ROUND TABLE: WEALTH MANAGEMENT

Mr. Paikert: How do you see the business outlook for 2007? Do you see continued growth, and if so, what will drive it? If not, what do you think will deter it?
Mr. Henske: Definitely, there’s going to be growth. But I see compliance getting in the way of that growth. What you’ll find is mass consolidation with a lot of these smaller mom-and-pop practitioners. The pressure of compliance and the need to be compliant will force that consolidation.
Mr. Spears: We are very optimistic about the industry and about the prospective clients — their knowledge of the best way to really address their personal wealth. They are becoming more and more knowledgeable, and that’s a very big positive.
Mr. Doty: From the standpoint of the client, one of my biggest mantras is just information pollution. People don’t know where to turn. But even though there’s a lot more information out there, and everybody can access it, it doesn’t make for better judgment.
As far as drivers of the business, [it] used to be, “Give me the hot stock, the hot manager.” The discussion’s now starting to change to, “Will my money run out before I do?” So the client expectations are shifting — and shifting pretty quickly — and in order to grow as effectively as we can, we have to be responsive. The deterrent is if you can get the bureaucracy out of the way.
Mr. McLaughlin: The demographics certainly suggest there’s a great growth opportunity, but I don’t think it will be enjoyed by all equally. I’m not prepared to agree on the ascendancy of the smaller investment adviser yet. I’m not prepared to dismiss the large broker-dealers and banks who have scale. If they elect to deploy their capital, they can take this business anywhere they want. They have been somewhat slow to do so in the recent past, but they are aware that this is a terrific annuity stream.
In the same breath, I think the smaller boutique clearly is in favor, because the bigger institutions completely botched it from the client perspective. Culturally, their compensation programs and their public-company focus on quarterly earnings is antithetical to creating a true optimal client experience, but they’ll figure that out to some degree.
Cash crunch
I do agree in regard to the smaller boutique capturing market share. They can provide a better client experience. They can provide a relationship that aligns the interest of the client with the individual adviser. The only thing that I think stops them from really getting greater market share is capital. That’s the one thing they don’t have.
Ms. Nesvold: I have a top 10 list on why people call me up to sell their businesses, and historically, it never included compliance. That has changed, and it is stunning. It is a more capital-intensive business than it used to be. It used to be easy to just hang a shingle out, but now with the [USA] Patriot Act and a whole host of other regulatory requirements, it is harder to be in the business, especially for some of the smaller shops. I don’t know that it’s going to compel everybody to look at selling out, but I do see more mergers of equals — smaller people saying, “Well, if we’ve got to spend a-hundred-and-some-thousand dollars a year, and the small shop next door has to, why not talk about a merger among us?”
In terms of the growth, what I’ve seen with the larger firms and the smaller firms is pretty attractive numbers, and I suspect that that is a wonderful linkage with the whole baby boomer phenomenon. There is just incredible transfer of wealth occurring. For the mergers-and-acquisition bankers, broadly speaking, this is the happiest time in their lives. I think we’ll all be very busy for the next five years or so.
To Steve’s comment about information pollution, I absolutely agree with you. Everybody is a wealth adviser. Everybody provides holistic, comprehensive wealth management services — whether it’s through proprietary products, open architecture or a blend — and it’s hard for clients to weed out who’s really the right match for them. It doesn’t mean that there’s one perfect provider. But clients aren’t as sophisticated, in many cases, as they should be. And the more information that we have out there, the harder it is for them to figure out what’s right for them.
To your point on the terrific annuity stream, Jamie, there is no question this is one of the chief reasons diversified financial services companies are looking to acquire into this space. You wake up in the morning, and there’s money flowing into [accounts].
In short, it’s just a wonderfully opportunistic time for everybody, and I expect to see more consolidation, more people getting into the space, more de novo opportunity, more lift-outs, more of everything.
Mr. Doty: One of the drivers of the business going forward is going to be the breadth of your offerings, and that comes with scale. So are you just doing the investment adviser function or are you doing the other planning around that? Are you doing lending? Are you doing trust services? You name it. That is a potential advantage for the larger institutions if we can all get it right.
Mr. McLaughlin: Liquidity at the company level has never been greater, and with relatively little downside risk to most of these balance sheets. I saw in The [Wall Street] Journal this morning that we have seen greater than 10% returns on earnings for 12 quarters in a row, and that is a remarkable thing. Can there be some change in just the raw liquidity, which is really a part of what’s driving your business and the merger-and-acquisition [activity]? They can’t go on forever.
Ms. Nesvold: If we’re talking about the whole baby boomer phenomenon, then you have 10, 15 years with this tremendous liquidity and wealth transfer. And then what happens? Only the strong survive. There’s more consolidation.
My business isn’t so cyclical, because when the market is going up, and people are making more money, they want to go out and make acquisitions, so they call on us. If there is an economic downturn, people are feeling pressured, it’s harder to be in business because of compliance, and you’re not seeing the new flows of the assets. People sometimes are prompted to look at acquisitions.
