It used to be that simply being a fiduciary was enough of a differentiator to attract new clients, to the point where the growth of fiduciary assets widely outstripped the growth of assets in the advisor industry as a whole, according to Boston-based Cerulli Associates.
But the marketplace has changed, and independent RIAs need to change with it, said Matt Belnap, a Cerulli associate director covering U.S. managed accounts, during a virtual discussion on the state of the industry earlier this week.
“Advisors generally were able to stand out by being a fiduciary in the past. That was a way to differentiate their practice, that was a way to differentiate themselves from other channels,” he said. “But now you can find good, solid, fiduciary financial planning-based wealth management in a lot of different advisors and in a lot of different channels. You don’t have to find an independent RIA to do that for you anymore.”
The next path for differentiation for fiduciaries, he said, is advanced personalization, or heightened customization. And while the solution—separately managed accounts (SMAs) of all stripes—is right in front of the industry, independent RIAs aren’t taking advantage of it, Belnap said.
In fact, the advisor industry has been downright slow to adopt SMAs, he said. Cerulli found 55% of advisors in general don’t use SMAs at all, and among independent RIAs that rises to 86%.
“They have a core market of $750,000 clients, so they’re large enough that their clients could benefit from the personalization and customization rather than a pooled vehicle,” he said. “But they’re still building these portfolios out of mutual funds or ETFs.”
Going forward, Cerulli expects growth in the category of separately managed accounts will outstrip that of mutual funds and ETFs, largely because independent RIAs are expected to recognize their value for differentiation.
Another driver for SMA growth will come from the home offices of large firms, Belnap said. When asked what investments they wanted to put on their platforms this year, executives replied their top priority is direct index separate accounts.
“The sponsor firms see the value in this, they want help from their asset management partners in better educating their advisors, and they’re looking for products,” he said.
And even more importantly, he continued, they need to know how to tell their advisors how to use SMAs, develop use-case scenarios to demonstrate their value, and be clear about how this customization and personalization fits into their platform and their portfolio construction methodology.
“You don’t have to read personalization and customization as just direct indexing, or just S&P 500 large-cap tax loss harvesting,” Belnap said. “That is a lot of the story but it is not all of the story, especially for managers considering getting into this space.”
While tax optimization is the biggest success story within direct indexing to date, he said, another great story is a tax-managed transition, where a financial advisor brings new clients onto their book and their assets are under an older financial advisor’s model with embedded gains.
Concentrated stock positions are another key area for successful advising.
ESG, while initially a big draw for direct indexing, over time has slipped to third place, “and next year I expect it to be a little further down,” Belnap said. However, ESG can be much more important to a younger client with less net worth than tax optimization, he added.
Of all the SMA options, two in particular have been garnering RIA attention.
The first, Belnap said, are unified managed accounts consolidated into one account registration, with the customization provided by a home-office’s overlay services.
“Those programs have grown at 34% over the last three and five year periods,” he said. “They’ve seen strong flows, a good number of conversions from a mutual fund or ETF wrap or rep-as-portfolio-manger or rep-as-advisor program being rolled into those unified managed account programs.”
That customization and the more efficient outcomes that an advisor can deliver through those programs have been a key point of emphasis for the sponsor firm, he said.
The second popular program are the rep-as-portfolio-manager programs, which have seen growth percentages in the high teens and low 20s, he said.
“When we talk to advisors or executives who run these RPM programs, they tell us in a down market you’d think that perhaps it would be more advantageous to look at something like a home-office solution or a model so you’re not in charge of the investments when the portfolio is down, but the opposite is true,” MATT said. “The advisor wants to be more high-touch, and be able to personalize and have those conversations with the client more in a down market because there’s that point of personalization.”
That’s when the advisor can prove their value reminding clients they had looked at the manager together and discussed how the manager fit into the clients’ portfolio.
“If you’re in a model, there isn’t that point of commonality,” he said. “You can’t say, ‘We believe in the model manager but I’m not sure what they’re doing on this buy-and-sell decision, let’s see if I can get the portfolio manager or product specialist on the phone.’”