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THE BRAVE NEW WORLD FACING WEALTH MANAGERS

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Ben Leighton

Wealth managers face a far more challenging environment now than they did ten years ago. Historically a low-priority for the Regulator, the sector is in the cross-hairs like never before thanks to a series of mis-selling scandals, and the Retail Distribution Review. This comes against a backdrop of an intense race to grow and ever increasing client expectations around levels of service and digital enablement. For many wealth management firms – especially smaller ones – the new burdens will come as something of a culture shock, and require substantial changes. Ben Leighton from Baringa Partners explores the challenges facing these firms from a regulatory, organisational, and technical standpoint – as well as the question of how best to adapt, grow and progress to the next level.

The regulation challenge

Since its inception over a year ago, the FCA has established a number of running remits concerning the wealth management sector. These touch on issues such as the FCA’s keen focus on Suitability and, of course, stability since the Retail Distribution Review. The latter has fundamentally transformed the way and extent to which firms can offer financial advice to clients. Further to this, the wider focus on Conduct Risk and effective supervision is currently topping the agenda for both the Regulator and wealth managers.

This increasing scrutiny is creating a plethora of extra demands on wealth managers across the business, from data management to client liaison. The amount of data firms need to collect, maintain and evidence regarding interaction with their clients has ballooned, particularly with regard to suitability and appropriateness requirements. Client objectives, particularly those of retail investors, must be clearly defined, recorded and continually checked against the nature of the portfolios being offered. What processes does each firm have for monitoring this? What happens to unpick any issues should the boundary be breached? How must the firm ensure that the client’s situation is regularly updated to allow for such assessments?

Under the Conduct Risk umbrella, standards of transparency in client reporting have become more onerous: clients must be able to see exactly what fees are being applied, on what basis and where, and firms must ensure they report against adequate external benchmarks. Consolidated on-boarding of new clients is now essential. There is also an increased focus on incentives (how firms are structuring remuneration for their advisors) as well as stricter due diligence requirements on the source of customer wealth. And all this is before we even touch on the challenge of reporting everything back to the Regulator, and the difficulties this brings with it in terms of reconciling data from a range of platforms. The list goes on.

Ben Leighton

Ben Leighton

When it comes to Suitability, larger wealth management firms can sidestep the issue to some extent by stepping back from recommending portfolios to clients (and many are doing so). Smaller firms, however, do not have this luxury. Indeed, smaller wealth managers will need to ensure that the Suitability test applies not only to new sales but also to existing clients. This might necessitate a full ‘past business review’ of products and clients. The issue is how to deliver all of this effectively and efficiently without creating unnecessary, debilitating overheads in terms of people and resources, and without overly distracting from the core business.

The growth challenge

In addition to satisfying the Regulator, the second challenge faced by the industry is the race to grow while maintaining client service levels. The overall client experience is as important as ever. Clients expect the bespoke, individualised touch of a wealth manager in tandem with the digital, accessible service they are increasingly being offered by any high street bank.

From easily navigable online access to intuitive apps and live functionality, expectations are increasing fast. Existing clients expect to be able to see an integrated view of their accounts and customisable reports with just a few clicks. Prospective clients expect a smooth, automated on-boarding process far removed from tedious paperwork and numerous manual handoffs.

Operations and technology capabilities are vital in defining customer experience. However, these areas are particularly vulnerable in periods of change and growth. It would be a mistake to ignore important enhancements in these critical areas in the race to expand.

Therefore, progressive, scalable changes are paramount, not only to meet requirements of the present, but also to prepare for the challenges of the future.

The change challenge

When it comes to making big changes, firms may often be tempted to ‘skip to the end’, and get caught up in debates over what specific changes are needed, or whether to put this or that extra process in place. The prior question of how to manage change itself – of whatever sort – is often ignored. But it is crucial. There are three pillars upon which any change management process should rest: get the right people in, have a process, and know your business. It’s a challenge for firms of all shapes and sizes, but particularly for more niche firms that do not yet have a well-established change capability.