But I do expect, at some point, we’re going to see a shift in people’s perceptions on being in this business, because there are a lot of folks who want to be in this business who don’t necessarily understand it, and that to me is a very scary thing. It doesn’t mean you have to be the most sophisticated buyer. But the reality is, if one out of every two transactions fails post-acquisition, people should spend a lot more time reflecting on what they’re trying to accomplish.
Mr. Henske: In the smaller firms, you find people who are tremendous marketers. They started off by themselves, they hung that shingle, and all of a sudden, they started to grow this business. They really were in tune with those clients, and now all of a sudden, they’re in a heap of trouble, because there’s a thing called servicing and being compliant, and those don’t always go hand in hand with getting new clients.
You’re going to find firms that have very deep client benches but have very different expertise. So what you’ll need to do is match a firm that’s excellent in operations with a firm that maybe is excellent in marketing. Then, instead of trying to acquire new clients, really go deeper and offer more services to that existing group.
‘Merger of equals’
The firms that will win are the ones that have the ability to match that up. I don’t know that it will always be a merger of equals, because I think you need to have one firm that is dominating the acquisition. You’ll find companies that are, let’s say, a hundred people in size acquiring firms that are 20 people in size and then re-branding that together.
The paper clips are now bought in quantity, the copy machine and all the things that you’re spending double on — there’s power in that, and there’s also power in that combined asset pool, because now you’re going out to the vendor, and you’re bringing them, instead of $1 billion under management, $3 billion or $5 billion. And that gets a voice, and it helps your marketing. It helps your compliance. It makes those companies want to reinvest back into your business.
Mr. Spears: Besides having different services they provide the client, the client profiles look very different in a lot of these firms, maybe because of how they positioned themselves. We found that most of the mergers don’t make sense, because the profile of the clientele doesn’t match ours, and therefore, you aren’t getting much in this merger other than scale that looks better than it is.
Ms. Nesvold: Beyond the client profiles, it’s the professional profiles. It’s the chemistry match, because if you don’t understand each other’s client base, and you don’t see eye to eye or have a philosophical alignment, you should run the other way.
Mr. Doty: I’m going through my fifth merger, and I’ve seen good ones and bad ones. Two considerations for sure are to have clarity around your business model and the culture. The issue is getting people together who have the same kind of approach. If you’ve got an entrepreneurial-type firm, and you’re joining with a bureaucratic-type firm, guess what? It’s never going to work.
Mr. Paikert: Do you think the announced acquisition by Bank of America [Corp.] of U.S. Trust [Corp.] from Charles Schwab [& Co. Inc.] is an anomaly or a harbinger of things to come?
Ms. Nesvold: For Bank of America — which has been restricted from acquiring banks because of antitrust implications — what [will the bank] do with all that cash? It’s some inordinate amount of earnings that they have on their books to deploy into a space that could create a tremendous opportunity for them.
But I come back to the same point that we’ve all raised, which is: What’s the fit going to look like? And will it survive longer term? Will they try to radically change what is special, and has still been special, about U.S. Trust, despite a series of difficult years, and some people and client attrition? BofA is known as a wonderful integrator, so we’ll see what shakes out.
In terms of the prediction on deals to come, there is no question we’ll see another couple of sizable transactions. The typical transaction might be anywhere between $10 million and $50 million or maybe $100 million, max. But I don’t think it’ll be like 2000, where every other week, it seemed like there was another billion-dollar transaction occurring. But I think we’ll see some larger pairings to come.
Mr. McLaughlin: I think the U.S. Trust franchise was an albatross for Schwab. They jettisoned it. But the idea that is really to be highlighted is, those two firms were incompatible.
A business is really quite curious at the client level, because while we might describe wealth segmentation by assets-under-advisement-, assets-under-management-type data, there’s also wealth segmentation across client psychometrics.
The only thing I can say for the people at U.S. Trust is, they are once again going through another period of instability in terms of their mission, their role, what they do when they get up in the morning — and that is not good for clients.
Getting it straight
Mr. Doty: I think it’s wonderful for both firms to get out of the disconnect of Schwab and U.S. Trust. U.S. Trust has struggled of late, but they’re in the middle of changing the way they do business, and I wouldn’t bet against them in the long run. I think they will be an 800-pound gorilla in this business. They will get it straight at some point. I’m not sure how long it will take, but they will. And so there’s a window of opportunity for a lot of us to do the same and make sure that we’re properly positioned, as well.
This consolidation is going to continue, and probably, it’s going to mirror asset management where you’re going to have a bifurcation. You’re going to have the ones that do everything; you’re going to have the ones that are specialized in one thing and do it very, very well.
Mr. Spears: The thing that Bank of America has been struggling with for the last 10 years is how to grow the trust business. It is a mantra that they have been really focusing on for a long time. And in essence, this fits perfectly with their strategy. I’d be shocked if it doesn’t work. But the next year or two is going to be good for getting dissatisfied clients from this merger, because there’s a lot of integration and a lot of overlap.
