The Long Tail by Chris Anderson printed in 2006 by Hyperion was a revelation in the ways that business had and was going to change to a new model. The implications went far beyond the music and book industry that were highlighted in the book. A quick synopsis is that music and book stores stock very few choices because of the constraint of space. Ever wonder why when you walk into a book store and piled everywhere is the most recent best seller. Where it is true that people are buying the best seller it is also true that it limits the number of titles available for purchase. The best sellers overwhelm the store. Same with music stores as they carry around 60,000 different tracks which translate into a much smaller number of CDs available for purchase. There are piles of the hot new CD but selection is limited to what the store believes will be sold quickly. Yet music online, in 2006, were offering well over 900,000 different tracks for purchase and you could/can buy individual tracks and not the whole album or CD. Book stores typically handle around 25,000 different titles and yet in 2006 Amazon "stocked" over 5,000,000 books and around 2,000,000 CDs.
If electronic delivery was not possible but only physical (books and CDs) delivery existed the online stores would still dominate given the breath of their offerings.
But for us that is not what caught my eye and changed my thinking on the retail financial model and how we need to adjust the way we think about customers and the offering we need to move to. The important point was that 30% to 40% of online sales were of one item per quarter. Think about that. One title of a book or CD per quarter is over 30% of total sales. This is the fact that should drive the retail financial firms to change their thought processes which are firmly rooted in the distant past.
Major financial firms are racing as fast as then can to exclude "small-sized" accounts from their platforms. BACML now has a cut off of $500,000 for an account that advisors can be paid on with Morgan Stanley at $250,000 and UBS at $100,000. The firms are concentrating on best sellers and stocking their shelves accordingly. These numbers could be higher as we speak as compensation packages are being re-written again. Firms have spent and lost tens of millions trying to impose "high net worth clientele" on a supposed "high net worth salesforce" that actually doesn't exist. But that is another story for another day. Today is about technology and building a business model that takes advantage of the new world.
Financial firms should look to expand their market not contract it. The major firms had virtually 100% market share in the 1970s and now are controlling around 38% and it is rapidly eroding. There is no need to discuss but it should be mentioned that the average age of a financial advisor and the average age of a wire house customer is not demographically favorable. In fact those two facts are scary bad. The firm's technology is notoriously bad and certainly doesn't fit into the new world of easy interconnectivity.
Thirty years ago business was driven by transactions and the firms have consciously priced themselves so far out of the business that a customer is either lazy or stupid to execute a transaction with a wire house. The firms in the name of maintaining "pricing power" have totally forsaken large segments of the market. Somewhere along the line the firms decided that transactional business was not part of our business model. Adaptability is not one of our strong suits.
Now even if you have a managed account the firms are vigorously working to to move you out if you fall below an arbitrary asset size. So is there a different way?
The technological revolution has changed the way advisors do their business in several ways. First, there are standardized reports now available on every client. This is a huge time saver. No longer do advisors have to create their own reports. Second, and most importantly the firms have developed discretionary platforms that use investment models. Third, the have developed a firm discretionary account that is administered by the firm's Investment Committee.
These three things taken together offer the firms the beginning of changing their offerings to attract new assets and change behavior with their advisors. First small accounts, defined by the firm, would all be required to be in the firm's discretionary account. The firm's can even put in their own grid for these accounts. Quarterly performance reporting would be automatically generated and emailed to the client. All clients on the platform would be required to go completely paperless. Advisors would receive full payout on all accounts.
Second, firms should raise grid payouts on all accounts on the discretionary platform for advisors. The firm wants to drive clients to the discretionary platform to free up the advisor's time to capture life events.
Third, advisors need to be retrained to recognize and bring to bear centers of expertise for client life events.
* see my blog on all assets are good assets
There are very viable low cost solutions that will allow firms to grow in a wealth management environment. All it takes is a little change.
Tuesday, December 9, 2014
Friday, September 5, 2014
Retail Financial Firms can become client-centric by restructuring existing assets
There is no question that financial firms are not structured to be client centric but that does not mean that the firms don't have the client's best interests at heart. We are speaking about how financial firms are structured to support their brokers and not their wealth managers. Basically financial firms employ brokers not wealth managers and the firms continue to structure themselves internally to support their brokers.
First we can not get sidetracked by the different investment products. The rule of thumb we will follow is that if the investment vehicle ends up buying stocks and bonds it doesn't matter how the they are wrapped, mutual funds, ETFs, hedge funds, private equity, outside money managers, unit trusts or a straight purchase of a bond or stock it is an investment. Discretion or non-discretionary are platforms not products.
Clients are rated by assets kept at the firm and accounts with low assets, $100,000 to $500,000 and below, are considered unprofitable. This again is driven by the fact that the firm only recognizes investable assets and not the potential relationship. Brokers are only about investments and wealth managers are all about the relationship. The Firms correctly surmise that their brokers have not solved the Gordian Knot on how to capture and offer solutions for life events so they base the business model on a simplistic and ultimately wrong assumption; that assets are determinate of revenues. Assets are a function of revenue but not the ultimate determinant.
Financial firm's can restructure themselves in three (3) ways to start the process to become more client centric and to help wealth managers to capture life events.
