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Investment Management Is Just a Commodity Service...or Is It?

Two advisors say it is anything but a commodity.

David J. Drucker, 04/20/2006

When we think of a commodity, we normally think of an article of trade or commerce, particularly an agricultural or mining product. Broadly speaking, a commodity is any bulk good traded on an exchange or in the cash market such as grain, gold, or natural gas.

Many in our profession believe investment management has become a commodity--a service that is basic in nature and doesn't vary greatly from one advisor to another, a service that, like an agricultural commodity, is largely unprocessed and can be bought, processed, and resold by the advisor.

The parallel with index funds isn't difficult to see. Other than slight differences in cost structures, there are hundreds of index funds available to advisors to be assembled into portfolios for clients (i.e., processed and resold). Let's face it, there's not a whole heck of a lot of difference between the Vanguard 500 Index Fund, Fidelity Spartan 500 Index Fund, and SEI Index S&P 500 Fund. Advisors use these funds interchangeably every day.

So, is this controversy just the old index-fund-versus-managed-fund dispute? No, it really goes beyond that to ask, "How important is, or should, investment management be to the client?" Important enough to spend significant time to get it right, says Michael Dubis of Touchstone Financial in Madison, Wis. Oil and butter are commodities, says Dubis, the purchase of which, if done poorly, will hardly have an impact on the client equivalent to that of a misguided investment management strategy.

"Last year," he says, "I spent approximately 300 hours on non-client-specific investment research and management issues, and then about two to 10 hours per quarter per client ensuring individual portfolios adhered to investment policy statements." In defense of the time he spends, he says, "Many advisors don't have the training or capacity to understand investment management, so they take the path of least resistance and fail to give any original thought to the process."

Janet Briaud of Briaud Financial Planning in Bryan, Texas, couldn't agree more. "Different clients need different allocations," she says, "depending upon whether I'm investing in an IRA or a non-qualified account. Each client is different as relates to taxes. Allocations change along with changes in stock valuation and interest rates. As Woody Brock says, you plant different crops for different seasons; we might do something different in rising versus falling P/E environments."

Briaud is one of those rare advisors who didn't let client money ride the market downstroke of 2000-2002. "We made wholesale changes in 1999 and stuck with them. It was difficult because the market was still rising. We lost six clients that year who thought we were being too conservative. Now, it's a lot easier. Clients understand I generally don't make big moves, but when I do, I believe it's necessary."

Like Dubis, Briaud spends significant time thinking through the investment process. "I develop scenarios asking, 'If this were to happen, what would work in this environment?'" This thinking has led her to include gold ETFs, emerging markets, and oil and gas in her clients' portfolios--investments many advisors would just as soon leave out of their commoditized asset allocations.

Briaud's possible scenarios also make room for such possible events as the topping out of boomer debt. "There's so much debt out there, if boomers ever stop spending, you have some real issues, so we look at deflation as one possible scenario. We also have a crisis scenario--the dollar falls, the Avian flu takes off, or we get another terrorist attack--there's gold in our portfolios for these outliers."

The services Dubis and Briaud provide don't sound commoditized. "When I think of a commodity," says Dubis, "it has to be fairly rigid--a science, perhaps--but the process of investment management is so individualized, how can it be a commodity? People think this stuff is easy; I wish it was, but it's hard."

In pointing to all the parts of the investment management process that aren't commoditized, Dubis and Briaud mention client behavior, product awareness, an advisor's adherence to rebalancing, recognizing alpha, and tax efficiency--just to name a few. "What's commoditized is modeling, where an asset manager dumps the client into one of seven portfolios without regard to the client's tax bracket," says Dubis. "Or, some advisors outsource execution to the client and find out later on they didn't do it right. Giving the clients the portfolio's ingredients doesn't make them a chef."

Maybe, this author opined, investment management commoditization has less to do with what we think the client should have and more with what the client values. If the client thinks it's a commodity and is generally happy with market-based returns, should we expend the substantial resources to improve on that at the expense of giving the client other services he values more highly? Maybe we should just outsource the whole investment management process to someone else?

"That gets to the question of where our competencies are, as advisors," says Briaud. "The advantage of having somebody else do [investment management] is you don't have to think about it-- but you must have confidence in what they're doing and you must be able to explain it to clients. In doing the difficult is where you make money, so if you have somebody you're comfortable with who's in value funds at the right time, you have to keep your clients invested that way. I couldn't convince 90% of my peers to put their clients in gold right now. Last May, gold mining shares were down 17%, so clients ask if this is really the right thing to do. If you're not convinced, you've got to get out."

Adds Dubis, "I think the bottom line is that, whether or not you do it yourself, investment management must be done as if it's not a commodity. The fact that different advisors who engage in the investment management thought process come up with different answers just enforces, for me, the idea that this service is anything but commoditized."

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