Mr. Paikert: We’ve talked about the advisory firms and banks. Where do multifamily offices and the elite Wall Street wirehouses and brokerage firms fit?
Mr. McLaughlin: Well, the multifamily offices are certainly in ascendancy, and it’s a natural outgrowth of some of the economies of scale that come from consolidation. The multifamily office has appeal when you look at the sheer cost of doing a single-family office on your own.
But I think the multifamily-office cost structure is coming upon its own Rubicon. They’ve done some things on the cheap historically, and I think they have to pay up for some of the talent to go to the next level. So that’s their challenge.
And head count, depending on the [profit-and-loss statement] and the cost structure for the multifamily office, is a 60% to 80% line item in the general ledger on the cost side. So it needs to be higher to do the things that they really want and include a number of things that certainly we don’t think are particularly profitable.
So if you pick your shots, certainly lead from the investment piece and the planning piece, and jettison some of the lower-margin aspects of the multifamily office, I think clearly it has great currency. I think we’re going to see a lot more of it.
Ms. Nesvold: Broadly speaking, it’s a challenged business model, and a lot of it may stem from the fact that while the pinnacle of customization may be the single-family office, those who migrate from a single-family office to [a multifamily office] may still have these founding families for whom they are hiring staffers, travel planning, household maintenance — a whole host of things that are not profitable.
It is picking what you do best. Even larger institutions may still seek to outsource to family-office-services providers that will do a lot of the concierge elements. It’s the way that smaller shops can stay in business. There are so many other aspects to comprehensive wealth management that people need to reflect on that.
This is the least profitable segment of the investment space. Margins are typically 10% to 20%. If you’re doing any better, you’re probably only focused on the investment and financial planning and estate planning piece — which from my perspective is a very good way to go, because you stretch yourself so thin with drawing on very expensive talent in different segments of wealth management that it makes it hard to make a buck in the business.
The other thing worth pointing out is that people in the MFO space don’t typically charge their clients what they should. There’s a whole host of service creep. It’s a challenge for the industry.
Mr. Henske: I think the family office was originally viewed by a lot of smaller firms as a great way to bring assets in the door. As a partner of a 100-person firm, I wake up in the morning, and I say, “Why would I want to take on the responsibility of a family office?” First of all, what’s the economic benefit? Second of all, what’s the potential of losing clients if we don’t get it right? If we forget to pay one bill or if we could have gotten that Mercedes $100 cheaper at a different car dealership, [will we experience client defections]? At what point do you start to lose clients and offset that marketing benefit?
I would venture to say that there probably is a great case to be made to go a step below ultrahigh net worth, whatever that number is.
I think you can make quite a case for that $5 million to $50 million client and building that relationship, so that once it’s on track for five or 10 years, it’s really tough to get off track.
Ms. Nesvold: I’d also dissect the type of ultra-affluent client that you’re dealing with. If it’s first generation wealth, maybe someone who created a business, who’s used to delegating to a number of lieutenants, that may be a very profitable ultrahigh-net-worth client. But if you’re dealing with fourth-generation, third-generation wealth, silver-spoon children who never have to work or maybe are going to collect maps for a living, that may be a more challenged relationship in terms of the profitability, also in terms of the requirement of service.
Mr. Spears: It gets back to: Where are these firms going to deploy their capital? Every firm has a core competency where they make most, if not all, of their money. Therefore, they are willing to do things as a loss leader to bring in the client. That usually isn’t in the client’s best interest, but from the competitive landscape, everyone’s saying they do it all.
Mr. McLaughlin: I was on a panel about a year ago where IBM Business Consulting [Services] had done a study for financial services. The one comment I took away was that out of 400 financial institutions they surveyed over two years, only somewhere in the range of one to 10 firms knew their profitability per client.
It was astounding, and I would assert that those that do will be further out of the gate with a head start. We’ve spent painstaking time on this, so that we can actually build a bottom-up methodology around which we could quality approve an inbound client and apply a fee — and maintain, with impunity, that this is what we believe our service is valued at for a client like you. I challenge, frankly, all of my colleagues here or most people in this industry to think about this. We’re in the second full year of doing this. We think it’s a healthful thing for our business.
Mr. Henske: It also defines who you’re looking for. If you don’t know who you’re looking for, then you’re just out there bringing in clients, and that isn’t always the best thing for your firm.
Mr. McLaughlin: Bingo. We approved a new client two weeks ago, but there was a question mark raised: “Gee, on temperament, is this client a maximizer?” That’s a bad thing. Meaning, is this client going to be looking at our asset allocation, going right down into the gory detail of tracking error by asset class to see exactly how we did? That probably isn’t going to be a client we’ll keep forever if they really aren’t partnering with us. So there’s certain temperament issues here that you just want to say, “No, we don’t want this client.”
Mr. Henske: It demotivates your staff to have a client like that. So we believe in letting employees be part of the decision process in bringing on those new clients, because people tend to support things that they themselves create.
