The Handwriting on the Wall of the Future
The mutual fund industry has problems beyond the ones regulators are investigating, and unfortunately they have included a combination of arrogance and indifference to the needs of customers. As a professional advisor, you are closer to your clients than are most mutual fund groups. You take the time to understand and address clients' needs. In this column, I'd like to help you focus on specific ideas for changing your practice in 2004, to take advantage of powerful trends in your profession.
Even before the mutual fund headlines of the past year, leading advisors had begun implementing changes designed to increase their objectivity, revenues and practice efficiencies while meeting clients' need for lower costs. Many of today's clients want to pay fees (not commissions) for professional investment advice and asset management, and they want the total (all-in) cost of these fees to be 2.0% annually or less.
Recently, I have spoken with several successful advisors who are helping clients meet all-in cost targets ranging from 1.50% to 2.0%. They are generating personal earnings, before overhead, of $400,000 and up. Several years ago, they were advocates of mutual funds. But under the new cost-conscious model, they just can't make funds with high management fees work. You can't generate $400,000 a year selling funds with high expense ratios, when your clients are only willing to pay total ongoing costs of 2.0%. The math doesn't work.
The New Model
So, what are these leading advisors doing instead? They are creating new low-turnover investment models implemented in fee-based brokerage accounts with: 1) individual securities; 2) exchange-traded funds; 3) index funds; and 4) no-load or fee-waived mutual funds with low expense ratios. They personally receive about 1.0% percent of assets for building the models and keeping clients informed via frequent personal meetings. The underlying investments' average cost is 50 to 75 basis points annually. The fee-based brokerage account sponsor (broker-dealer) takes 25 to 50 basis points. Everybody wins -- except the high-cost mutual fund groups.
Last December, New York attorney general Eliot Spitzer made headlines by negotiating a five-year fee-reduction agreement with Alliance Capital. While it sounded like a "consumer-friendly" idea, it's already behind the curve of consumer needs. The high-cost mutual fund is becoming a dinosaur. The studies conducted by the Investment Company Institute, to justify mutual fund costs, are an exercise in futility because they ignore the most important fact: Most of today's investors want a combination of objective financial advice and low cost.
Big chunks of mutual funds' cost structure don't support objective advice with low cost. One example is the expensive wholesaling organizations that large fund groups have built. Although the best wholesalers have become valuable allies of financial advisors, their services and perks aren't free. Ultimately, it's the advisor and client who pay for them -- and the product you're buying, in part, is a sales pitch. It's not a good value.
Another example is a 12b-1 fee or "trailer." It's a way of funneling money from clients through fund groups to advisors, so that the advisor's loyalty attaches to the product. You only keep earning trailers as long as clients hold that particular product. This is not a good value, either, because the trailer can become a barrier (conscious or unconscious) to increasing the advisor's objectivity and the client's trust.
In the new professional model, advisors set goals for the amount of "personal time" they spend with clients. Several advisors I've met insist on holding 20-30 client meetings per week. During these meetings, honestly and disclosure are emphasized -- and it's not the kind of disclosure buried in the footnotes of prospectuses.
If you are receiving perks from wholesalers like free meals or golf outings, are you disclosing them to your clients? If clients are paying trailers, are you letting them know about comparable alternatives that are more cost-efficient?
To some advisors, these are shocking questions. But they are shocking only because your profession is changing so fast. Don't get left behind in 2004. Below are some specific predictions and suggestions that may help.
Exchange-Traded Funds (ETFs)
ETFs will experience rapid growth in 2004, and it will be driven by advisor-implemented programs using fee-based brokerage accounts. Successful advisors are learning about ETFs and using them in creative ways, including sector rotation strategies, covered call writing programs, and puts or short sales to hedge equity mutual fund exposure.
