The Rise of Non-Investment Advisors
Removal from the investment process is nearly complete.
Investment advisors are being pushed out of the investment business. The trend started decades ago, and now with the advent of packaged investment products and their enthusiastic embrace by fund companies, individual investors, and even advisors themselves, the trend has perhaps reached its logical conclusion. Advisors have transitioned in both their own minds and in the public’s perception from being investment advisors to being relationship managers. Now, admittedly a huge number of activities occur under the financial planning umbrella, and advisors bring diverse talents to the table as they address a multitude of client needs. Still, the trend of curtailing the advisor role in the investment process is undeniable.
Decades ago, advisors often defined themselves as stock-pickers. Using either their own research or that of their parent brokerage firms, they would construct portfolios of blue-chip stocks and perhaps a few fliers for their clients. They would also ladder bond portfolios or pick a few municipal or utility bonds to add income to the portfolio. No scorecard of their success was kept, but the record was likely spotty. Eventually, the costs and limited diversification of these portfolios came to be seen as disadvantages, especially before deregulated stock trading commissions. Mutual funds presented themselves as a solution, and advisors shed their role as security selectors and adopted the new role of selectors and evaluators of fund managers.
Now freed from the need to be linked to a brokerage firm’s stock research, the independent financial planner movement really took off. With their newfound independence, advisors became investor advocates, searching out the best managers, seeking lower-cost options for their clients. They turned the tables on Wall Street. Rather than selling what they were told to promote, advisors could direct assets to the best managers in the market. While there was much to like with this system, picking managers proved difficult as many muchloved managers stumbled and disappointed. Also, the costs of these investments still took a toll, especially when coupled with the advisors’ fee.
It was then that the index revolution took hold. Despite the success many advisors had had in selling funds like those from the Capital Group, academics told advisors they had no business picking investment managers and instead should build portfolios out of index funds. Manager selection was too difficult, they were told, but not to worry, advisors were still left with the mission-critical task of asset allocation, which they were told was where the vast majority of the value was. And with the lower fees from index funds, the advisors’ fee could be more readily justified. If the resulting portfolios looked too much like something the client could do on his or her own, the fund industry offered up exchange-traded funds—some basic, but many exotic—that advisors could use to spice up portfolios and dazzle clients with their responsiveness to that week’s hot topic. That this was all done with an academic halo of cost reduction and market efficiency made this approach seem all the better.
Today, this trend of pushing advisors out of the investment decision-making is reaching its logical conclusion. Advisors are being told that their continued involvement in portfolio construction—even in this greatly diminished capacity of merely stringing together index funds—is still too great. Vanguard’s recent pronouncements under new CEO Tim Buckley signal that firm’s intent to move boldly into services like basic allocation and rebalancing. Vanguard argues that robo-advisors and packaged services are far more efficient at portfolio construction than are advisors. Vanguard maintains that advisors should focus on client relationships, perhaps including behavioral coaching and some more complex financial planning, but certainly advisors should have very little to do with traditional investment selection.
And, thus, the cycle reaches its logical conclusion. Advisors have been increasingly removed from the investment process—first from security selection, then from manager selection, and now from portfolio construction. These trends have advantages. Costs are declining, and diversification is rising. Investors on the whole are likely to be better served, especially beginning investors who benefit from simpler solutions like targetdate funds. Obviously, some advisors will continue to select individual securities, and many will continue to deploy actively managed funds. Most will also continue to have a hand in portfolio construction for now, but the odds are strong that advisors of the future will do less, not more, of these activities.
There’s a great irony that advisors are dialing back their involvement in the investment process at the same time that the independent advisor community is dialing up its rhetoric about being fiduciaries. A fiduciary standard is a wonderful thing and something that is entirely appropriate for someone who is making investment decisions. Surely, fund managers and robo-advisors who craft packaged portfolio solutions should be held to such a high standard. But if advisors don’t pick stocks, don’t pick managers, don’t even determine the asset allocation of a client’s portfolio, should they be held to that same standard? I have great respect for anyone who embraces higher standards, but it’s worth asking: If the advisor’s task no longer includes selecting investments, is a suitability standard perhaps the more appropriate expectation? After all, today’s advisor is not your father’s stockbroker.
This article originally appeared in the June/July 2018 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.