Ms. Nesvold: In terms of the fee model, it’s still a challenge, because people naturally gravitate to an assessment of fee by assets under management, as opposed to retainer or project-based fees. If you can keep track of what you do, it’s easier to go back to your client and say, “We did all of this for you. We need to reassess your fee.” And if you’re overcharging them, you should be prepared to do it, as well.
Mr. Doty: The implicit philosophy behind that is, we’re bringing value to the table. The biggest questions that I see in dealing with clients, in an increasingly commoditized business, are: What are you bringing to the table? What’s your value added to me that I’m willing to pay you a premium over index?
As to the demotivating issue you mentioned, when you find that you’ve got some very serious problems with clients, and they are causing significant issues internally with good employees that you don’t want to lose, you’ve got to make some hard decisions. And some of the best situations I’ve seen was where you fired a client. Your employees will love you, and I think it will only motivate them to do more later on.
Mr. Henske: We’re not wired to interview clients, because we came into this business and said, “We’re going to take any client that we can possibly get. Anyone that can fog a mirror, we’re going to bring into our practice.” You change the dynamic of the relationship with the client when you interview the client.
Once you’ve been down the road enough, and you know the clients, you know what to anticipate. You know the client traits that are going to give you a potential problem down the line. And the most costly thing that a firm will incur is losing clients.
There was a study done in 2005 where they said it is six and a half times more expensive to get a new client than to retain an existing client. So why don’t we spend more time getting to know that client? Take on fewer clients. Go through the interview process and know that we’re only going to take on X number of clients per year.
Ms. Nesvold: It comes back to the business model though. It’s not like you have six months to get to know a relationship or date a prospective client a little bit. You may be one of five other advisers that they’re interviewing.
How can you really get to know them unless it really is through networking and social interaction or you have a sphere of influence who knows you well and your business model extremely well. That’s why people have to figure out what they’re trying to accomplish with their model. People are going to gravitate to the relationship managers that they feel comfortable with.
And sometimes someone is just a savvy, thoughtful marketer. They said the key phrases and the client gravitated toward that individual in particular. So it’s how you pay those marketers. Are you paying them a percentage of revenues? Or is it a function of the trailing relationship or the profitability of the relationship?
Mr. Paikert: What do you feel is the sweet spot for your firm and, more broadly, wealth management in general?
Mr. Spears: Our target market is $10 million in investible net worth and above, and the reason for that is twofold. One is that that person we believe has significant enough net worth that they can benefit from a more complex, sophisticated approach. Second reason is that below $10 million, [a] client probably is more interested in financial planning and budgeting and/or wanting to take more risk than is necessary to fund a lifestyle that is too extravagant. So since that is not something we bring to the table, we just try to say no to that client.
The sweet spot is anywhere below where the person has the means and the desire to set up their own family office. And that is a moving target. But $100 million to $300 million seems to be where that is. But it’s also a mind-set, because people are aware of how much time, energy and money it takes to set up their own family office, and they’re saying there’s probably a better way to do that. So that’s my only hesitation with putting a cap, but the floor is something we feel very strongly about.
Mr. Doty: As we merge, this may change, but our sweet spot at this point is probably in that $5-million-to-$15-million-dollar range — the ability to be able to get in at a trusted-adviser level pretty quickly, before they grow or related issues get them to a point where all of a sudden, outside consultants are involved. You want to be wedded to them before that happens.
We want to feel like the long-term loyalty is terrific. My experience around this has been, you can spend years building up good will, and you can lose it in a nanosecond with a few things that go wrong that are fairly minor but from the client’s standpoint are important.
Mr. McLaughlin: Our minimum is $10 million. We believe that we can do what we do optimally at that level, but the number goes up into the hundreds of millions for certain clients that [delegate responsibility]. I would describe the minimum as what mechanically allows us to do what we’re doing with non traditional assets.
‘Young and entrepreneurial’
We’re trying to figure out where our sweet spot is. I would say our sweet spot is a client that delegates. Typically, it is someone who has accumulated their wealth in this generation. We do have some independent wealth, but not a lot. It’s really not who we are as a firm. It is a remarkably young and entrepreneurial client list, and that seems to be propagating itself forward.
We’re doing some really wonderful work on segmentation to try to determine the profile of the client. Are they attempting to live the good life? Are they artisans? Are they granola-eating backpackers like me? There are a lot of variations here, and if we know more about that, we think we can propagate our business better.
Mr. Paikert: What are the benefits and challenges of working with the ultrahigh-net-worth client?
Mr. McLaughlin: The “maximizer” is someone we would want to avoid, and there are a lot of them. [They are] going to be at a client review on a quarterly basis and really judging you on some issues that are market driven. Broadly, they may be more dismissive of the benefits of planning than they should be, and their orientation to those things that are measurable and empirical may be driving their sense of accomplishing the mission, when, in fact, over meaningful periods, they’re less important.
Mr. Henske: The mind-set is different too for the ultrahigh-net-worth person. They view the wealth manager as an employee, whereas below that, they view the relationship as a partnership.
