial literacy. Communication about fees should begin after you gain a sense of the client s understanding of investing and how the financial-services industry works. This helps you know where to begin the discussion and what to emphasize. Be upfront, consistent and concise. Take the lead and address your fee-value proposition before your client asks. Keep it simple by spelling out and personalizing the services that matter most. Stress the collaborative nature of the work you will do with the client. Ensure comprehension. After explaining your compensation structure, ask questions intended to reveal if they understand what you've explained. State Street Global Advisors State Channel Street Name Global Goes Advisors Here 5

6 Embracing Change as Opportunity Studies also show a direct correlation between age and current utilization of particular services offered by online financial providers. For example, about one-fourth of investors under the age of 40 use web-based advice features, in contrast to just 13% of respondents in their 50s and 12% of those in their 60s. 3 The good news for advisors is that while younger investors are comfortable using technology and want to play an active role in their financial affairs, that doesn t mean they don t want human interaction (see Figure 1). New technologies can help advisors better execute on these criteria, but reliance on technologies alone will not be enough. Younger investors also value faceto- face contact and have a more collaborative planning style, real-time information delivery expectations, and a movement toward a holistic, goals-based approach to wealth management. Figure 2: Percentage of Investors Who Consider the Following Criteria Important When Selecting a Financial Advisor Is upfront with me and represents situations truthfully Understands my financial needs and goals Has a high level of integrity 97% 96% Acts and performs consistently 95% 95% Another factor working in favor of traditional advisors: Investors overwhelmingly place a higher value on advice when a person is involved, according to a 2014 Cerulli report. 4 Has my best interests at heart 95% The Move to Passive Rounding out this dynamic environment is the rapid rise of passive exchange-traded funds (ETFs). Investors still grappling with residual trauma and cynicism from the financial crisis are looking for the simplicity and transparency that ETFs deliver. At the same time, traditional advisors are increasingly drawn to the flexibility and low costs of ETFs when building client portfolios. 5 This is a secular shift to passive management, not a cyclical one, says Suzanne Duncan, Global Head of Research for State Street s Center for Applied Research. This shift, though, is fueling the emerging investor perception that basic asset management is a commodity service, not a source of added value worthy of the significantly higher fee charged by traditional advisors. Investors are more pricesensitive now because they have been burned too many times, says Michael Stevens, Managing Director, State Street Global Advisors Global SPDR Group. So for traditional advisors to differentiate their value proposition from that of robo-advisors, they need to rethink not only the services they offer, but also how they charge for them and how they communicate their value to clients. The role of advisor planning platforms and their ability to streamline the goals-based process cannot be underestimated. Welcomes open and honest communication Follows through on goals and promises 91% Works for a reputable firm Keeps me informed on a regular basis about investment products Is knowledgeable about new, innovative investment products Is a top performer Charges low fees and/or commissions Is highly recommended by a family member, friend or colleague 95% 90% 89% 89% 84% 76% 61% Source: State Street Global Advisors Quantitative Survey Financial Advisors Value Proposition and Compensation, August Question asked: How important is each of the following to you when you are selecting an advisor? Percentages represent respondents ranking the variable in their top two factors on a five-tier scale. 6

7 The True Value of Financial Advice It is true that the low-fee structure of robo-advisor services can be attractive, particularly to younger investors who are only now getting serious about investing and are just beginning to accumulate wealth. They provide a cost-efficient way to begin building a diversified portfolio. Cerulli research 6, for example, found unanimous agreement among traditional investment firms that robo-advisors will continue to gain market share among investors with accounts below $100,000. However, fewer firms in that survey expect market share gains by robo-advisors for accounts in the $100,000 to $500,000 range, and only a minority of the firms polled anticipate robo-advisor market share gains among clients with more than $500,000. Of course, cost is not always the primary variable in investor decision-making. In fact, as Figure 2 illustrates, charging low fees and commissions ranks 12th on a list of 13 factors investors weigh when picking an advisor. Still, complexity around advisory fees can become a source of friction or even dissatisfaction when clients are unclear about what they are paying for, how the amount is determined and the value they are receiving for the price. Investors are seeking greater value from their financial advisors along with a clearer understanding of services provided, Williams says. So it is critical for clients to understand and value the broader services that advisors can deliver when they address their clients financial needs holistically. John C. Christianson, CEO of Highland Private Wealth Management, sees a wide gap and thus a big opportunity between the pure robo-advisor market and the traditional assets-under-management (AUM) fee-based business model that most advisors follow. Christianson combines a foundation of low-cost, ETF-based portfolio management with high-touch services that allow him to customize comprehensive financial planning strategies for each client at a level a computer could never match. For example, robo-advisors automatically rebalance portfolios to maintain the fixed-allocation model (see side-bar). What they cannot do, however, is exercise nuanced judgment about the timing of the rebalancing and decide which positions to liquidate in the process. And most can t take into consideration the role that assets outside the portfolio might play in designing an asset allocation. WHAT DO FULL-SERVICE ROBO PLATFORMS OFFER? Common Services and Fees for Robust Robo Services Establishing Goals Can distinguish between retirement and other objectives Risk-tolerance Determination Based on age, goals and responses to investment style questions Asset-allocation Establishment Determined by goals and risk tolerance assessment Asset Management Generally model-driven with high concentration of passive ETFs Portfolio Rebalancing Automatic Some can improve tax-efficiency by applying new funds to underweighted sectors rather than selling assets in overweight sectors, which could trigger capital gains taxes Qualified Retirement-plan Vehicles Generally available Tax-loss Harvesting Automated generation of tax loss by selling appropriate shares then repurchasing others with similar investment attributes Investment-performance Analysis Time-weighted asset return calculations and overall account growth percentages for each distinct goal-based account Account Funding Automated transfers from bank accounts Fees Vary Some have a flat percentage of asset structure (e.g.,.25% or.30%), others use a sliding scale with fees ranging between.35% and.15% State Street Global Advisors 7

