Mercer Capital's RIA Valuation Insights


Will Direct Investing Give Wealth Management Firms an Unfair Advantage?

matt-crows-bmw-cap-d-antibes
My car on Cap d’Antibes, her natural habitat.


Normally, we would expect strong financial markets to validate most RIA models and at least hide the weaknesses of others. In this case, though, a rising tide isn’t lifting all the boats.  Why?


In the two years since we started the RIA blog, I’ve written seven posts about Ferrari, four about Porsche, three about Jaguar, two about Aston Martin, two about Lotus, and even one about Subaru. It occurred to me that I’ve never written about my own car, pictured above a couple weeks after I picked her up from the factory in Munich.

In 2009, I had the unfortunate experience of turning 40, and my dad had the even more unfortunate experience of turning 70.  So, I ordered a car from BMW for factory delivery around the start of the biggest cycling event of the year, the Tour de France, and took my dad to pick up the car and follow the Tour through five countries and every kind of terrain from the Alps to major cities.  We almost ran out of gas in Germany, got lost in Zurich, found ourselves in Italy by accident, and had to get special permission to cross a police line in Verbier.  I highly recommend it.

Buying from the factory saved me nearly enough to justify the trip (if I ignored what was a very weak dollar at the time), and sitting on an Alp watching nearly superhuman cyclists race uphill was an effective way to forget all about the credit crisis.

Eight years later, some things have changed: Lance Armstrong has been banned from competitive cycling, the greenback is about 35% stronger against the Euro, and the stock and bond markets have rallied to a degree we all wish we could have predicted in the summer of 2009.  Other things have stayed the same:  I still have the car, my dad still follows bicycle racing, and the effects of the credit crisis still hover over asset management in spite of a long and nearly continuous rally.

Where’s the Party?

This last point has been stealing a lot of my attention lately.  Normally, we would expect strong financial markets to validate most RIA models and at least hide the weaknesses of others. In this case, though, a rising tide isn’t lifting all the boats.  Why?

  • Regardless of the actions of the administration, the Fiduciary Rule has left a mark on the industry. Some firms have voluntarily embraced the rule, clients are asking questions they wouldn’t have asked had it not been for media coverage of the issue, and some states are suggesting they will enforce their own versions of the Fiduciary Rule if the federal government backs down.  There’s no turning back.  Transparency makes it hard to sustain outsized margins in broad swaths of financial services – particularly anything that pays commissions or walks and talks like insurance.
  • The actively managed mutual fund industry is rudderless. Joshua Brown recently pointed out the industry is lacking in leading personalities like Peter Lynch and Abby Joseph Cohen to be the face of active management.  Without Sir John Templeton to capture the imagination of the mass affluent, the mutual fund industry is like golf without Tiger Woods or competitive cycling without Lance Armstrong.  Investment management has always been as much about marketing as it is about markets, and these days there’s no “story” to tell investors except to cut fees in an era of lower returns (although “smart-beta” was a nice try).  As a consequence, net mutual fund inflows are going to Vanguard.
  • Disintermediation is gutting layered fees. We are coming out of an era where an investment committee would hire a consultant to choose a fund of funds manager to pay subadvisors for access to sector funds.  The food chain is getting shorter, and everyone along the way is working harder to justify their role.
  • The deflationary impact of technology has spread to all corners of the financial services sector. FinTech is coming for your job.  As fee pressures mount, the only way to sustain margins is to shift client assets into lower cost products and cut the line item that accounts for two-thirds or more of overall expenses: staff.  Technology gutted the labor force in manufacturing and distribution, and quickly moved on to retail.  Hedge funds have replaced research staff with algorithms, and the only actively managed products getting any press are active-ETFs.  There won’t be a sub-segment of financial services that isn’t directly affected by technology.

The investment management industry seems to be coming to terms with a new era in the global economy.  It may not be fair to call this the era of de-financialization, but clearly the growth in the financial services sector as a percentage of GDP is over.  Readers of this blog aren’t unaware that financial services ballooned from less than 3% of GDP in 1950 and less than 5% in 1980 to a peak level of almost 8.5% of GDP on the eve of the credit crisis.  Mean reversion seems inevitable, but to what extent?

Everything Old Is New Again

The message of evolution isn’t survival of the fittest, it’s survival of the most adaptable.  In this environment, it appears that wealth management firms have the upper hand, because they hold the key to industry revenue: the client relationship.

Financial advisors are able to step beyond the role of simply being an investment product distributor to actually managing their client’s portfolios through cost-efficient ETFs and index funds.  This act of disintermediation cuts out the mutual fund industry and all of its subservient industries entirely, and it also preserves more fees for the financial advisor, not to mention the wealth management firm.

Some people are suggesting this is a cutting edge trend, but it sounds to us more like financial advisors are now finding themselves in the position of providing investment management services, just like their predecessors – who were known as stock brokers – did when financial services were 3% of GDP.

Mean reversion indeed.


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