1) Firms need to revisit how and why insurance is sold to it's clientele. Without access to any firm's sales numbers I would guess that the vast amount of insurance revenue generated is through the sales of variable annuities. This leads us back to the earlier premise that all investments that end up buying a stock or a bond is an investment. Variable annuities are an investment with an insurance wrapper design to minimize current taxes and in some cases minimizing any losses through stop-loss features.
Very rarely is insurance sold as a strategic solution for an estate planning issue. So how do we start changing how brokers use insurance.
First having annuity days is counter-productive. It is so product centric, so yesterday. Most firms have employ highly trained internal wealth managers to work with the brokers. These people meet clients with the broker to offer estate planning strategies. They are very good at their job and they will tell you the hardest part of their job is getting the brokers to let them in front of their clients.
Firms should use their in-house resources, insurance department and internal strategists, and outside strategists, most firms use Capitas, to develop a program to teach brokers estate planning strategies involving trusts and insurance. These strategies should be high level complex solution sets that are employed everyday in the world to solve a client life event. They should not be dumbed down in any way. By teaching your brokers through examples of complex strategies the brokers learn to spot opportunities when they present themselves. I know that is why we developed a financial planning tool. The tool will capture these opportunities. The problem is the tool creates a static solution set and misses opportunities when they arise. It is like you just finish a financial plan for a client and the next day he calls and says he has been told he has cancer. Things change.
By learning strategies the broker can have the confidence to actually broach the subject that they don't historically talk to their clients about. I have developed a theory about brokers and why we are so firmly entrenched in the investment world. It is called the "don't look stupid theory".
No human being will sit in front of another human being and look stupid on purpose. We look stupid everyday but we just don't do it on purpose.
By teaching our brokers complex strategies we are not asking them to execute the strategies we are asking them to recognize opportunities and bring the correct Center of Expertise to bear.
Lets consider a couple of examples. I have asked hundreds of brokers what would they say to a client, prospect and friend if they were told that they were expecting a baby. All but two said they would tell them to open up a 529 Plan. A plan that has dubious benefits and generates little to no income and a recent study shows that 97% of investors do not use the 529 Plan. Yet it is a fact that 86% of people expecting a baby actually increase their life insurance. Where do we want to position ourselves? Do we want to be brokers or wealth managers?
Another example. A thirty-five (35) year old hedge fund trader who has three young children who is in exceptional health asks a broker what mutual fund would he recommend as he gives $14,000 per year (tax-free) to each of his three children. Instead of recommending a mutual fund right away the broker could suggest that the trader could consider giving the money to a trust in his children's names and buying $10 million in life insurance on himself. Whether the strategy is accepted or even makes sense the broker has set themselves up to be a wealth manager and not just a broker.
Going back to the usefulness of the financial tool to capture life events with the last two examples. How could it have possible helped in a dynamic world of constantly changing scenarios? The broker must have enough knowledge to be confident to bring in Centers of Expertise when an opportunity arises.
Knowledge equals confidence, confidence equals sales.
2) Corporate Services. Firms have spent an enormous amount of time and resources and political capital to develop a fairly seamless backend delivery of institutional quality services to the retail client when appropriate. The political capital was spent developing the splits for payouts to the brokers and for what length of time they were paid for introductions. But again the entire system is product centric not client centric. Access to Corporate Services by retail brokers is by institutional desks not by a client need. Re-design the front-end.
It is important to note that one of the most significant advantages in working at a full service firm are rarely used by senior financial advisors and not consistently used in training of the new brokers. Training FAs to all the services at their finger tips is a competitive advantage that the firms treat as a throw away. In today's world of RIAs, robo-advisors and alternative platforms this is a mistake.
The access template that a broker uses should be based upon a life event. A client in a passing conversation mentions that he buys and renovates strip malls in Florida. What is the advice, service and product that can be brought to bear because of this conversation? Corporate Services should be designed to be queried by an life event and then present a quick presentation with a yes or no to whether we are in the business. If yes what are the 3, 5 or 8 qualifying questions to ask the prospect and finally a few examples of previous business done.
A concerted effort in recognizing opportunities and how to analyze their exiting clientele should be presented to the brokers consistently. A true example. A large broker was trying to close a very large prospect for a couple of years to no avail. The broker kept representing to the client investment ideas but this prospect was so large he had access to the firms at the highest levels and nothing made sense. The prospect loved the broker but couldn't wouldn't pull the trigger. It was suggested to the broker to offer the prospect a way to protect himself against interest rates increasing when everyone was predicting run away interest rates. The broker presented the trade to the prospect by email and was promptly responded to with the fact that the prospect had just instituted three trades with Goldman Sachs and gave the particulars. We reversed engineered the trades and figured out the broker would have received a $1.2 million commission. All the information about the institutional services was on the machine but in language that no one understood because it was written by the institutional desk. Communication written using institutional language and acronyms is not a highly effective way to increase understanding and driving business. Knowledge equals confidence, confidence equals sales.