8 Embracing Change as Opportunity While some robo-advisors can perform tax-loss harvesting, they cannot take into account other facets of a client s financial picture beyond the portfolio they are managing. For example, a client may have ramped up charitable giving, sold a home or taken another significant step that might play into the client s tax situation. The most important difference between a person and computer algorithms, though, might be the emotional governor advisors use to keep their clients from making investment decisions based on excessive fear or irrational exuberance. Their experience guiding clients through a variety of market conditions or helping them make important decisions after an emotionally paralyzing event in their life cannot be duplicated by a robo-advisor. One approach some advisors take is to charge a flat annual retainer for their services. This places the emphasis on the high value of the consultative dimension of the service that which is lacking in a pure robo-advisor model. Charging retainer fees, though, requires assessing and then conveying to clients both the complexity of their needs and the resources that will be brought to bear to address them. Those needs are not necessarily correlated to the size of the client s portfolio, which means fees for large but low-maintenance accounts might be lower than those for smaller accounts requiring more time and attention. The Advisor Advantage Advisors intuitively understand the value they bring to the table. Going forward, though, they are going to have to do a better job of quantifying that value-add to clients. One way this can be accomplished is by identifying and assessing key facets of the service, particularly those that can only be delivered by a human being. Morningstar Investment Management studied the topic and came up with a formula for what it calls Gamma, the additional value that can be achieved by an individual investor [typically when guided by a financial professional] from making more intelligent financial planning decisions. In their study published in , researchers David Blanchett and Paul Kaplan pinpointed five variables that impact portfolio performance, using retirement income as the metric: A total wealth framework to determine the optimal asset allocation A dynamic withdrawal strategy The role of guaranteed income products Tax-efficient decisions Liability-relative assetallocation optimization Using Monte Carlo simulation, we estimate a retiree can expect to generate 22.6% more in certainty-equivalent income using a Gamma-efficient retirement-income strategy when compared to our base scenario, the authors concluded. The challenge, however, will be providing the added value on an affordable basis as robo-advisors and other technologies continue to put pressure on fees. For many advisors, the answer will be found in deploying robo-like, labor-saving technology solutions, freeing them up to spend more time working with clients while simultaneously cutting overhead costs. An Intermediate Approach Advisors who aren t quite ready to reinvent themselves entirely as bionic advisors can instead incorporate robo services through a process of thoughtful client segmentation based on clients unique behaviors and attitudes. 8

