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Why Advisers are Outsourcing Portfolios

Since the global financial crisis, many financial advisers have freed up time by seeking outside help to build client portfolios

Dan Kemp 26 June, 2018 | 11:55AM

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Outsourcing investment management has become very popular among financial advisers. Faced with the complexity of financial markets and clients’ needs, it makes sense to standardise investment solutions.

Model portfolios are supplied by investment consultants but implemented by the advisers themselves, while managed portfolios are implemented on a discretionary basis by an asset manager. Both approaches are popular and share several common characteristics.

One of the most notable changes to financial advice in recent years has been the decline in the use of insurance company products in favour of funds, meaning that advisers increasingly defining their service as investment advice.

After the global financial crisis of 2008, though, many advisers saw a need for additional help in building portfolios that more closely aligned to the risk profile of their clients. This help was often found in model portfolios supplied by investment consultants and implemented by advisers.

Time and Resources

Model portfolios are widely used today. An enduring advantage of is that the adviser remains in control of the investment proposition and client experience. In many cases, clients are unaware that the model portfolios are supported by a third party. The downside of control is that it comes with responsibility. While many advisers have embraced creating portfolios for clients, the implementation can be more troublesome.

Most UK advisers need to seek permission for each portfolio change from every client. This requires considerable administrative work, which may hinder an adviser from taking actions recommended by the model portfolio provider. If clients fail to give permission, portfolios may become misaligned with the models. That in turn can have a knock-on impact on reporting and performance.

In short, model portfolios typically require advisers to make a considerable investment of time and resources. Such an investment makes sense when advisers define their value proposition as investment specialists. However, an increasing number of advisers are emphasising their focus on financial planning rather than investing.

Growing Demand

The increasing popularity of passive investment has contributed to the growing commoditisation of portfolio services. One driver of this popularity is undoubtedly the poor relative performance of active managers over the past few years, which may prove to be cyclical. But a more important trend appears to be greater transparency on costs.

Meanwhile, as portfolio services become commoditised, behavioural science is revealing the value of advisers as financial coaches. Advisers can show significant value by engaging with their client on goals-based planning and improving investor behaviour. Of course, the challenge of a coaching model is that it requires the adviser to spend more time with clients, necessitating the streamlining of the business model to reduce operational costs.

Such a business model is naturally aligned to a managed portfolio service where both the investment decisions and the execution are undertaken by the portfolio manager on a discretionary basis. Although advisers lose the benefits of presenting their own portfolios to clients, they gain efficiencies and can demonstrate value by critically appraising the work of the managed portfolio provider. This allows advisers to focus on the financial goals and behaviour of their clients.

Cost Gap is Shrinking

Both model and managed portfolios have advantages. The right choice is linked to an adviser’s choice of business model. The current environment appears to favour the coaching model, which suggests that managed portfolios will come out on top.

The growing interest in managed portfolios is also being boosted by an ongoing decline in costs, presumably as managed portfolio providers use the benefits of scale to reduce the impact of fees on returns. Managed portfolio services still tend to carry higher costs than model portfolios, but the gap is shrinking.

Advisers must be clear about the benefits and drawbacks of each service before recommending one. Ultimately, human relationships have an enduring appeal and a power to change behaviour – and that service is very difficult to outsource.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Dan Kemp

Dan Kemp  is Chief Investment Officer, Morningstar Investment Management EMEA

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