3) Opening Accounts. When client opens an account at any firm they are asked a series of questions before the account can be opened. These questions are based upon two themes; what information the firm needs to know to legally open the account and what information the firm needs to understand about risk tolerances. Think about those two type of questions. What the firm needs to legally open the account is pretty much basic information, like name, rank and serial number. The second set of questions continues the business model that we are all about investments. We do not even try to understand the needs/goals of the client for possible applicable solutions we focus on just what can we invest in. I know we do financial plans. But basic questions can be asked to enhance the relationship with the client right from the start. Examples. Do you anticipate your children living at home after 21? Are you a sole business owner and do you have key man insurance? If you are ill for an extended period of time how will you pay for it? If your spouse is ill for an extended period of time and you have to work how will you handle it? There are a myriad of questions to ask that enhance the FA from a broker to a wealth manager and it is the firm's job to help with the questions.
Changing culture is a process. Nobody likes change. It is said that 97% of change comes through fear, 2% because you have to and 1% because you think it is a good idea. Change is hard but we should be fearful as robo-advisors and fee transparency is challenging our investment only business model. We need to rethink how we do business and how are firms are structured to support the new business model. If a multi-millionaire hedge fund trader invests all his money in his hedge fund because he gets better terms but then tries to open a $100,000 account a major firm we tell him no. We don't want your mortgage, insurance or lending opportunities because you will not invest enough money with us. Huh?
What do I mean by brokers versus wealth managers? A broker is one who derives that vast amount of their revenues through managing investments and a wealth manager is one who not only manages investments but also employs wealth strategies for solutions to client needs. These strategies usually employ the use of trusts and insurance products. Obviously financial advisors can offer many other financial products like mortgages and non-purpose loans. One only as to look at the revenue mix of a financial advisor to know that they are brokers as the revenue from investments is usually between 95% and 98% of generated revenues. Some people get confused on the revenues because they look at the firm's revenue mix which is totally different from a financial advisor's revenue mix. Firm's have capital markets groups that make the vig off of every trade made by a client both in equities and fixed income, they sell shelf space to outside products companies and they make money off of all cash balances and money market funds. Firms also decrease their own internal funding costs by selling structured products to their clientele and trading the underlying for their own profit. The financial firm's have successfully fought off any attempts to make their brokers advisors. Where this may seem like a small thing it would fundamentally alter the way financial firms could earn money through capital markets and product pay-to-play. But that is another story. To understand a broker's revenue we must study the individual broker's revenue mix.
First we can not get sidetracked by the different investment products. The rule of thumb we will follow is that if the investment vehicle ends up buying stocks and bonds it doesn't matter how the they are wrapped, mutual funds, ETFs, hedge funds, private equity, outside money managers, unit trusts or a straight purchase of a bond or stock it is an investment. Discretion or non-discretionary are platforms not products.
Financial Firms today are structured to support products. Internal and external wholesalers are assigned by product. Whether it is a mutual fund, ETF or a manager the product has its own P&L and internal structure in the firm. The product pays a fee to be on the platform in the form of an access fee. Firms have streamlined internal support by having one person represent all the investment products but that was done for cost cutting not for any altruistic reasons.
Clients are rated by assets kept at the firm and accounts with low assets, $100,000 to $500,000 and below, are considered unprofitable. This again is driven by the fact that the firm only recognizes investable assets and not the potential relationship. Brokers are only about investments and wealth managers are all about the relationship. The Firms correctly surmise that their brokers have not solved the Gordian Knot on how to capture and offer solutions for life events so they base the business model on a simplistic and ultimately wrong assumption; that assets are determinate of revenues. Assets are a function of revenue but not the ultimate determinant.
Financial firm's can restructure themselves in three (3) ways to start the process to become more client centric and to help wealth managers to capture life events.
1) Firms need to revisit how and why insurance is sold to it's clientele. Without access to any firm's sales numbers I would guess that the vast amount of insurance revenue generated is through the sales of variable annuities. This leads us back to the earlier premise that all investments that end up buying a stock or a bond is an investment. Variable annuities are an investment with an insurance wrapper design to minimize current taxes and in some cases minimizing any losses through stop-loss features.
Very rarely is insurance sold as a strategic solution for an estate planning issue. So how do we start changing how brokers use insurance.
First having annuity days is counter-productive. It is so product centric, so yesterday. Most firms have employ highly trained internal wealth managers to work with the brokers. These people meet clients with the broker to offer estate planning strategies. They are very good at their job and they will tell you the hardest part of their job is getting the brokers to let them in front of their clients.
Firms should use their in-house resources, insurance department and internal strategists, and outside strategists, most firms use Capitas, to develop a program to teach brokers estate planning strategies involving trusts and insurance. These strategies should be high level complex solution sets that are employed everyday in the world to solve a client life event. They should not be dumbed down in any way. By teaching your brokers through examples of complex strategies the brokers learn to spot opportunities when they present themselves. I know that is why we developed a financial planning tool. The tool will capture these opportunities. The problem is the tool creates a static solution set and misses opportunities when they arise. It is like you just finish a financial plan for a client and the next day he calls and says he has been told he has cancer. Things change.
By learning strategies the broker can have the confidence to actually broach the subject that they don't historically talk to their clients about. I have developed a theory about brokers and why we are so firmly entrenched in the investment world. It is called the "don't look stupid theory".