9 Case Study MEET THE BIONIC ADVISOR For industry pioneer and entrepreneur Steve Lockshin, combining the two business models meant starting from scratch. The former CEO and chairman of Convergent Wealth Advisors launched a new registered investment advisory (RIA) firm, AdvicePeriod, in The firm was founded on the premise that while basic money management can be offered and priced as a commodity, clients with significant assets can still benefit from more sophisticated investment services. AdvicePeriod represents the next generation of advisory firms bionic advisors that combine robo-type asset management services with significant human interaction on strategic issues, including estate planning, where robo systems currently do not compete. AdvicePeriod outsources some of its services to two firms, Fortigent and Betterment, depending on the complexity of the account and different client needs. Fortigent, founded by Lockshin and now owned by LPL, is one of a growing number of Turnkey Asset Manager Providers (TAMPs) targeting the advisor market by offering private-label platforms that advisors can incorporate into their business. Betterment, which started out exclusively serving retail investors, launched an institutional division in 2014, which also includes a broker-dealer entity. Ensuring that client relationships are built on fee transparency and a rock-solid foundation of trust is more essential now than ever, Stevens says. Transitioning smoothly through this period of disruption will not be possible without it. Combining the human touch of traditional financial advisors with the logic, fee transparency, methodology and accessibility offered by robo-advisors is a powerful combination for advisors. Clients can access their portfolios and much of the advice they may need online, but they can still receive the hand-holding and personal advice they need from a human being. This can make all the difference as situations evolve and market corrections occur. 1 State Street Center for Applied Research Survey Analysis 2014; Question asked: In the future, do you think that technological advancements in providing financial advice will better serve individuals with regards to value and cost than financial advisors? n=1,698 individual investors. 2 State Street Global Advisors Quantitative Survey Financial Advisors Value Proposition and Compensation, August Cerulli Associates, U.S. Retail Investor Advice Relationships 2014: Evolving Roles in Client Relationships 4 Cerulli Associates, U.S. Retail Investor Products and Platforms 2014: Matching Product and Distribution Strategy to Client Demands 5 SSGA s Partnering with ETF Strategists report, September 2014; Investment Company Institute; Morningstar. 6 Cerulli Associates, Managed Accounts 2014: Confronting Threats 7 Alpha, Beta, and Now Gamma, The Journal of Retirement, Fall 2013, Vol. 1, No. 2: pp State Street Global Advisors 9

10 Embracing Change as Opportunity NOW IT S YOUR TURN Instead of viewing robo-advisor platforms as the competition, advisors should focus on the opportunities they present. First, adding the new technology to your service menu can help you more fully articulate your value proposition to clients and prospects. Second, these platforms can add efficiency to your practice, increasing your profitability and, possibly even more importantly, helping you economically serve clients who may have limited assets today but over time will have more dollars and more complex planning needs. To determine whether adding a robo platform is right for your practice: 1 Talk to your custodian and other service partners to find out how you can leverage their technology solutions to build scale into your business. 4 Analyze the demographics of your book and determine how many of your clients, especially younger clients, would have a high level of comfort with self-service technology solutions. 2 Critique your service package and the competiveness of your fee structure relative to the services you provide. 5 Examine the efficiency of your operational processes and explore technology solutions that could bring operating costs down. 3 Using a survey or through individual conversations, gauge your clients understanding of what they are paying for your services and the actual services they are receiving. 6 Consider the impact, both in terms of how you spend your time and its potential benefits to average clients, of deploying robo asset management tools. 10

11 State Street Global Advisors Channel Name Goes Here 11

12 About Us For nearly four decades, State Street Global Advisors has been committed to helping our clients, and those who rely on them, achieve their investment objectives. We partner with many of the world s largest, most sophisticated investors and financial intermediaries to help them reach their goals through a rigorous, research-driven investment process spanning both indexing and active disciplines. With trillions* in assets under management, our scale and global reach offer clients access to markets, geographies and asset classes, and allow us to deliver thoughtful insights and innovative solutions. State Street Global Advisors is the investment management arm of State Street Corporation. About Practice Management The cornerstone of our business is helping advisors succeed. We are inspired to make a difference by delivering a comprehensive practice management platform offering actionable insights and consultative solutions. Our programs are grounded in proprietary research and leverage the latest thinking and trends from both industry and academia. We offer a diverse range of capabilities that address forces shaping the investment landscape; best practices to drive results and optimize your business; conversation starters to guide and engage with clients; and continuing education to hone techniques and accentuate your value. * Assets under management were $2.56 trillion as of March 31, AUM reflects approx. $33.33 billion (as of March 31, 2017) with respect to which State Street Global Advisors Funds Distributors, LLC serves as marketing agent; State Street Global Advisors Funds Distributors, LLC and State Street Global Advisors are affiliated. ssga.com spdrs.com For public use. State Street Global Advisors One Lincoln Street, Boston, MA T: Standard & Poor s, S&P and SPDR are registered trademarks of Standard & Poor s Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation s financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index. The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor. All material has been obtained from sources believed to be reliable. There is no representation or warranty as to the accuracy of the information and State Street shall have no liability for decisions based on such information. Investing involves risk including the risk of loss of principal. The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA s express written consent. State Street Global Advisors Funds Distributors, LLC, member FINRA, SIPC, One Lincoln Street, Boston, MA State Street Corporation. All Rights Reserved. ID10047-IBG Exp. Date: 07/31/2018