Participants in the discussion were: Patty Loepker, MMI Governor, Senior Vice President, Director, Externally Managed and Institutional Accounts, Advisory Products Group, Wells Fargo Advisors, LLC; Steven Mattus, Managing Director, Head of Product Management, Credit Suisse Private Banking North America; Vincent Pandes, MMI Governor, Director, U.S. National Accounts, Brandes Investment Partners, LP; Lorna Sabbia, MMI Governor, Managing Director, Head of Managed Solutions, Bank of America Merrill Lynch; Jim Tracy, Past Chairman, MMI Board of Governors, Director, Consulting Group Wealth Advisory Solutions, Morgan Stanley Wealth Management
InvestmentNews: From their roots in the traditional separately managed account programs developed at the large wirehouses almost 40 years ago, managed solutions have evolved significantly. What has driven this innovation?
Lorna Sabbia: It's probably a combination of things. The first is growing acceptance around fee-based advice being the delivery model. The other part of it, I would suggest, is client expectations. Clients are demanding now, probably more so than ever, outcome-oriented investing, which ties nicely into goals-based wealth management. The combination of these factors is really what has been driving the innovation over time, and a lot of the evolution has been on the investment and product side.
Patty Loepker: I agree, and another factor is that financial advisors and clients are increasingly more educated and have more exposure to the financial services industry. The growth of the financial media has been significant over recent decades. When you look at that, you see that financial advisors and clients have been expecting all of us in the industry to broaden what we can provide for them.
Steven Mattus: Separately Managed Account programs started as pretty much a U.S. equity business and have since evolved into fixed-income, non-U.S. equity, and so on. Obviously, both the advent of no-load mutual funds and the development of ETFs changed the game pretty dramatically. The availability of these new investment vehicle types allows us to build a fully diversified asset allocation using both active and passive strategies in a single account. We've come a long way from what was essentially a portfolio of individual stocks representing a particular investment style.
Loepker: Yes, while we continue to have the very traditional asset-class-specific investment options available within managed solutions, we certainly have continued to see an increasing demand for – and an increasing availability of – offerings that cross asset classes or have very specific directives for a client. As an example, a multi-cap separate account solution was a little bit unheard of probably 15, maybe 20 years ago; there are numerous offerings in that space now. And as Steve pointed out, the ETF space has given us additional options to build client portfolios. You now see lots of solutions that are either tactically driven or that are cyclically driven; you would not have seen those kinds of offerings years ago.
Sabbia: Overall, the biggest difference is, in fact, the choice. If you go back, we really started in the SMA structure and the SMA structure only, and then over time mutual funds and ETFs were added. In addition to that, and the targeted exposures that are now available in terms of size, style and sector, you also have to consider the proliferation of non-traditional mutual funds, real assets, and true alternatives. The explosion of choices as it relates to specific market exposures, product structures and formats is perhaps the most significant driver of the evolution in advisory solutions.
Vincent Pandes: And that's where the financial advisor comes in. Clients get so bombarded these days with so much financial information, and all of this information, while it's great, can blur the lines between an investor's attitudes or feelings at the time and their real long-term financial goals for themselves and their families.
Jim Tracy: That's why I think about the innovations that have taken place in managed accounts less in terms of products and more in terms of “solutions.” Client needs these days are increasingly complex, and that's why the true advisory function is so critical. Conversations between advisors and clients shouldn't be product-specific. They need to be centered on client goals. That's why managed solutions resonate with clients.
What clients really appreciate about managed solutions is that they embody a complete process that typically includes a discovery phase, a risk assessment process, and a proposal customized to their exact goals. The recommendation generally entails asset allocation modeling, portfolio stress testing, and a high degree of research. And the strategy is typically implemented in a unified structure – which ties back to performance reporting and the types of reports that clients like to see to gauge how well they're doing against their goals and how well they're doing relative to the market.
IN: It seems like a lot of recent changes have been driven by the need for clients to take greater control of their own financial security. If you look at the decline of defined benefit pension plans and the rise of 401(k) accounts, individuals are now largely responsible for securing their own retirement income.
Loepker: I would agree with that completely – as defined benefit plans have gone by the wayside, more and more clients are being forced to think about these types of issues. Knowing you are going to receive a fixed monthly check for as long as you live is very different from knowing that you have to take ownership of your income in retirement. And over maybe the last 10 years, maybe even a little longer, many younger baby boomers and certainly the Millennials say they aren't even sure that Social Security is going to be there for them, so they have to pay a lot more attention.