No human being will sit in front of another human being and look stupid on purpose. We look stupid everyday but we just don't do it on purpose.
By teaching our brokers complex strategies we are not asking them to execute the strategies we are asking them to recognize opportunities and bring the correct Center of Expertise to bear.
Lets consider a couple of examples. I have asked hundreds of brokers what would they say to a client, prospect and friend if they were told that they were expecting a baby. All but two said they would tell them to open up a 529 Plan. A plan that has dubious benefits and generates little to no income and a recent study shows that 97% of investors do not use the 529 Plan. Yet it is a fact that 86% of people expecting a baby actually increase their life insurance. Where do we want to position ourselves? Do we want to be brokers or wealth managers?
Another example. A thirty-five (35) year old hedge fund trader who has three young children who is in exceptional health asks a broker what mutual fund would he recommend as he gives $14,000 per year (tax-free) to each of his three children. Instead of recommending a mutual fund right away the broker could suggest that the trader could consider giving the money to a trust in his children's names and buying $10 million in life insurance on himself. Whether the strategy is accepted or even makes sense the broker has set themselves up to be a wealth manager and not just a broker.
Going back to the usefulness of the financial tool to capture life events with the last two examples. How could it have possible helped in a dynamic world of constantly changing scenarios? The broker must have enough knowledge to be confident to bring in Centers of Expertise when an opportunity arises.
Knowledge equals confidence, confidence equals sales.
2) Corporate Services. Firms have spent an enormous amount of time and resources and political capital to develop a fairly seamless backend delivery of institutional quality services to the retail client when appropriate. The political capital was spent developing the splits for payouts to the brokers and for what length of time they were paid for introductions. But again the entire system is product centric not client centric. Access to Corporate Services by retail brokers is by institutional desks not by a client need. Re-design the front-end.
It is important to note that one of the most significant advantages in working at a full service firm are rarely used by senior financial advisors and not consistently used in training of the new brokers. Training FAs to all the services at their finger tips is a competitive advantage that the firms treat as a throw away. In today's world of RIAs, robo-advisors and alternative platforms this is a mistake.
The access template that a broker uses should be based upon a life event. A client in a passing conversation mentions that he buys and renovates strip malls in Florida. What is the advice, service and product that can be brought to bear because of this conversation? Corporate Services should be designed to be queried by an life event and then present a quick presentation with a yes or no to whether we are in the business. If yes what are the 3, 5 or 8 qualifying questions to ask the prospect and finally a few examples of previous business done.
A concerted effort in recognizing opportunities and how to analyze their exiting clientele should be presented to the brokers consistently. A true example. A large broker was trying to close a very large prospect for a couple of years to no avail. The broker kept representing to the client investment ideas but this prospect was so large he had access to the firms at the highest levels and nothing made sense. The prospect loved the broker but couldn't wouldn't pull the trigger. It was suggested to the broker to offer the prospect a way to protect himself against interest rates increasing when everyone was predicting run away interest rates. The broker presented the trade to the prospect by email and was promptly responded to with the fact that the prospect had just instituted three trades with Goldman Sachs and gave the particulars. We reversed engineered the trades and figured out the broker would have received a $1.2 million commission. All the information about the institutional services was on the machine but in language that no one understood because it was written by the institutional desk. Communication written using institutional language and acronyms is not a highly effective way to increase understanding and driving business. Knowledge equals confidence, confidence equals sales.
3) Opening Accounts. When client opens an account at any firm they are asked a series of questions before the account can be opened. These questions are based upon two themes; what information the firm needs to know to legally open the account and what information the firm needs to understand about risk tolerances. Think about those two type of questions. What the firm needs to legally open the account is pretty much basic information, like name, rank and serial number. The second set of questions continues the business model that we are all about investments. We do not even try to understand the needs/goals of the client for possible applicable solutions we focus on just what can we invest in. I know we do financial plans. But basic questions can be asked to enhance the relationship with the client right from the start. Examples. Do you anticipate your children living at home after 21? Are you a sole business owner and do you have key man insurance? If you are ill for an extended period of time how will you pay for it? If your spouse is ill for an extended period of time and you have to work how will you handle it? There are a myriad of questions to ask that enhance the FA from a broker to a wealth manager and it is the firm's job to help with the questions.
Changing culture is a process. Nobody likes change. It is said that 97% of change comes through fear, 2% because you have to and 1% because you think it is a good idea. Change is hard but we should be fearful as robo-advisors and fee transparency is challenging our investment only business model. We need to rethink how we do business and how are firms are structured to support the new business model. If a multi-millionaire hedge fund trader invests all his money in his hedge fund because he gets better terms but then tries to open a $100,000 account a major firm we tell him no. We don't want your mortgage, insurance or lending opportunities because you will not invest enough money with us. Huh?
Thursday, July 17, 2014
All assets are good assets...
All assets are good assets! Seems like a logical statement but in today's financial world there are firms and financial advisors that believe that this statement is false. How did we get to this point? What were the drivers that have firms purging their systems of small accounts and some firms defining small accounts as accounts with less than $500,000 in assets?
I believe that it all started with the book, The Supernova Advisor: Crossing the Invisible Bridge to Exceptional Client Service and Consistent Growth by Robert D. Knapp. Printed by John Wiley & Sons, Inc. in 1995.