For learning about sector-based ETFs, an informative Website is offered by ALPS Distributors here:
http://www.spdrindex.com
You can view fact sheets, recent performance and expense ratios on each of the nine Sector SPDRs. A Portfolio Builder tool allows you to dial an allocated portfolio of all nine sectors until they match a specific client-set target for return and volatility. It's one of the neatest financial counseling tools on the Web because a client can select an asset allocation interactively, visually and intuitively, without seeing a single piece of numerical data. Try it here:
http://www.spdrindex.com/fundbuilder/
ETFs will allow you to add new asset classes to your portfolios. For example, you soon will be able to add a "gold bullion" asset class through the new Gold Bullion Securities, in which each share is structured to represent a tenth of an ounce of gold. These ETF shares currently trade on the Australia Stock Exchange and London Stock Exchange. Their sponsor, the World Gold Council, has said it intends to list shares in the U.S. soon.
Another interesting asset class is U.S. Treasury Inflation Protected Securities (TIPS), available through the new iShares Lehman U.S. Treasury Inflation Protected Securities series.
Four currently available iShares Lehman ETF series track 3-year Treasury Bonds (symbol SHY), 7-10 year Treasury Bonds (IEF), 20-year Treasury Bonds (TLT), and high-grade corporate bonds (LQD). All four have expenses of just .15%. If your client is only willing to pay 2.0% all-in for investment advice and management, why use an actively managed bond mutual fund costing three times as much to implement fixed income allocations? It's money out of your pocket.
Individual Stocks
In the new model, buy-and-hold stock positions are making a comeback because of their low cost and high tax-efficiencies. Each client can decide when the time is right to take a 15% long-term capital gain on non-qualified assets, instead of the 35% short-term gains that some high-turnover mutual funds distribute. But advisors need strong independent sources of research to make stock recommendations. So, why not allocate money in 2004 to purchasing a research service you can rely on from a company such as Morningstar, Standard & Poor's, Value Line, Thomson Financial, or Zacks Investment Research? The Wall Street Journal is an outstanding general-interest financial publication. But for daily stock ideas and updates Investor's Business Daily is better.
Portfolio Tracking
The new model involves buying low-cost, low-turnover securities in a fee-based brokerage account and then meeting with all your best clients in person at least two to three times per year. That means you need a system for tracking portfolio performance and analytics, with manageable preparation time for each client review. Some advisors are finding that the portfolio management systems offered by their broker-dealers are not adequate, so they are going outside. Recently, one successful advisor who follows this model told me that he sets up a portfolio for each client on the CBS Marketwatch site, and has his assistant manually key in each security position. His prep time for client reviews is minimal, because he simply clicks into the client's portfolio and displays it a big flat-panel monitor mounted on his desk. Portfolio analytics are evaluated using up-to-the-minute market data, based on specific "data slicing" that each client requests.
You aren't locked into your own broker-dealer's platform. Look around for the best alternatives, with the most powerful portfolio analytical tools and client customization features. Get away from paper reports, and show your clients the benefits of professional investment counseling supported by real-time data.
12b-1 Fees
"Trailers" served their purpose in the past to help advisors move into a fee-based world, but they don't give you the same objectivity or predictable revenue flows as fee-based brokerage accounts. In 2004, make yourself a pledge to link fee-based revenues to the relationship, not the product. It is becoming unethical to put trailer funds into fee-based advisory relationships without disclosing to clients that they are paying double for the same assets. Look for opportunities to move high-cost trailer mutual funds into fee-based brokerage accounts implemented with lower-cost alternatives, to save clients money while increasing your earnings.
Wholesalers
It's not unethical to depend on wholesalers for practice management ideas and assistance. But if you have an advisory relationship with clients, you owe them disclosure on any meals or events that are "comped" by wholesalers, especially if those clients own products represented by the wholesaler. If you are not prepared to make those disclosures, don't take freebies. The consulting services that outstanding wholesalers have provided to advisors in the past probably aren't sustainable in a world where mutual fund revenues are being squeezed so hard. Some advisors are filling the gap by contracting with their own independent practice consultants and coaches, who cost hourly fees but have no strings attached. Maybe 2004 is the year that you hire such a person, instead of relying on wholesalers to help (and influence) you.
Yes, these commitments will cost you money in 2004. But they also will put you into the mainstream of your profession while saving valuable time. Can you afford the due diligence required to answer the many questions clients are asking about mutual funds, and the skills and ethics of those who manage them? Can you afford to prepare accurate analytical data for 20-30 client meetings per week if you don't know what specific securities are held right now in each client's mutual funds?
