What to consider when farming out your investment management

The investment advice business is increasingly being automated and outsourced. The combination of advanced computing power and easy access to inexpensive funds that cover virtually every niche of the financial markets allows for the creation of model portfolios that can be sold to the investing public in bulk, that is, without individual customization. Industry observers refer to this phenomenon as the "commoditization" of investing. Robo-advisors are a prime example of the commoditization of investment advice. Robo-advisors allow an investor to work directly with an online investment platform in which investment decisions are rules driven and investments are made using a mix of mutual funds or exchange-traded funds rather than individual stocks or bonds. The defining feature of robo-advisors is that human involvement is minimized: direct human decision making in the investment process is replaced by algorithms and the investor's interaction with a flesh-and-blood advisor is minimal to non-existent. Robo-advisors have gained market share over the past five years as an alternative for investors who want investment advice but do not necessarily want to engage a human advisor. Millennials, for example, seem to find robo-advisors very appealing. Many investors, though, still prefer to work with a real person. Increasingly, investors will find that even many advisors are outsourcing investment management, traditionally one of their core services. Advisors who outsource often turn to a third party known as a TAMP, a turnkey asset management program. A recent industry survey revealed that well over half of all certified financial planners outsource their investment management to a TAMP. An estimated $2.3 trillion of managed assets currently are held in TAMPS and the trendline suggests still more outsourcing in the future. One prominent commentator predicts that "TAMPS and outsourced investment management are the future for most financial advisors." The term TAMP is industry jargon and is not something you are likely to hear in practice. That means it is important to know what a TAMP arrangement looks like so you can identify it. In some cases, the client first engages an investment advisor, who then introduces their client to the TAMP. The client and the TAMP then enter into a direct contractual relationship, and the initial advisor stays involved to oversee the relationship. The investor ends up engaging two investment advisors, the initial investment advisor and the TAMP. In recent years, the more typical arrangement is for the investor to engage an investment advisor, who then engages the TAMP as its sub-advisor to manage the investments. In either case, the investor who initially sought help from an investment advisor finds that a third party, a TAMP, has been introduced into the mix by the advisor. So, are TAMPS a good thing and, if so, for whom? Because the investment advisor acts as a gatekeeper, TAMPS are marketed to the advisor community, not to the investor, the end user. The pitch that TAMPS make to advisors focuses on two selling points: less work and greater profitability. When a TAMP is brought into the picture, the advisor outsources most of the tasks associated with portfolio management. Tasks such as investment research, manager due diligence, portfolio construction, rebalancing, performance reporting, as well as the associated costs of licensing the tools to manage these tasks, all become the responsibility of the TAMP. The advisor's role is focused on the more limited tasks of vetting the TAMP provider, selecting the investment strategy from among those offered by the TAMP, and continuing to monitor the TAMP's performance. TAMPS are a good business solution for investment advisory firms, but are they good for their clients, the investors? Here are three points to consider. First, identify the services you need and what your advisor can deliver. Part of the marketing pitch to advisors is that by outsourcing investment management, the advisor can spend more time with their clients working on important financial planning issues. Is this relevant to your situation? Do you have financial planning needs that merit significant attention by your advisor? Are your planning needs ongoing or more limited in time and scope? Determine whether the outsourcing of investment management by your advisor translates into added value added to you or whether it just means more time for the advisor to do other things. Second, inquire about performance. The marketing materials put out by TAMPs may suggest that you, the investor, are gaining access to "world class managers," but are you? We know from the regular scoring done by S&P Dow Jones that most fund managers, even the elite institutional managers, underperform their relevant market benchmarks over 10- and 15-year periods. Is the TAMP adding value in the form of better investment performance or is it simply an added cost for the investor? Third, inquire about the all-in-cost of the relationship. Everybody is getting paid something, and it's generally coming out of your funds. The cost of a TAMP is in addition to the fees paid to your direct investment advisor relationship. If we assume that the industry standard for investment advisory fees is about 1% of assets under management, is that fee still reasonable when the advisor has outsourced a core function, the investment management? And how much, in addition, is it reasonable to pay for a TAMP for outsourced services? Fees charged by TAMPS range from as little as .30% to over 2% annual. The all-in-costs to the investor may run as high as 2% or 3% annual. At some point-and you, the investor, must judge-those expenses are an unnecessary drag on performance. Investment advice may be increasingly commoditized in the sense that it can be delivered in bulk to many investors, but that does not mean that it has been homogenized. TAMPS can vary considerably in cost and performance. They can also vary in their investment style. TAMPS can be built around nearly every conceivable investment strategy from low cost, index tracking to more tactical active management. The TAMP chosen for you should comport with your investment philosophy. Leveraging technology can be a boon to investors. But before working with an advisor who has chosen to outsource investment management, be sure that the outsourcing benefits you and is not simply a convenient solution for the advisor. As always, caveat emptor. ----- David Peartree is a registered investment advisor offering fee-only investment and financial planning advice. This column is a collaborative work by Patricia Foster and David Peartree. Patricia Foster is a securities law attorney who represents clients in various sectors of the financial services industry, including broker-dealers, investment advisers and investment companies. The information in this article is provided for educational purposes and does not constitute legal or investment advice. Published: Wed, Jun 26, 2019