Getting the right people ‘onto the pitch’ is paramount. This will likely involve up-skilling and training existing personnel who may have little to no experience of change management. It may also be prudent to consider bringing in third-party specialists with experience of delivering change to oversee and support the process. The ability to affect this in an organisation is a distinct skill in and of itself and shouldn’t be treated as an afterthought, or something anyone can ‘just do’, any more than you would assume that anyone can ‘just be’ a wealth manager.

The change process itself is key. This means knowing, as far as possible, precisely what you’re going to deliver, and how you’re going to deliver it. People need to understand their roles and responsibilities – what is expected from them, and when – even if only at a very high level.

Up-front and honest analysis of the present situation – from business objectives and processes to revenue streams, strengths and weaknesses – should also be the foundation of any change project. This way, everyone is aware of what is being built upon, and the firm can properly assess the impact of proposed changes.

For smaller wealth management firms it is also important that new structures and processes are implemented in a smart fashion.  Copying and pasting wholesale from a large player, assuming that ‘what works for them will also work for us’, is a common pitfall which can quite easily lead to the creation of unnecessary layers of work. Be smart about each new process – really question, ‘Do we, specifically, need this? Why?’, and then focus energies on those changes you do need.

The infrastructure challenge

The right approach and attitude is, however, only half the battle. The challenge ultimately boils down to doing more with less – increasing structure while retaining nimbleness. Technology is a vital ally in this fight, especially given the new emphasis on data. Wealth management firms need to ensure they have adequate hardware to support the level of data collection and reporting they are aspiring to, responding to ever increasing regulatory demands and client expectations regarding customer service and digital enablement.

Similarly, automation of processes can be a powerful tool. Manual slaving over spreadsheets can be a serious drain on time and skill. Investment in specialist third party software tailored for wealth management – or even your individual business – can pay dividends down the line. There is a cultural element to this: the shift from seeing IT as a secondary concern to placing it at the heart of your business, and treating it as the enabler of growth that it should be, rather than just something the business depends upon to function. Importantly, any technology change must be scalable and future-proof to avoid the need to rip out recently implemented systems just a few months down the line.

Carpe Diem

A lot of the above relates to taking pre-emptive action, and seeing the challenges of growth and regulation as an opportunity to invest in the future as opposed to a reactive chore. It’s all about avoiding the lure of false economies. It may be tempting to take short cuts when implementing a change project, but the danger of not doing it in a structured way is that the project will almost certainly stumble in terms of time, cost and negative impact on client service. Money saved by avoiding automisation will simply be lost down the line to payroll when you have to hire a specialist to run reports for the Regulator. And a failure to invest in IT infrastructure will inevitably cause more pain at a later date when systems simply break, and your hand is forced.

But a wealth management firm with the courage to make smart – and sometimes bold – changes in order to adapt will reap dividends down the line.

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The benefits of automated pension plans

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The benefits of automated pension plans 1

While many people will prefer to speak to fellow human beings when discussing their investments, automation is already part of everyday life. Over the last few years we have seen introduction of robo-advisors, with many pension investment companies placing these new platforms front and centre of their future strategies. So, what are the benefits of automated pension plans and robo-advisors?

No-nonsense information gathering

KYC, or Know Your Client, is an integral part of the investment world. The wider your knowledge base on a particular client the more personalised the service you can offer. Failure to gather the correct information, and use it accordingly, is a breach of investment regulations in many countries. Therefore, the use of robo-advisors allows a no-nonsense and clear approach to information gathering.

These systems use an algorithm to choose the most appropriate investment strategy for your pension fund. The algorithm is based upon issues such as:-

  • Your attitude to risk
  • Your investment term
  • Your current investment goals

It is worth noting the variable “your current investment goals”. Due to the way that the system is set up, you can update your investment goals on a regular basis. This means that your portfolio would be automatically adapted to your new goals.