The Supernova Advisor looked at the way an Advisor functioned everyday and what were the roadblocks that held back advisors from greater productivity. It was a ground breaking book I believe because it focused on the way advisors functioned. It did not focus on investments which in of itself was revolutionary. Robert Knapp was a former advisor, manager and regional manager for Merrill Lynch. Coaching was Robert's forte.
I cite this book for several reasons. First, Robert Knapp worked for Merrill Lynch and this is an important point because the retail financial industry has been dominated by ex-Merrill Lynch executives for the past 15 years. At one point every major retail sales force was led by someone from Merrill Lynch. Even today UBS, Merrill Lynch and Morgan Stanley are led by Merrill people. This is no surprise as the "Merrill way" in the 1980s, 1990s and through to the new millennium was the envy of Wall Street. This was/is a very influential book among Wall Street executives. Second, as mentioned before this was one of the few books that focused on the way Advisors functioned on a daily basis and third the book was written in 1995. The second and third points are connected as 1995 was the beginning of the great technological revolution which is still in full force today. We are in an age where the rate of technology change is parabolic, straight up, and will remain that way for the foreseeable future.
The Supernova Advisor can be broken down into the thesis that an advisor because of all the paperwork could no longer manage/service a great number of accounts. If you cannot manage a great number of accounts then the accounts you want to cultivate are large accounts and the accounts you want to cull are the small accounts. Totally logical. In 1995.
Next around the year 2000 McKinsey worked with all the financial firms both institutionally and retail to execute the first profitability studies of their clientele. Typically any group of clients breakdown as 70% unprofitable, 20% break-even and 10% as driving all the profit. Which was almost exactly the percentages of the studies conclusions for the financial industry. These studies led the firms to create or beef up their private banking/PWM offerings so they could reach the most profitable segment more effectively. I will discuss this strategy in another blog but will only point out here that the firms did a client segmentation study and then segmented their Advisors.
So these two unrelated events have driven the strategy of the full service firms for close to 15 years. The Supernova Advisor introduced the concept of "swimming upstream" and the profitability studies "confirmed" that the firms do not want small accounts (unprofitable). Now the full service have bracketed their clientele on the top end and on the bottom end based on the size of the account. Services are divided up according to the size of an account and where the account is located in the firm not necessarily on the actually needs of the client. Accounts not in the Private Banking/PWM broker segments are not allowed access to certain products and services. UBS(to it's credit) is the exception. UBS bases it's services on the needs of the client no matter where the account sits in the firm. Merrill Lynch has strict requirements on where an account can be actually sit in the firm. If you are a $10 million account you must be in the Private Bank.
The Supernova Advisor circa 1995 was correct in it's assessment on how to deal with a major issue everyone dealt with in 1995, an overload of paperwork. It was overwhelming for every aspect of the industry, advisors, CSAs, branch office operations and operations on a national level. No one was immune to the paperwork problem. But that has changed as technology has changed every aspect of retail firms from opening accounts, performance reporting and how we manage the assets. The changes have allowed advisors to manage a lot more assets with a lot less effort.
So, are all assets good assets or not? If we are going to judge assets as good or bad is the best methodology based on the amount of assets? What about the mix of the assets? Or what is the potential of the assets? Unfortunately because of the limitations the industry's technology the method used is the amount of assets. But it makes sense given the current business model. The amount of assets multiplied by the average fee that the firm earns minus the average cost of the firm for the account maintenance. Profitable or not? In or out? But this methodology re-enforces the current business model which is firmly entrenched in the "we only do investments" business model.
In my career I started as a Customer Man, then an Account Executive for years, then to a Financial Advisor before moving on the a Wealth Advisor or Wealth Manager. The name changes parallel the hopes and dreams of the industry's senior management teams to cross-sell their existing clientele more financial products. But as much as we try the industry remains mostly, above 95% of revenues from Advisors, in the investment world. There have been definitive inroads into lending in the last 6 years as the banks have pulled out of mortgages above the Fannie/Freddie limits and the wirehouses have responded to the demands of their clientele.
So the decision to look at an account size as a correlation for revenues is correct, in the investment business model. But in reality revenues are in fact are driven by life events. I am buying a house, we are having a baby, do I have enough to retire, I own my own business are life events. Mortgages, life insurance, long term care, loans and disability insurance all are revenue opportunities driven by the needs of a client not by the amount of their assets at the firm. It is the inability of the Financial Advisors to capture life events and deliver a solution that make small accounts seemingly not profitable to a firm. That is a training issue not a business model issue per se. This does not mean that firms can/should change their business model to support a change in culture to move a wealth management model to increase cross-selling.
The advisors business model today is driven by investment events. Changes in interest rates, equity markets, emerging markets or small cap versus large cap. But wealth management is driven by the needs of the clients and their life events. This entails retraining our advisors to capture life events and to bring centers of expertise to bear so we can employ more wealth strategies than we do today.
Corporate client segmentation is only useful for a corporation to decide what services and/or products to give for fee or free.
To answer the question, are all assets good assets, it is not true as long as the current business model of advisors is solely based upon investments.
