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Advisory and Discretionary Portfolio Propositions

By 26 October 2017November 7th, 2022No Comments

One the most read articles on our blog is about the pros and cons of advisory and discretionary portfolio services, and the decision to go one way or the other (or both) continues to be one of the first questions I get asked about by advisers and licensees in our engagement process to help them.

What We have found is that the considerations of this question continue to evolve and change over time, largely being driven by the changing landscapes of regulations, consumer trends, business margins, and the service provision capabilities of other components in the puzzle, such as investment platforms, researchers and technology providers.

There are however some common themes that appear to continue to be relevant throughout this journey and they are:

  • an increasing proportion of consumers are buying services that deliver they way that best suits for them
  • regulators are increasingly tightening up around disciplines of portfolio management in two key areas
    • Ensuring that portfolios are maintained in line with agreed investment policies agreed with the investor
    • That where ongoing fees are being charged for portfolio services, that there is clear evidence that there are service provision activities performed ahead of clients being charged
    • Increased regulation overhead associated with products and services that have embedded fees or any form of conflicts
  • wealth management margins are continually under pressure, driving the need for increased efficiencies and simplicity

So let’s checkpoint where we right now (oct 2017). These are some of the main considerations:

  • Change, change, change, change, change – we are apparently in the 4th industrial generation and every day there are new technology driven initiatives and methods to do things better. Wonderful in one way, but a challenge in seeking to get a stable business and operating model. The good new is that much of the evolution is about person to person communications, and we live in a world that with things like Docusign and several other apps (for things like singing documents on line) the process of doing business interactions with people is getting easier all the time.
  • Regulatory scrutiny of discretionary portfolio management. Around the world there is increasingly convergence of the approach to regulating discretionary portfolio services. In Australia, a stop gap measure of what was called ‘Limited Managed Discretionary Account’ permissions ceases in 2018, there are increasingly special requirements and conditions to be met to operate with discreation, such as minimum license endorsements (which may take some months to achieve), staff and skill levels, minimum operational standards and audits, and even minimum financial resources such as capital levels. Given the global concern around consumer risks by regulators after the GFC, with MIFID in Europe and DOL Fiduciary rules in the USA, this doesn’t appear to be going away.
  • With increased consumer education, awareness and access to on-line resources and investing methods, there appears still further downward pressure on fees by wealth advisers. Whilst many thought that this would impact advisers fees, what seems to have happened is that
    • this pressure has been further applied down the supply chain to investment managers, brokers and platforms, many of which have experienced 50% cuts in revenue in the last few years
    • investment advice (not investment management) fees have amorphed in many cases to more fixed fee per service (often tiered scales) which are becoming more consumer understandable, accepting and some would say fairer
    • increased scrutiny as to what is being paid for what services, and consumers imposing their selection of service providers into the puzzle

So what are we finding happening in some of the various markets around the world:

  • Australia : the compounding effects of the shift to independence, desire for business model simplicity, combined with technological development is creating some exciting and new business model innovations. We are seeing many firms that are shifting from the traditional product on platform proposition to both discretionary and advisory portfolio propositions, mainly leveraging the growing availability of model portfolios. We are finding that the decision as to advisor or discretionary is largely being a function of the skills in the practices, and the influence of consultants and legal input, often with varied perspectives. Increasingly we are seeing firms with both advisory and discretionary, and the use of outsource discretionary services to minimum advice firm overheads.
  • UK : we are seeing signs that the decision around discretionary vs advisory is largely a service proposition and efficiency decision. Many firms are using personalised advisory and the premium service, and using discretionary (either outsourced or insourced) for the mass of clients.
  • USA : we see in the USA that the largely used investment propositions (and likely to increase with the DOL Fiduciary rule), are shifting to service based portfolios, both discretionary and advisory. New regulations are forcing higher standards of servicing and the phrase ‘continuous and comprehensive counsel’ is being used as to the standards to be met to support Fiduciary obligations, highlighting needs for more sophisticated portfolio monitoring processes.

So what do we read into all of this in relation to the decision of discretionary vs advisory ?

  • Not suprisingly, one of the main drivers is the strong consideration of what your client base wants in terms of your advice to ‘go ahead’ and how your relationship works with them – if you want to discuss with them then clearly tilted to advisory, if they dont want to be contacted  then discretionary is more likely to suit. As with most groups of people, they may have differences, and so perhaps both is a wise answer
  • Increasing also there is the strong case to think how you can efficiently service
    • Interaction with clients – which is rapidly changing with collaborative technologies
    • Monitoring of portfolios
    • Production of content in adjusting portfolios (whether just trade lists or professionally formatted reports)
  • Consider the skill sets you have in the businesses to both perform various activities but also to manage, monitor and check such activiites are being done to a sufficeint standard. What we find is that interaction with clients and placing instructions are core competencies in advice firms, however the monitoring and making decisions and outputs on portfolios is often a specialist skill
  • Consider outsourcing of such capabilities, but considering also what that means in terms of your client ‘relationship equity’ and business operating margin

Clearly there is no right or wrong here, but certainly some considerations as to what may suit for each practice or business.

In Financial Simplicity’s world, we have seen some really sound examples of firms that have thought a bit outside the square and are achieving great results:

Case 1 – an independent financial advice and accounting firm that really values all of their client interaction and yet to achieve their business growth and scale goal required to achieve a higher level of automation. In this scenario, their desire is clearly an advisory proposition, and to compound this they recognised that they do not have skills or appetite to invest in the operationg and licenseing model for a discretionary propositon, nor seek to hire portfolio mamagement resources. What they discovered is what they wanted was a service to monitor their clients investment portfolios assets held where they are currently (not to move them to a custodian), and to compare the existing assets with their house model portfolios and client rules, and notify them when portfolios go ‘outside the flags’ (an Australian expression for outside safely defined parameters) .  The group signed up for our ‘Nudge‘ service which automated this process for them and alerts  (‘nudges’) them when any client portfolios need to be adjusted to keep them in line with their agreed investment policy. This both saves their practice time, effort and costs and the need to hire portfolio management resources. After being nudged they can if they want request a fully formatted portfolio review which they can present and discuss with their client.

Case 2 – a discretionary portfolio manager that manages many portfolios for clients on behalf of other financial advisers, seeking to be able to achieve growth. Clearly this business is a discreationary business that has invested in the licensing and key components to support a discretaionary operating model. By definition their client interaction model is discretionary and they work closely with financial advisers to support them in delivering portfolio solutions for their clients. As with most businesses in this area they are seeking to be price and service competitive and this meant having to be able to service more portfolios with less resources. As an execution broker they already have the trade execution and markets skills, however didnt want to invest in the skills and operating infrasturcture to support porfolio managers. Clearly recognising that this being an opportunity for a technology solution, they licensed our Taylor technologies to automate the monitoring and decision making on their client portfolios, generating client trades and aggregate trades at the click of a button for their execution teams to implement.

Conclusion: advisory vs discretionary is a choice dependent on a number of factors, primarily desired client engagement models, relationship of the portfolio manager with the investor, and the skill sets available. Regardless though there is a common function of portfolio monitoring to mandates, alerting and execution content (trade lists of reports) generation which the efficiency of which will be key to dealing with the very pressing issue of operating margins.

Stuart Holdsworth

Author Stuart Holdsworth

Stuart has over 30 years of experience in the use of technology for the strategic competitive advantage of businesses in the financial markets and investment industry.

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