As pension-fund regulations continue to be tightened, information gathering is becoming even more important. This initial data gathering exercise will also incorporate a degree of guidance and thought provoking comments. For example, this could highlight the risk/return ratio and the suitability for pension fund investment. The concept of the robo-advisors platform is simple; participants have time to think about the consequences of their attitude to risk for example. The majority of platforms use a concept known as modern portfolio theory.

Source: Unsplash

What is modern portfolio theory?

As a sidenote, you will find that many robo-advisor platforms will mention the concept of modern portfolio theory. This is a Nobel Prize winning economic theory based on the use of data points to create a personalised portfolio of investments. Modern portfolio theory presumes that the majority of investors are risk averse. This means that those looking to take additional risk will expect additional rewards. As a consequence, their pension-fund portfolio would need to reflect this.

Using ETFs to create a personalised portfolio

Automated pension investment platforms (also known as robo investing) tend to use Exchange Traded Funds (ETFs) to create personalised investment portfolios. ETFs have been around for many years and they are an integral part of the investment scene. There are numerous benefits to using ETFs such as:-

Focus on a particular market/type of investment

ETFs are basically funds which are structured to mirror the make-up of a particular market, sector or type of investment such as a commodity or index. For example, the S&P/TSX Composite Index is recognised as the benchmark Canadian index. As a consequence, for those pension fund investors looking at a balanced risk/return, an ETF mirroring this index would be ideal for their portfolio. The funds are created by replicating components/weightings of a particular index with some ETFs also using futures and options

Continuous adjustments

Just as indices are rebalanced from time to time, it is important that your pension fund investments undertake the same process. Say for example the robo-advisor system created a personalised portfolio consisting of two index ETFs. If one index was to perform much better than the other, at some point this would need to be reweighted. The strategy behind this is simple; if the balance of your portfolio was tilted towards one particular ETF index then your future performance would also be tilted towards that index. This could lead to increased volatility and impact the balanced approach to investment.

Price visibility and trading

While many people view ETFs and mutual index tracking funds as one and the same, there are a number of differences. The main difference is liquidity, with ETFs constantly traded throughout the day and mutual fund prices set at the end of each trading day. As a consequence, robo-advisors can react to intra-day news flow, while those holding mutual funds will need to wait until the daily price has been set. You’ll often find that transaction costs associated with ETFs can be significantly less than mutual funds.

Risk profile criteria set by human experts

While the majority of the processes associated with automated pension plans have little or no human input, there is significant input with regard to risk profiles. This means that investment experts will allocate particular ETFs, and other exchange traded instruments such as futures, to various risk/reward profiles. When we talk of risk/reward in the context of pension investments, this does not indicate extreme risk – this isn’t advisable for long-term pension investments. Indeed, those pension advisors allocating funds to ETFs offering extreme risk/reward ratios may find themselves answering questions from the regulators.

In the modern era, there is nothing to stop the process of opening a pension fund, right through to management of investments, from being fully automated. Whether we move closer to this alignment in the future remains to be seen. However, in the meantime the vast majority of investors prefer an element of human expert involvement, even if just to oversee any potential discrepancies.

Low-costs improve long-term returns

The cost of any service or product comes down to the components. Traditional active pension fund investment will involve an array of different people with different skill sets. The combined cost of these teams can be significant and is reflected in the fund’s management and ongoing charges. Therefore, the more elements of the system which can be automated the lower the management fees and ongoing charges. When you also consider that many robo-advisors will use ETFs, which simply track various assets or indices, the cost element is yet another competitive edge.

While there is certainly a place for active investment management, using expert investment advisors, very often automated pension plans will complement this alternative approach. Many people now choose to maintain a core element of their pension fund under a robo-advisor platform, as their pension-fund backbone. Allocating an element to a more active investment approach offers the opportunity to enhance returns, although there is an obvious element of risk.