The retail financial industry it at a cross-roads on multiple mega-trends that threaten the long-term viability of the full service model. The average age of the full service relationship, the average age of a full service advisor, the percent of advisors under the age of 30 years old (5%), the growth of net new assets, fee transparency, recruiting expense, advisor versus broker legal model, inability to train a replacement salesforce and an unappealing offering to the younger generations to maintain longterm revenue streams. One just has to look at Schwab's net new assets growth year after year without advisors to realize that a serious review of the strategic initiatives is in order.
Facing these daunting challenges it seems that embracing an offering that limits entry level relationships based upon assets instead of retraining advisors to capture a bigger slice of the financial services spend rate is counterproductive.
All assets are good assets, it is all about how the assets are managed. My next blog will discuss how assets can be profitably managed no matter what the size of the assets.
I believe that it all started with the book, The Supernova Advisor: Crossing the Invisible Bridge to Exceptional Client Service and Consistent Growth by Robert D. Knapp. Printed by John Wiley & Sons, Inc. in 1995.
The Supernova Advisor looked at the way an Advisor functioned everyday and what were the roadblocks that held back advisors from greater productivity. It was a ground breaking book I believe because it focused on the way advisors functioned. It did not focus on investments which in of itself was revolutionary. Robert Knapp was a former advisor, manager and regional manager for Merrill Lynch. Coaching was Robert's forte.
I cite this book for several reasons. First, Robert Knapp worked for Merrill Lynch and this is an important point because the retail financial industry has been dominated by ex-Merrill Lynch executives for the past 15 years. At one point every major retail sales force was led by someone from Merrill Lynch. Even today UBS, Merrill Lynch and Morgan Stanley are led by Merrill people. This is no surprise as the "Merrill way" in the 1980s, 1990s and through to the new millennium was the envy of Wall Street. This was/is a very influential book among Wall Street executives. Second, as mentioned before this was one of the few books that focused on the way Advisors functioned on a daily basis and third the book was written in 1995. The second and third points are connected as 1995 was the beginning of the great technological revolution which is still in full force today. We are in an age where the rate of technology change is parabolic, straight up, and will remain that way for the foreseeable future.
The Supernova Advisor can be broken down into the thesis that an advisor because of all the paperwork could no longer manage/service a great number of accounts. If you cannot manage a great number of accounts then the accounts you want to cultivate are large accounts and the accounts you want to cull are the small accounts. Totally logical. In 1995.
Next around the year 2000 McKinsey worked with all the financial firms both institutionally and retail to execute the first profitability studies of their clientele. Typically any group of clients breakdown as 70% unprofitable, 20% break-even and 10% as driving all the profit. Which was almost exactly the percentages of the studies conclusions for the financial industry. These studies led the firms to create or beef up their private banking/PWM offerings so they could reach the most profitable segment more effectively. I will discuss this strategy in another blog but will only point out here that the firms did a client segmentation study and then segmented their Advisors.
So these two unrelated events have driven the strategy of the full service firms for close to 15 years. The Supernova Advisor introduced the concept of "swimming upstream" and the profitability studies "confirmed" that the firms do not want small accounts (unprofitable). Now the full service have bracketed their clientele on the top end and on the bottom end based on the size of the account. Services are divided up according to the size of an account and where the account is located in the firm not necessarily on the actually needs of the client. Accounts not in the Private Banking/PWM broker segments are not allowed access to certain products and services. UBS(to it's credit) is the exception. UBS bases it's services on the needs of the client no matter where the account sits in the firm. Merrill Lynch has strict requirements on where an account can be actually sit in the firm. If you are a $10 million account you must be in the Private Bank.
The Supernova Advisor circa 1995 was correct in it's assessment on how to deal with a major issue everyone dealt with in 1995, an overload of paperwork. It was overwhelming for every aspect of the industry, advisors, CSAs, branch office operations and operations on a national level. No one was immune to the paperwork problem. But that has changed as technology has changed every aspect of retail firms from opening accounts, performance reporting and how we manage the assets. The changes have allowed advisors to manage a lot more assets with a lot less effort.
So, are all assets good assets or not? If we are going to judge assets as good or bad is the best methodology based on the amount of assets? What about the mix of the assets? Or what is the potential of the assets? Unfortunately because of the limitations the industry's technology the method used is the amount of assets. But it makes sense given the current business model. The amount of assets multiplied by the average fee that the firm earns minus the average cost of the firm for the account maintenance. Profitable or not? In or out? But this methodology re-enforces the current business model which is firmly entrenched in the "we only do investments" business model.
In my career I started as a Customer Man, then an Account Executive for years, then to a Financial Advisor before moving on the a Wealth Advisor or Wealth Manager. The name changes parallel the hopes and dreams of the industry's senior management teams to cross-sell their existing clientele more financial products. But as much as we try the industry remains mostly, above 95% of revenues from Advisors, in the investment world. There have been definitive inroads into lending in the last 6 years as the banks have pulled out of mortgages above the Fannie/Freddie limits and the wirehouses have responded to the demands of their clientele.
