Why Advisory Firms Pay For Services They Don’t Need
March 22, 2016
by Matt Lynch
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
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Nobody wants to get a bill for services they didn’t need or purchase. But that’s what’s happening – unwittingly – to advisors as the vendors that supply them expand their service offerings.
With recent regulatory activity riling up compliance departments and shifting consumer preferences to lower-cost advice models, players in the advisor-to-client supply chain are feeling the squeeze. In response, advisor-service firms are expanding into non-core functions – expanding their value in an effort to capture a larger slice of the pie. Consider, for example, Fidelity’s acquisition of eMoney Advisor as a way to expand its technology suite to serve a segment of the advisory industry.
Many firms are incorporating these extra services, such as asset allocation and data aggregation, into their existing advisor offering. That’s all well and good – but, as a result, advisors could be paying for the same function twice, or even more times over, because they now exist within a bundled pricing model from separate third-party firms. If you are a Fidelity client, you are paying for a piece of the eMoney acquisition even if you don’t use that service.
Over the past decade, those adding the most value or creating a more efficient platform from the advisor’s perspective have gained share. Vanguard, for example, has gained share at the expense of higher cost active fund management firms. The same dollars passed through the supply chain, but they shifted between players. When we think about the key trends that are reshaping the industry today, one of the pre-eminent ones is margin compression. Today, the “lower your costs” trend has expanded its reach to include the end-client. A second trend is a demand for increased transparency. This, too, has become endemic among both industry players and individual investors. And why not: After all,every dollar or basis point flowing through the supply chain is, of course, the end-client’s money.
Consumers have been sensitized, in a fashion analogous to taxpayers. Think about how the dollar (or trillion dollars) that Congress spends comes from us taxpayers. Let’s say, now, that Congress shifts expenses down to the state level. The taxpayers don’t get off any easier – and they know it. The vendor consolidation game hasn’t made overall costs lower for the end-client, either. At least, not yet.
But that time is likely to come soon.
As regulation and/or consumer preferences nudge advisors to become more transparent and disclose clients’ actual investment costs, some advisors’ business models will raise red flags. In our consulting practice, we routinely interact with advisory firms that have limited knowledge of what we consider key data points in terms of their overall expenses related to their industry vendors (in other words, the supply chain). We help advisors evaluate their business models to eliminate duplication of costly purchases, improve efficiency and reduce overall outsourcing expenses. It helps to start with a review in visual form. The exhibit below illustrates 13 functions common to many advisory practices. Your firm may make use of more or less, but this will do for purposes of our discussion.
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