Source: Unsplash

Easy-to-use investment platforms

The subject of pension investment can be complicated at the best of times. Therefore, the introduction of robo-advisor platforms, offering regulatory updates and guidance, has been extremely useful for many people. A growing number of people seem to prefer this plain talking approach to pension fund investment. You could argue that this removes any potential conflict-of-interest, the volatility of human nature making way for cold hard facts. Obviously, there will be advice and guidance available, as and when required, but this would likely come at an additional cost.

It is worth noting that before any robo-advisors platform is released to the market it will undergo stringent testing. This testing will take in both in-person testing and remote user testing which is unmoderated. As a consequence, those creating these platforms can help and assist those testing the systems in person. On the flipside, remote user testing is akin to releasing the platform into the mass market. These users are guided by the instructions and design of the platforms, giving invaluable feedback on any tweaks and changes required.

Removing human emotion

The removal of human emotion from investment decisions can be considered something of a double-edged sword. However, robo-advisors provide a no nonsense approach to pension fund investment. A relatively swift in-depth questionnaire will gather all of the information required, allowing algorithms to calculate the appropriate risk/reward ratio. The use of EFTs takes away day-to-day management of investments, in favour of index tracking funds. Auto rebalancing and opportunities to adjust your risk/reward ratio going forward creates a very flexible environment.

Those looking for a passive investment strategy will be attracted to robo-advisors. Those looking for a more active approach still have plenty of choice in the wider market. Then there are those looking for a mix of the two. In recent years we have seen huge advances in artificial intelligence, which already play a role in wider investment trading strategies. Will this technology become more commonplace in the future?

Summary

Robo-advisors have been around, in some shape or form, for some time. In many ways they do the time-consuming legwork that human advisors did in the past. This allows pension advice companies to focus their funding on areas where they can enhance their business. There is a general misconception that robo-advisors have total control over pension fund investments. This is wrong. There are human advisors and investment experts in the background tweaking the system, allocating EFTs to specific risk profiles and constantly enhancing their offering. 

While the current raft of robo-advisors make little or no use of artificial intelligence, the ability to learn, this must surely be an aspiration for the future. This is an area of the market which is constantly developing and changing. We already accept artificial intelligence in many areas of our life, so why not the world of investment? Would you trust an advisor who was able to learn from human mistakes?

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The Viral Return On Investment

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The Viral Return On Investment 2

By Sabine Saadeh Author of Trading Love

Investment Pitch

It was around August 2018 when a friend of mine approached me with an investment scheme that was remarkably enticing.  At first I hesitated because going into business with close friends is never a good idea for me, let alone have your money pooled into an investment fund. The business model was exceptionally thought through and I knew for a fact that it will generate value. Nonetheless, I declined the investment offer. A year later, the fund was generating income long before it had planned to, and I thought I had missed out. The return on investment from that fund in relation to the cost of the investment was outstanding.

A year later, I watched from afar as my friends began to squeeze each other out given their greedy excitement after the success of their fund. As more time went by, I watched them make the biggest mistake of their lives, and that was letting go of the creative element in that fund. Return on investment is the value created by the said investment that is closely tied to economic, financial, psychological and societal factors. However, creativity is their cornerstone.

Covid-19

Come 2020 and Covid-19 reshuffled the classic value mantras. The whole world experienced complete disruption. The path of the virus and the length of time the global economy will remain shuttered is still very much unknown. So what does this mean? This means that investment value will change. The risk of the investment does not have to do anymore with the amount of capital available for resiliency but with the amount of creativity available in the business.

Sabine Saadeh

The viral return on investment should change people’s economic narrative. Businesses should focus on liquidity, contingency plans, multiple supply chains and CREATIVITY. After all a business’ local resilience will be highly priced in the value of the investment rather than what the market views as efficient. Taking my friends’ fund as an example, if they had retained their creative element, their business would have proved to be resilient, despite the high debt incurred by the fund to continue operating during lockdown. This high debt increased the risk of their business collapsing and in turn weighed in on their capacity for growth.

