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Wirehouses Want Their Discretionary Reps in Model Portfolios

By Thomas Coyle August 7, 2018

The category of financial advisor known as “rep as portfolio manager” is a source of consternation to some of the biggest firms that employ them, say experts in the field. To mitigate the performance risk these dyed-in-the-wool stock and fund pickers can pose, wirehouse brokerages are encouraging them to use model portfolios that are managed in-house or by third parties.

Across all U.S. brokerages, reps as PMs accounted for $1.15 trillion in assets at the end of 2016, says Tom O’Shea, head of research and consulting firm Cerulli Associates’ managed account practice. They differ from other fee-based brokers (who accounted for $845 billion two years ago) in taking complete discretion over the portfolios they manage using individual stocks, ETFs, mutual funds or separate accounts.

But reps as PMs are relatively poor performers — a fact that raises the specter of legal and regulatory action by clients against brokerages for putting clients’ money at undue risk.

“Statistically an average portfolio managed by an advisor underperforms portfolios managed by the consulting group,” O’Shea tells FA-IQ. In this context, “consulting group” is a generic term for in-house asset management, especially at the four so-called wirehouses: Morgan Stanley, Merrill Lynch, UBS and Wells Fargo Advisors.

Maybe worse, fund provider Envestnet suggests the results from reps as PMs show “greater dispersion than by third-party” asset managers, says O’Shea. That’s a vital point where wide variance can signal intrinsic unreliability.

Models Provide “a new entry point" to asset management on the most active edge "of the outsourcing continuum.”
Natalie Wolfsen

The Department of Labor’s recent efforts to require more stringent standards for retirement-account advisors has also had an impact on brokerage attitudes toward their reps as PMs. Abortive or not, “the DOL rule has had the tremendous effect” of forcing firms to watch their advisors’ activity more closely than ever, says O’Shea. This ramped-up and tech-enabled oversight has shown that some rep as PM-directed accounts “aren’t being managed well, if at all,” he says, citing instances of reverse churning — that is, willful inactivity — and failing to rebalance portfolios that have clearly drifted askew.

As a result, some firms have started pushing reps as PMs to use model portfolios — ready-made and often customizable portfolios modeled by in-house teams or outside money managers such as BlackRock, Russell Investments and Wilshire Associates.

Models have the added attraction of lowering fees, and, where the management is done in-house, directing those fees back to the home office.

But it’s not an effortless sell. Reps as PMs tend to be older “and often stuck in their ways,” says O’Shea. “It’s to some extent a generational issue.”

Adds O’Shea: “There’s sometimes real tension” between firms and employees when it comes to pushing models — especially where truly talented reps as PMs are feeling the heat. “You’ll get a guy saying, ‘I’ve got lights-out performance, and you people are telling me I’m not doing well, and I’m not doing right by my clients? I’ll just go to an independent broker-dealer.”

To mollify such FAs, O’Shea says brokerages provide access to versions of model portfolios that let reps exercise active discretion, mainly in the name of providing greater customization. In practice, this comes down to “taking, for example, a Wilshire model, but instead of auto-rebalancing, it’s shown to the advisor for approval,” he adds.

For brokers still determined to make the leap from W-2 employment to independence because of models, the reality is that IBDs don’t provide a refuge from them so much as choice to use them or not, says Rob Johnson, a senior vice president with IBD Kestra Financial in Austin, Texas.

“We want to support advisors in the way they want to run their practices,” says Johnson.

More and more though, models are coming into play for independent FAs who use Kestra as their broker-dealer, Johnson adds — with the difference that demand is bottom-up, not top-down as it is in wirehouses and other “captive” shops.

“Captive firms want everything to fall into nice easy boxes,” says Johnson. “They want to mitigate risk, and models help mitigate the risk because they rely on managers.”

At Kestra, models — especially in customizable versions — come to play for FAs seeking “opportunities to add value and get more focused on sophisticated clients’ individual goals and objectives.”

Meanwhile, third-party investment provider AssetMark, sees a bigger role for model portfolios on the horizon.

Natalie Wolfsen

Natalie Wolfsen, EVP, chief solutions officer at Concord, Calif.-based AssetMark, says models help advisors push back on robo competition by providing them with “a new entry point” to asset management on the most active edge “of the outsourcing continuum.”

This hybrid approach to outsourced fulfillment, coupled with simpler, more intuitive reporting, can be used “to support richer conversations with clients,” says Wolfsen.

So, while robos have shown themselves to be adept at providing investment solutions broadly in sync with the client’s personal goals, “they’re not able to replicate the hand-holding” a live investor can provide, according to Wolfsen. “And that’s here to stay.”