So the decision to look at an account size as a correlation for revenues is correct, in the investment business model. But in reality revenues are in fact are driven by life events. I am buying a house, we are having a baby, do I have enough to retire, I own my own business are life events. Mortgages, life insurance, long term care, loans and disability insurance all are revenue opportunities driven by the needs of a client not by the amount of their assets at the firm. It is the inability of the Financial Advisors to capture life events and deliver a solution that make small accounts seemingly not profitable to a firm. That is a training issue not a business model issue per se. This does not mean that firms can/should change their business model to support a change in culture to move a wealth management model to increase cross-selling.
The advisors business model today is driven by investment events. Changes in interest rates, equity markets, emerging markets or small cap versus large cap. But wealth management is driven by the needs of the clients and their life events. This entails retraining our advisors to capture life events and to bring centers of expertise to bear so we can employ more wealth strategies than we do today.
Corporate client segmentation is only useful for a corporation to decide what services and/or products to give for fee or free.
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Wealth Managers should be trained to recognize and bring to bear centers of expertise for life events because...
Today the advisor's business model is driven by investment events and revenue is almost solely derived from investments.
A Wealth Advisor's business model is driven by the needs of the client which calls for wealth strategies that encompass all advice, services and products.
To answer the question, are all assets good assets, it is not true as long as the current business model of advisors is solely based upon investments.
The retail financial industry it at a cross-roads on multiple mega-trends that threaten the long-term viability of the full service model. The average age of the full service relationship, the average age of a full service advisor, the percent of advisors under the age of 30 years old (5%), the growth of net new assets, fee transparency, recruiting expense, advisor versus broker legal model, inability to train a replacement salesforce and an unappealing offering to the younger generations to maintain longterm revenue streams. One just has to look at Schwab's net new assets growth year after year without advisors to realize that a serious review of the strategic initiatives is in order.
Facing these daunting challenges it seems that embracing an offering that limits entry level relationships based upon assets instead of retraining advisors to capture a bigger slice of the financial services spend rate is counterproductive.
All assets are good assets, it is all about how the assets are managed. My next blog will discuss how assets can be profitably managed no matter what the size of the assets.
Thursday, June 5, 2014
$tre$$ Te$t
Mr. Geithner’s new book, Stress Test, is an excellent read if you like the behind the scenes “real time” look at how the decisions were made during the greatest global crisis since 1907. I have always maintained that the bailout was necessary and the “fog and friction” of war time decisions are hard to criticize if the results met our needs. Yes, I would have insisted on all the banks CEOs resigning along with their Board of Directors. That is the minimum that should have happened. Jail? That would come under a whole other argument I believe would be defined by the word, fraud. The banks had legally created Special Investment Vehicles “SIVs” that off-loaded assets as actually being “sold” by the banks and then the assets were borrowed against by the banks. The “fraud” is the misrepresentation that the assets were “sold” to a SIV when in fact the SIV was wholly owned by the bank. This allow the banks to dramatically increase their leverage while representing that they had not. Jail time? Maybe. Termination? Certainly. We will never know because CEOs were not brought to the Courts for judgement.
Mr. Geithner in his book does not address the real cause of the crisis which was a lack of capital in the banks. In other words a highly leveraged banking system couldn’t pay the piper when the music stopped. Interestingly the solution to the crisis was for the Treasury to inject capital, TARP, into the banks to deleverage them while the Federal Reserve “bought bad assets” for a 100 cents on the dollar when those assets were trading well below par. Both solutions were designed to deleverage the banking system.
The main issue of no capital in the banks led to other “symptoms” popping up. First the banks would not trade with each other because of the lack of counter-party trust between banks. There was no trust. Counter parties wouldn’t trade or facilitate any financial transaction because they were well aware of their own illiquidity and leverage issues. Banks did not believe they would be paid for the other side of the trade. This led to a spiraling down effect on the markets as nothing could be bought or sold. Price discovery did not exist so bank’s balance sheets had no sense of value. Next issue was the the shadow banking system represented by the money market funds. Money market funds are mainly used as funding vehicles for the banks and other financial institutions like GE Capital. When the oldest and largest money market fund, The Reserve Fund, ”broke the buck” a large portion of the short-term funding capabilities of the banks was literally going to disappear overnight. US Banks funding requirements from the money markets funds was around 20% of the total funding needs of the banks. When you are leveraged over 30 times your capital base losing 20% of you funding is a catastrophic problem. We won’t even discuss the problem of borrowing “short” and investing “long” as any banker can tell you that it is a losing proposition when the assets can’t be sold because of market’s freezing up or prices declining to fast to liquidate.