The Investor

After all, an investor is looking for an investment that will preserve his/her purchasing power without undermining their wealth. If I had invested in that fund, I would have lost the capital invested and spent the income generated during the lockdown period. So what was the point of the capital without the talent in that fund? Covid-19 is not the only threat; climate change is even a bigger threat. It is therefore imperative for us to respect and nourish interdependence, and especially in business environments.

Sabine Saadeh

Sabine Saadeh

We cannot act like the virus anymore, latch on to a person with creativity and sup them dry just because we invested in them. We need the creative more than the creative needs us, it is their talent that is going to generate income for us. Our capital opens the path for the creative to generate income for us. The smart people of the world already set their bets on that, through ESG investment schemes, which is the most sustainable form of investing. ESG which means environmental, social and governance investing; seeks positive return on investment while taking into consideration the long-term impact of the said investment on society, environment and the performance of the business.

ESG

The year 2020, is when the world went up in flames and ESG established itself as the mainstream way for investors to make profits. Although the investment preference had already began to change over the last five years, the inflow was still very mediocre in ESG.

It was after the wildfires and the social issues erupting everywhere in the world and the corruption stories of the businesses that are too big to fail, that it became a no brainer that the inflow in ESG would increase massively. Then The DWS Group’s ESG funds according to CNBC began to outpace the S&P 500 this year, and Blackrock highlighted ESG as the most sustainable form of investing.

Businesses that are taking into consideration empathy and creativity while operating are better equipped for future sustainability, even though they are sacrificing return on investment in this present time.

What are we waiting for then? If Covid-19 didn’t help us see clearly that we all intertwined in nature for our future’s sustainability, then what will?

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European market responds to second wave of infections

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European market responds to second wave of infections 3

By Rupert Thompson, Chief Investment Officer at Kingswood

Global equities ended last week on a negative note and were down around 4.5% from their all-time high in early September. This morning, European markets have fallen back a further 3%.

The initial catalyst for the correction was a sharp run-up in the mega cap tech names which had left them looking extended and ripe for some profit taking. The FAANGs are now down over 10% from their highs and the froth looks like it has been blown off. While they may well remain volatile, there is no obvious reason for them to be at the forefront of any further sell-off. The fundamentals behind the tech sector remain strong and valuations are once again looking more reasonable.

However, the correction also clearly had its roots in the sheer scale of the rebound from March with global equities up some 50% from their low. This inevitably left markets vulnerable to a set-back, particularly with valuations at twenty-year highs.

The rebound in turn was in good part a result of the massive policy stimulus. The weakness late last week was triggered by disappointment that the US Fed had not extended its QE program. Even so, the Fed is still buying $120bn of bonds a month and remains a major support for equities. Indeed, it made it clear that it has no intention of raising rates for at least another three years.

The Bank of England also decided to leave policy unchanged last week. However, it kept open the possibility of cutting rates into negative territory next year if it should be necessary. An extension of its QE program later this year also remains quite possible.

All the same, the fact of the matter is that central banks have now spent most of their ammunition. Going forward, changes to fiscal policy will be much more important than any tweaks to monetary policy in shaping the economic recovery. And on this front, the news is not particularly encouraging as the markets may now be appreciating.

The US has failed to agree on an extension of the fiscal stimulus measures which expired in July and may now not be able to before the November elections. As for the UK, Rishi Sunak is still resisting calls to extend the furlough scheme beyond October.

Just as important for markets will of course be Covid-related developments. This morning’s declines are a response to the second wave of infections now being seen in the UK and across much of Europe and fears that renewed social distancing measures/localised lockdowns could disrupt the economic recovery.

While the latest wave of infections is clearly a major cause for concern near term, it shouldn’t be forgotten that the longer term outlook regarding Covid is not all bad. Several late stage vaccine trials are now underway and a vaccine could quite possibly become available within a few months.  Some countries, most notably China, also seem to have avoided a major secondary spike despite the reopening of their economies.

In short, the outlook remains quite uncertain. We believe it remains prudent at this juncture to maintain a broadly neutral stance on equities until some of these unknowns are cleared up – one way or another.

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