Tracy: When clients start to really think about retirement, that tends to be the key point in their financial lives when they pull everything together and typically sit down with a single trusted advisor and say, “Okay, together we're going to get through the next 30 or 40 years, and here's everything – here's where it is, here's what it is, and now develop a plan and a strategy for us to make sure our custom goals are met.”
IN: How has the volatility of the past 10 or 12 years, particularly the recession, affected clients' actions and expectations?
Loepker: Whenever you have significant downturns in the market like we had in 2008, investors become suddenly extremely focused on downside risk. What they end up saying is, “Don't lose me that kind of money again. I can't afford it.” I think that's the biggest shift that we've seen over, say, the last 10-year period. People tend to say, “That's fine. I can tolerate that level of deviation in return. I can handle a 10% downside risk.” Or, “I can handle the downside risk of being an aggressive growth investor.” But when they actually see the value of their account drop by 20%, it's a much, much different experience for them, and one that most of them for many reasons either can't stomach emotionally or, frankly, don't have the time for their portfolios to recover fully and enable them to still achieve their goals.
Sabbia: It depends on the particular client experience and the reality of essential goals versus goals that are aspirational or nice to have. Post-2008, advisors and clients have both been reminded of the lessons around volatility, long-term investing, emotions and all of that. What investors learn when they go through bouts of volatility is which investment vehicles they feel more comfortable with during these periods and how important it is to them to be protected on the down-side.
Mattus: Since the financial crisis, I agree that clients are more focused on risk management, lower volatility and portfolio income. In the current low interest rate environment, it is difficult to achieve traditional income targets from your fixed-income portfolio, so we're seeing a focus on income on the equities side. We are also seeing a demand for strategies that are more hedge fund-like in a separately managed account structure, meaning tactical strategies or those that use options like covered calls in order to reduce volatility and generate income.
IN: Is the financial crisis the sole reason for that?
Mattus: I think there are a number of factors at work. One is the risk appetite having changed since the financial crisis. One is the demographic issue. Another is historically low interest rates.Certainly in the 1990s there was an expectation that you could generate double-digit returns every year in your equity portfolio. I think most people have abandoned that notion. Even though the last few years have delivered very good results for investors, that positive psychology has not yet taken hold. I think asset allocation now drives a lot of investment decisions for clients, whereas maybe in the '90s, for example, people were more concentrated in equities and, in some cases, sectors of equities like technology. You don't see that sort of behavior any longer.
Pandes: I think we definitely still see clients experiencing a bit of a hangover from the financial crisis, and there's still a risk-on/risk-off type of mentality. At the same time, I think people in some ways have become more realistic with their goals. There's a recalibration, if you will, taking place within our industry. In the past when you asked about return figures for a retirement plan, people would punch in numbers like 10%, 12%, 15% or even 20%. Now when you see those numbers, they are more like 6%, 7% or 8%, if that.
Sabbia: Any time there's a period of massive volatility, the benefit for advisors is that they have an opportunity to help clients be more articulate about what they're willing to accept. And that's what we have to anchor to and remind folks of, because there are moments when 2008 seems like a very long time ago.
IN: As a result of the changes that we have been discussing, do you see a difference in what clients are looking for in an advisory relationship?
Tracy: The bottom line is that clients are changing very, very quickly, and what clients want today is very different from what they wanted five years ago. There is much more of a focus on how they're going to receive their money as opposed to how they're going to grow their money. So distribution strategies are very important to them. There's much more of a focus on risk management versus performance, so they need to make sure that they have a strategy that they're comfortable with and that aligns well with how much risk they're willing to take. Clearly if you look back at the decade of the 2000s, there were two very volatile years – I call them near-death experiences for many clients. But because the market has rallied in the last three or four years, a lot of people have recovered from some of the losses in 2008 and earlier in 2002, and we're seeing clients changing their behavior and what they actually want from a relationship. So it's more about communication, it's more about customization, it's more about risk management and managing outcomes, and it's less about making money. I like to say, client focus today is on staying rich, not getting rich. And that has created a good opportunity for the advisor-client relationship to really develop.
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