Mr. McLaughlin: Tom is spot on. That is as important as it gets. For us, we’re looking for a partner. Someone that is willing to [delegate responsibility, and that is] a partner. We are not a vendor. We will not be a vendor. The relationship cannot work, and we’ll know that right from the outset.
Ms. Nesvold: Well, it’s a commodity, and they’re looking for best pricing and if you’re a best fit for them. It comes back to dollars when you’re dealing with a millionaire and up. Who’s going to give me the best deal?
Really, the best deal may be an unprofitable relationship with a firm which later regrets that. It’s such a long selling cycle, upwards of, let’s say, three years for the larger relationships. It’s so hard to unwind that.
Mr. Paikert: Liz, what do you mean by “selling cycle”?
Ms. Nesvold: A client at XYZ firm that you’re courting may be so entangled with the financial and estate planning — maybe cash flow management, bill pay, a whole host of other things — it’s hard for them to make a switch quickly. First, they have to be pretty [angry] about what is going on in the relationship, and then it’s a long transition to finally move that relationship. When I talk to families on behalf of the multifamily offices, I tell them to stop trying to squeeze these people for the last nickel you can get out of them. Pay fairly for these services, and find somebody who is a match.
Mr. McLaughlin: Liz has just really hit on it. It’s been my experience that with the best clients we’ve had, there was negligible competition or none, and the relationship was driven by the almost immediate chemistry that exists between me, or others that I’ve worked with, and the client family. And it’s just a matter of organizing the recommendation and getting started.
Now that sounds awfully easy. Getting well introduced is not. But often, where there is no competition, the trust is implied. The value is already understood. A good relationship then buds. The alternative is competition, pricing. I’ve made enough mistakes when we’ve taken on clients under that cloud.
Mr. Doty: In the ultra space, you’re increasingly a commodity. So the profit margins around ultrahigh net worth are not what we get in our regular high-net-worth business. Often what happens is that firms will get mesmerized by the dollars and say, “My God, here’s a $200 million prospect. I got to have him in [for a meeting].” We don’t do the proper vetting. We end up with a relationship that might be unprofitable at the end of the day, and you rue the day that you brought them [into the firm].
If we lose clients, a lot of times it’s because we didn’t properly reconcile what the right objectives were. We may be doing something very, very well, but we’re going this way, and the client wanted us to go a little bit that way. So the reconciling of those objectives is awful tough.
Mr. Henske: It is more costly to replace that employee than it is to replace that client, because that employee may be running with 50 to 75 relationships. If you add enough of those clients with unrealistic expectations, that drains on your employees. We need to make sure that we retain the people that are really running the relationship.
Brand loyalty?
Mr. Doty: The dilemma of the one point or main point of contact for the client is that you don’t have the multiple touches for the client, and they end up tied to a person rather than a firm. So that person leaves, because you’ve created an environment the employee doesn’t want to stay in anymore, and guess what? They take half their business with them to the new place. Trying to find that right balance between simplifying the contact points for clients, yet wedding the clients to the firm rather than the individual is really, really tough.
Mr. Paikert: One of the big issues, as you all know, is the talent shortage. One of the particular areas seems to be relationship managers. How severe do you feel the shortage is?
Ms. Nesvold: It is a very competitive marketplace for these relationship managers. And it affects the pricing of human capital. So I suspect what that will ultimately do is hamper margins a little bit. I think it’s only going to get worse as we continue to see so many more opportunities in the business.
Mr. Paikert: What’s the role of a relationship manager in the family office?
Ms. Nesvold: It’s facilitating every aspect of what the client needs.
Mr. Paikert: And what kind of expertise does that person have to have?
Mr. Spears: Rocket scientist who works for minimum wage.
Mr. McLaughlin: The role that’s emerging for this relationship manager is not a sales role. If we begin from that framework, we’ve virtually eliminated the entire brokerage business. I think we have to fish in different ponds, and we have to look at developing a core of individuals. There’s a difference between skills and competencies and intrinsic talents.
I’ll give you some examples of what we believe a person should possess. They have the ability to have others reveal themselves to you. Empathy comes to mind. The nurturing quality comes to mind. The notion of being intellectually curious [is important]. I’m talking about broadly across a whole bunch of things. They’re fairly unflappable. They’re fairly centered. But I could go on and on. I’ve got 16 elements.
Mr. Paikert: Is it difficult to find these people?
Mr. McLaughlin: I think we have to grow them. Not just because you have a [law degree] or [accounting] or [doctorate] in mathematics, not because you have what I would call conventional credentials but because there are other intrinsic abilities that you have.
This person is now more an ideal than it is a real person, but moving closer to that ideal and away from the sales role is where I think the industry will go. For instance, I think multifamily offices have a surfeit of individuals who don’t have ownership and are looking for a home and want to be this ombudsman.
