In an advisor practice, outsourcing takes on many forms. Principles can tap outsourcing to bolster their technology stacks, reduce time spent on boring but necessary back-office tasks, to improve record keeping, and yes, to manage investments.
By outsourcing those endeavors and others, advisors gain more time – the most precious commodity – to interface with current clients and to engage new prospects. Either way, those are rewarding pursuits when it comes to practice growth.
That’s good news, but advisor need to keep in mind that while outsourcing investment management, usually in the form of embracing model portfolio, has its benefits, those perks do not include simply setting it, forgetting it and collecting advisory fees. That “strategy” is one regulators are aware of and devoting more scrutiny to. Rightfully so.
A new rule — 206 (4)-11— proposed by the Securities and Exchange Commission (SEC) takes aim at the use of outsourcing investment management in an effort to simply collect fees and not prioritize client outcomes.
Important Regulatory Details
Advisors should ensure they’re up-to-date on the inner workings for Rule 206 (4)-11. FlexShares provides an eloquent synopsis of what the rule entails
“In summary, the rule would require advisors to 1) conduct due diligence prior to engaging service providers to perform certain functions, and 2) periodically monitor the performance and reassess the retention of each service provide,” according to the exchange traded funds issuer.
As Paul Binnion, Chief Revenue Officer at Hanlon Investment Management, noted in a recent interview with the unit of Northern Trust, the SEC wants advisors to take active roles in client outcomes, even when investment management is outsourced.
“Remember, the whole move away from the commission-based model was to create a more involved relationship with the client. The apparent intention of this rule is to stop advisors from charging a 1% commission, calling it an advisory fee, and acting like they're doing something valuable when in essence they're not,” said Binnion in the interview.
The SEC’s proposal also puts some burden on advisors when it comes to selecting the right outsourcing partners. Frequently, one of the selling points of outsourcing portfolio management is that it saves advisors time when it comes to conducting due diligence. However, advisors still need to take the time to ensure their partners are performing due diligence.
“There is talk about the advisor doing due diligence on the money managers on the platform, when in essence the broker/dealer already claims to be doing that,” adds Binnion. “It’s unclear if the SEC is saying that on top of the broker/dealer oversight, they will now require an advisor to oversee more of a partnership relationship, and less a distribution relationship. It will be interesting to see what this proposed rule ends up looking like and how it will be enforced.”
Outsourcing Still Has Merit
Obviously, outsourcing takes on multiple forms, but when it comes to portfolio management and using model portfolios, data confirm clients are largely open to the use of model portfolios with many believing model portfolios boost performance. That’s good news for advisors.
Likewise, while the aforementioned regulatory issues sound thorny and annoying, that doesn’t diminish the allure of outsourcing. In fact, there’s still ample value here if advisors know what they’re getting into at the start.
“When an advisor spends more time with their clients, the relationships deepen. There's a higher level of trust and confidence” concludes Binnion. “For example, in a period when the markets are down, advisors who have deep relationships with their clients are far less likely to run into problems regarding underperformance because they spent the time to explain and discuss it with them; those who haven't potentially open themselves up to a whole can of worms as far as compliance and oversight.”
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