It's not about bashing mutual funds. It's about heeding what top financial advisors are doing, and reading the handwriting on the wall of the future.
freeERISA.com FOCUS:
Fund Finder Gives You a New Prospecting Edge
FreeERISA.com has introduced an economical new service, Premium ERISA, that can create a prospecting edge for any financial advisor working in the retirement plan market. For an introductory cost of $30 for a six-month subscription or $49 for a 12-month subscription, you can use the Fund Finder Database of Premium ERISA to quickly identify plans in your market that offer specific mutual funds. In this article, I'll offer several ideas for how to use Fund Finder.
The best way to understand the database is to conduct a quick search of a familiar fund group. Let's use Putnam in an example. For the search criteria, you will type in "Putnam" and specify whether your search "starts with" or "contains" the name entered. In either case, the search will return Putnam Fiduciary Trust Company, the entity in which Putnam holds retirement plan assets. You will see that the database currently contains 1,361 "customers" of Putnam. Each customer is a retirement plan that holds at least one Putnam-managed fund.
In total, Fund Finder includes more than 200 fund managers, over 1,000 individual mutual funds, and more than 150,000 plans. It's by far the largest online database ever developed for searching plans by investment offerings.
Next, you click on the Putnam link to reveal a list of the group's individual funds contained in the database, with the number of customers identified for each fund. In this example, 19 Putnam funds are included. The one with the most customers is Putnam Stable Value Fund with 587.
Clicking on the Putnam Stable Value Fund link takes you to a multi-page listing of all 587 plans that hold the fund. You can sort this list by sponsor, plan name, state or zip code. To find plans in your market holding Putnam Stable Value Fund, sort by state or zip code. For example, there are 16 plans in Connecticut holding this fund. To research any of these plans further, you simply click on the EIN/Plan # link in the far left column. (You may need to click on the EIN/Plan # column header once to generate active links in this column.) The link will take you directly to the online Form 5500 filing for that particular plan. From the Form 5500 filing page, use the link in the top left corner to return to your Fund Finder results.
Fund Finder Applications
Fund Finder has many applications in the 401(k) and small plan market. For example, you can quickly see how popular any given fund group, or individual fund, is with plans in general. Or, you could tell a prospect the types of funds other companies in the same market are offering.
One idea for stirring up new business is to start with three or four fund groups that you know best, based on the counseling you are doing with existing clients (retirement plan or non-qualified). Use Fund Finder to identify plans in your market that offer funds of the same group. Conduct Form 5500 research to identify a decision-maker for each of those plans, and send those people a letter. The letter should contain this type of message:
"I am a financial advisor working in your market. My research of public filings indicates that your plan [plan name] includes mutual funds offered by [fund group]. For several years, clients of my firm have held funds offered by this group, and it is my job to monitor these funds and counsel clients on appropriate investment choices and decisions. I would like to spend about 30 minutes with you and share with you current information about these funds, their investment styles, and their recent performance. Perhaps this information will be useful to you personally, or in making decisions for your plan. If you then feel this meeting is productive, I would be willing to spend time with other managers or employees of your firm who would like to learn more about funds offered by [fund group]. There is no charge for the initial meeting. It's my way of introducing myself to your company and its plan."
Make sure to follow up each letter with a phone call within about a few days.
Market Research that Is Quick and Easy
Another idea is to monitor financial headlines in your local newspaper. Whenever a fund group is prominently mentioned, do a quick Fund Finder search to see what plans in the same market hold funds of that group. Contact decision-makers at those plans and offer to help them interpret the news and its impact on their plan and its participants.
Some plan decision-makers may be amazed that you know these details about their plans, down to the individual fund level. Tell them this is publicly-filed information that you have obtained through creative research.
What I like most about Fund Finder is its simplicity and speed. It takes less than 30 seconds to click through from the "first screen" of the search process to the Form 5500 of an individual plan. You can find and research dozens of companies that hold a particular fund in 15-20 minutes. Better yet -- show your assistant how to use Fund Finder!
| 