People that have been in client service roles that really like it and that can be trained, but be able to give this level of attentiveness that goes way, way beyond the mathematics of mean variance optimization. It goes way beyond the legal-planning tactics. It’s in another dimension, and everyone does not have these intrinsic talents.
Mr. Spears: You’ve got to be willing to say no to relationship managers as much as you have to be willing to say no to prospective clients if they’re not a good fit. If you find people that have the mind-set, then you have to marry that with a compensation scheme that rewards all these things.
Mr. Paikert: I’ve heard the situation is so desperate that people who are being courted for these jobs are asking for equity in the firm, participation in deals that otherwise their financial resources wouldn’t allow them to get into. Has it reached that level with you guys?
Mr. Spears: It definitely happens.
Mr. Henske: I believe that we need to find a technology solution to handle some of these problems, because we’re not finding those people who come in and naturally have those traits that you outlined before.
I believe that we’re going to become a database company, and data is going to be the key. The person that has the most data, and can draw upon that data and also regulate the relationship with that client from a technology perspective, will win.
Ms. Nesvold: It may not necessarily be a database company but an outsource provider, because it’s so expensive to have somebody who has all of these various disciplines. I mean, we can’t find them. Maybe we need to grow them.
Laying the groundwork
Mr. Henske: I don’t think that we grow them. I think what we do is, we provide the model, the framework. It’s like bowling. When you go bowling with your children, you have these bumpers, which are great if you’re a bad bowler, by the way. We need to set up bumpers to keep them narrowly focused.
When you do that, the skill set shrinks in the relationship manager, because you’ve laid the groundwork of what they need to do. You’ve implemented that and, for lack of a better term, policed that through technology, and at the end of the day, the partners of the firm are the people who know what the relationship manager needs to look like.
Mr. Paikert: Is there a need for an industrywide designation the way that there’s CFP and, God knows, a hundred others. Can firms really do this individually internally, or do you think there’s a market need for one of these third-party groups that are out there to give courses in this?
Mr. Henske: I think the big entities — the LPL [Financial Services], the National Financial Partners [Corp.] — are going to figure it out. And they’re going to make the life of a wealth manager easier and the practice management easier. When they figure it out and they pump the money into it, you’re going to see a potential migration of all the smaller boutique firms toward whoever is the keeper of that technology or offering.
Mr. McLaughlin: I disagree with the postulation that there will rise some new credential. There’s plenty of credentialing. There are plenty of designations people can get good training in, and these are around what I think are the core competencies and skills.
Moreover, large corporations have plowed immense amounts of money into training over the past three to five years. The training is coming along. The richest training is in these smaller registered investment advisers that just by dint of having to show up to work every day, they have this client-facing responsibility. But I think training is being very well supported by a lot of initiatives across the industry.
Mr. Paikert: Will firms continue to move increasingly toward open architecture as they have been?
Ms. Nesvold: I think it depends on the type of client you’re dealing with. Some of the smaller firms are resource constrained to develop the kind of competency around manager research and due diligence. When you’re dealing with a $50 million or $100 million family, you almost put yourself at a disadvantage if you don’t have some form of ability to go to the broader marketplace.
But I’ve seen some shops where I look at the open-architecture platform and I think, “This is not terribly sophisticated.” It is people wearing multiple hats, trying to do multiple things. I think it comes back to the sophistication of the platform, and that’s what’s so important when you’re dealing with open architecture.
But from my perspective, when you’re dealing with, let’s say, the $2 million to $20 million client — which, by the way, is the most profitable margin business — they’re looking for thoughtful people who can help on the financial planning side, do a good job on the investment side, are caring and nurturing, and are good listeners. I find with my clients who are dealing with smaller clients, they spend 90% of their meetings talking about the family and what’s important to them than they do on the investment side.
Mr. Doty: There are a lot of things we can’t train. You can’t train empathy. You can train a little bit on the listening skills perhaps, but some of this stuff becomes very, very tough.
On the open-/closed-architecture issue, prospects love to hear you say, “Well, we can’t do everything well,” because, frankly, it’s honest. No firm, as broad and as big as we are and others like us, can honestly say [that] in every asset class, we are really quite above average. So clients love to hear that you’ve got a core competency around which you operate, and you bring in access to third-party managers that complement and bring an investment solution more powerful than you’d have on your own with just proprietary.
Mr. Henske: We have to be careful of how important open architecture is, because when you add resources toward open architecture, you take resources from somewhere else. If you’re taking those resources from something that’s client-service-oriented, then how important are those returns to our clients? Is that really what it’s about? Is it really about eking out the last rate of basis point from a return, or is it more holistic?
What happens when you go toward an open architecture — which at Lenox we have, so I understand firsthand the issues that you have with that — you add complexity. When you add complexity, you must add dollars. When you add dollars, you take dollars from somewhere else.
Poppycock and balderdash
Mr. McLaughlin: I was at [Sanford C. Bernstein & Co. LLC of New York] and then Mellon [Financial Corp. of Pittsburgh] — good venerable places and great client-service-driven places — but my response to the models is poppycock and balderdash. The dirty little secret is that the proprietary shops have to give up margin to go to more open architecture, which is why they sort of begin to be half pregnant, and it is an invalid client-first model.