So the powers to be decided on three stop gapped actions. First the Central Banks of the world led by the Fed guaranteed all interbank transactions. This helped sooth the counter-party risk problem and unclog the world financial piping and allow transactions to start moving again. Price discovery was a paramount concern when assets were trading at incredibly low valuations and balance sheets needed to be assessed. The Fed bought all the crap but what the system also needed was decent pricing on the “good stuff”. Second the US Government guaranteed all the money market funds for two years. This secured the short-term funding of the banks and removed the immediate threat of all the banks declaring bankruptcy all at once because of the lack of funding. You don’t have to be from MIT to know if a bank had $50 billion in capital and was carrying a $1.2 trillion balance sheet that a $240 billion funding short fall would wipe out the bank in seconds. Little did we know at the time that the money market fund guarantee was sowing the seeds of the European crisis two years later. But that is for another day. Three, the US Government changed the law of pricing of assets held by the banks. FASB 157 stated that debt instruments no longer had to be “mark to market” on a daily basis but could be held as if trading at par or 100 cents on the dollar. What is amazing is that the rule not only applies to mortgages but also to derivatives! This meant that banks no longer had to recognize unrealized, not sold, losses on their books making their balance sheets somewhat pristine. It was all BS but such is the power of the government. The law took effect on March 15th of 2009 and April 2009 kicked off the greatest stock market rally in history. I’m shocked!
The book Stress Test leaves us wanting on many levels but the most important is that Mr. Geithner punted on the main issue of the crisis, the lack of capital. Even the name of the book refers I believe to the optically successful stress tests of the US Banks and not on the facts that the Central Banks had guaranteed the To Big To Fail banks. TBTF is a bigger problem today than before the crisis as the banks are now around 40% larger because of the crisis led mergers. There remains an implicit guarantee of the banks by the governments that can not be denied although the banks insist it is not true. The markets, the final arbiters, believe that the governments will never let the TBTF banks fail because of the dire consequences and the markets are correct. And I for one hope we don’t let them fail. This implicit guarantee allows the banks to fund themselves at artificially low rates, at US Government rates, instead of rates that would be reflective of their risky leveraged business models. I believe that the TBTF banks could not exist for a week if forced to pay the rates the markets would command without the implicit government guarantee. This means that the banks would have to de-lever quickly and considerable to survive. When I refer to the banks I am also referring to Goldman Sachs and Morgan Stanley. They are included because of the counter party risk that they bring to the big banks. If one of the two went bankrupt there would be little left of the global banking system in short order. This is where the Fed had to develop the notion of “systemically important financial institutions”. If you are a major counter party to the financial system you are also a major danger. It has nothing to do with deposits.
The banks have continued to be undercapitalized, leveraged, for if they were forced to de-lever their business model could/would not support the existing compensation structure. I know we talk about being a global competitor and how we would be at a disadvantage but all politics is local and the vote is for money not competitive advantage. We must read carefully the statements made by banks for their intent is to obscure not to enlighten. Banks now say, “we are in far better shape than we have been for a long time” or “we are completely different in how we manage the bank” since the crisis. These statements are true and false at the same time. Pre-crisis the banks average Tangible Common Equity (TCE) was around 1.4% and today it stands around 2.9%. Why is this important? If a bank suffers losses those losses can ONLY be written off against TCE. So, pre-crisis was a ridiculous 1.4% and frankly we got what we deserved. That we allowed the banks to leverage themselves to that level was criminal. But being 2.9% is equally bad. Is it better than 1.4%? Of course. Will it matter in a crisis, no way. Lets go bank to the earlier example. A bank has $50 billion in equity or TCE. It maintains a $800 billion book. 800/50 = 16. The bank is 16 times leveraged. Lets make the book $600 billion or 600/50 = 12. Twelve times levered. If the bank “book”, investments, trade down 10% the bank loses $60 billion. The bank is wiped out by more than $10 billion. The sad part is that if the bank lost just $10 billion it would be effectively bankrupt because it would lose the ability to self fund it’s debt. How do we know this?
The banks were forced to create a living will because of the Dodd/Frank Bill. This living will was to explain how the US Government would liquidate the bank if it was caught in a crisis and “failed”. One of our largest banks has around $240 billion in capital and runs almost a $3 trillion balance sheet. In their living will the bank estimated that if it incurred a $30 billion loss of their $240 billion in capital they would be effectively bankrupt. Why you ask? Because the bank said they would be unable to self fund because of the loss. Interesting to note that the living will of the bank also pointed out that the US Government would have to immediately make good on overpriced securities, thank you FASB 157, to the tune of $200 billion plus. Think about this fact. If FASB 157 did not exist the bank would have less than $50 billon in TCE instead of $240 billion. Now that is what I call cooking the books!
The situation is much worse than described here because we have not discussed that the capital of a bank is formulated with capital that is slotted Level 1, Level 2 and Level 3. Or the fact that there is netting of a bank’s notional derivative positions. These situations deserve their own time and space. Suffice to say the complexity of the banks balance sheets is so great that we have little to no transparency that is even worth discussing. The banks want it that way.
The Stress Tests that the banks had to endure led to the ultimate and inevitable conclusion that they were recapitalized and safe. US Banks proudly and defensively point out that TARP was repaid and with a profit. That they really didn’t need the money but the government forced them to take it. Banks insist that the business model is viable and we are all over reacting. That their compensation to do “God’s work” is justified.
What the banks don’t mention is that TARP was the smallest and least expensive remedy that was employed by the US Government to save them and that the other solutions employed were worth trillions of dollars to the banks. Some of these solutions still remain in place today saving them tens of billions of dollars per year in funding costs. All these issues and much more are ignored by Mr. Geithner in his book.
Mr. Geithner’s narrow but important oral history leaves us knowing only that the seeds of our ultimate demise have been sown and as of yet reaped
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