To be open architecture fully means you commit resources to build a pretty deep research team of your own, and then you create total transparency around the way in which there are no frictional costs in obtaining the best of breed. And the dirty little secret is, there are many frictional costs in third-party arrangements, soft-dollar arrangements. How did you get selected? Well, you know, I get paid more. Well, that’s not open. So transparency and the complete absence of frictional cost is true open architecture. Everything else is less than that. It doesn’t mean it’s bad.
Then I’ll put a footnote around this: I believe we all know the great driver of total return over meaningful periods is derived from the asset allocation. So there are many shops that can be proprietary and pick up the market beta. So that’s okay. But I think where there is alpha remaining, where there is skillfulness to be rewarded, it requires research. And just to get on an approved platform, because somebody paid to get on the platform, is just antithetical to what I think is in the best interest of the client.
Mr. Doty: The dilemma I have is, you can always find someone who’s a better manager. It’s just the nature of the beast. For larger firms, we’ve got to develop that balance between profitability and access, and you don’t necessarily have to sacrifice it if you charge properly for that added service.
I think you’ve got to build a core competency, and that core competency is going to drive your business. For instance, within our organization, there’s a large-cap-core process which a lot of our clients participate in. We’re not going to hand that off to a third party, even if the wheels fell off. We would fix it.
And then on an ancillary basis, as you have gaps in your asset allocation — which a lot of firms have, especially as we get over-diversified — bring in good outside managers and get access. Clients love the opportunity.
Clients don’t necessarily want you to go to third-party managers. They want to know you have them and just that you can get there if you ever needed to.
Mr. Paikert: What are some of the main issues that you face in asset management and portfolio management? Is it passive versus active? Is it issues around alpha? Alternative investments? Hedge funds?
Mr. Doty: People are not going to pay for passive management any more than index-type basis points fees. You’ve got to show the value added with your alpha management. That’s clear. I think that one of the detriments we’re facing is the balancing act between how many asset classes you bring to the table and the client experience.
I think the other thing is to bring in new products. The demographic shift is huge as far as the kind of investment products we should be bringing to the table for clients. We’ve got to be doing much more principal protection kind of stuff.
People, as they get older, they don’t have recovery time. That’s an issue and the related issue around income generation. So many of us have lost defined benefit plans. You’ve got to do your own health care. Everything is 401(k). Manage your own pension. That has significant ramifications for the kind of things we’re going to offer clients. Those are huge issues, I think.
Mr. Henske: It’s really a lot of the psychology of the game, too. In an up market, clients are focused on relative performance. In a down market, they’re focused on absolute performance. So you have to be very careful, because it’s almost psychological warfare out there with your clients, because you’re always trying to get them to do the opposite of what, down in their gut, they want to do. It’s having those offerings, but it’s also managing the psychology of the client.
Mr. Doty: It’s funny that the risk tolerance level of clients in up markets is infinite. It is.
Ms. Nesvold: But it comes back to the investment infrastructure. It’s the manager diligence and selection and review process. I mean, there are 11,000 hedge fund managers out there, so how do I know you have the best in class, best of breed. At the end of the day, it’s devising or being able to communicate the value proposition and knowing what you do well and outsourcing what it is that you don’t do well — or developing it or acquiring it.
But the objective is to do a good job for the client, a thoughtful job in a transparent model. I don’t think it’s always going to be one versus the other. Again, it depends on the type of client you’re dealing with.
If you’re dealing with a large family, they’re probably going
to want you to wear an open architecture hat, and you need to be able to go to the market if you do have proprietary product. But some say that the proprietary model is not going to exist longer term, in terms of dealing with high-net-worth individuals. Well, the reality is, it’s about thoughtful asset allocation, not the 49 asset classes.
Mr. Henske: And how do you explain those all to a client, and is that fair to the client?
Ms. Nesvold: It comes back to the sound bites that you get out there and what they see in the marketplace. There’s a lot of confusion. You can have a phenomenal model. I see so many great, great models, and I feel like it’s the undiscovered manager or undiscovered open-architecture advisers, but people don’t see the model because there’s so much noise out there.
Show me the alpha
Mr. Spears: The biggest challenge — when you’re looking for alpha — is what are you willing to pay for that alpha? And second, for the people who are able to generate that alpha, is it in their best interest to generate alpha, or to be an asset gatherer and get paid in that kind of scheme? That’s the difficult part.
Mr. McLaughlin: While the chase for alpha is more and more elusive, I think we’re coming upon a new era where being in U.S. long-only investments has passed.
There are going to be a variety of other things. Exotic beta comes to mind; things that have historically come with higher risk will be considered.
And second, there will be more focus on downside protection and emergence of metrics around which individuals will look at volatility and absolute return, and be willing to pay for elaborate portfolio so that they can actually do some things that are not unlike a hedge fund strategy but could be available to the lesser-net-worth universe.
Mr. Paikert: The traditional model has been percentage of assets under management. Do you folks expect that to change much, or will we see more retainer work?
Mr. Spears: You have to define a fee schedule based on your deliverables around that fee schedule.
I think it’s easier to do when you reach scale in your business than when you are taking everybody that darkens the mirror.
And so it’s going to take some discipline, like it does in everything.
Mr. Henske: You have to be careful with pay for performance. First of all, what are you comparing it to? What is the performance based on?
For the smaller firms, a lot of their infrastructure is based on that recurring revenue.
So some hedge funds realize that if they start off with a bad year or two bad years, they’re too far into the hole. It’s just easier to close up shop.
If the A student has a bad quarter, it doesn’t mean that they don’t get into college.
You have to be very careful about how you link that pay for performance.
Intuitively, it makes sense, but there’s a whole list of complex issues that are behind [about which] you have to be very careful.
On the other hand, your clients don’t like to get bills. So that pay for that hourly fee — I can tell you that every time I get the bill from my accountant, I want to ask, “Can you give me a line item of everything that you worked on?”
I’m sure that I am one of thousands of people who drive him and his firm and his species absolutely nuts every year with the same question.
At the end of the day, our clients are putting their trust in us to do the right thing, and we need to be able to service the clients at that level and to service multiple clients, not just one.
The only way to do that is to have some sort of infrastructure behind you.
And I think it’s going to be the wealth manager practitioner who will drive this decision.
Ms. Nesvold: No disrespect, folks, but we’re in an industry of lemmings. Everybody’s got the percentage-of-assets-under-management-fee model.
It’s hard for somebody to make the break. I mean, the people who are dealing with, maybe, more sophisticated clients will do retainer-based pricing; they’ll do project fees on top of that.
Performance fees worry me a little bit. Arguably, it aligns your interest on the way up, but the reality is, on the way down, you’re actually doing more for the client in troubled times where the performance isn’t as robust, and you’re getting less, because it’s actually linked to their account levels.
So how do you challenge that model, and do you go to a blended model? You have to reflect on complexity. If you’ve got a $250 million family who’s just had one liquidity in its first generation, that’s a lot different than a fourth generation, 50 trusts, multiple members, family members around the globe.
But how do you factor that in and also compete against your peers, who are using a model that’s very easy for clients to assess because it’s packaged so neatly?
Mr. McLaughlin: I’ve already made my point about our bottom-up methodology. Then based on issues related to neediness and temperament, we will plus or minus that and put a fee together. But the fee, importantly, would be a flat fee.
Then, nine months later, we might actually change the fee. Some heavy lifting goes on in the first nine months of the relationship, and we might rationalize the fee based on what we really believe it will be going forward.
I’ll entertain the notion of performance fees. There may be some pressure on that. There may be a small trend on that. But I think it’s an outlier. The reason it will
be difficult to get any traction is: There is no common gauge rail around which performance can be calculated. The vast majority cannot tell a client how they did against meaningful benchmarks, weighted-average benchmarks, dollar-weighted and time-weighted. They can’t provide that. So I don’t see it emerging as a trend.
Going for broke
Mr. Doty: The banks historically have been in the fee-based
approach, and to me, the interesting dynamic here is on the
performance-based thing. My worry as an investment guy is, if it’s performance based, my tendency is to jack up that risk parameter, because I want to take the chance that I’m going to get paid handsomely for doing it, and we’re not looking at the other side of the equation, which is the risk.
On the issue of the revenue tied to employee, the banks have never been in that. We’ve always been in the base bonus, and increasingly, we’re more formula-driven. The closer you can get to effort expended and reward received, the better — as far as motivation. We’re working on that. Not a trailer of one, two, three years. We’re working on the idea that you get a percent of your book as you go forward. Banks have never gone there, and I think there’s a motivation there that’s pretty strong and pretty important.
We don’t want to nickel and dime the clients. In financial planning, for example, our experience is, people don’t want to pay for it. And so what we have done is, we’ve turned it into a cost center as opposed to a profit center.
Ms. Nesvold: Isn’t that funny? It’s probably among the most important aspects of dealing with your client initially, and they discount it entirely.
Mr. Doty: Yes. But we’ve used it as the entree to get in the door with them to talk about the investment products. We’ve got our financial planners out there making sure that they’re focused toward bringing the client in, helping to build the breadth of product around that client, helping to tie them to the firm — those kind of things that are important.
I can’t tell you how many times clients have called up because you’ve charged them a fee for tax services of $125, and it’s just the worst.
So bundle that fee appropriately, and then create incentives for people to keep motivated in the right direction.
The benchmark issue is very, very important, because the industry is moving toward performance by objective, and I think that’s appropriate.
We [will] sit down with a prospect and say, “OK, we’ll meet that objective. Don’t worry about how we asset allocate to do it.” That’s ultimately the best benchmark I can think of with clients, and [it] gets away from this relative game. It’s an educational process.