In Practice November 30, 2016

Pricing Pressure Mounts On U.S. Advisory Industry

Data from Cerulli Associates shows a bright future for fee-based advisory arrangements—but individual advisory firms may struggle to maintain profitability. 
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A new report from Cerulli Associates, “U.S. Advisor Metrics 2016: Combatting Fee and Margin Pressure,” suggests low-cost product demand and pending regulation will only serve to amplify pricing pressure on the U.S. advisory industry; yet there are also bright spots in the findings. 

“Advisers are preparing for the impact that the Department of Labor’s Conflict of Interest Rule will have on their time and resources,” Cerulli observes. “They must be ready to thoroughly document investment decisions, as well as reassess the business risk of their practices under the new regulatory environment.”

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Even for firms that decide to wait and see what a Donald Trump presidency will mean for the controversial rulemaking—sticking with old business models and planning to rely on the Best Interest Contract exemption—technical compliance does not ensure client satisfaction. Nor does it ensure partner firms will decide to continue business as usual. 

“This rule may result in changing investment products, vehicles, or account types advisers choose for clients to alleviate any appearance of conflict of interest or negligence of their fiduciary duty to clients,” explains Emily Sweet, senior analyst at Cerulli Associates. Advisers, asset managers and other service providers “must be aware of the impact these reassessments will have on their partnerships … knowing that the new regulatory environment encourages advisers to make changes where the most obvious risks exist.”

Cerulli’s analysis suggests the adoption of low-cost investing is appealing to investors in a supportive market environment, as they can gain broad market exposure through vehicles such as exchange-traded funds (ETFs). As such, advisers must be open to new investing approaches to maintain relevance and trust with clients.

NEXT: Advisers open to active and ETFs

“Advisers are somewhat insulated from the cost impact of ETFs because they can incorporate them into clients' portfolios without significant loss of management fee revenue,” Sweet adds. “Many asset managers, on the other hand, feel the cost impact of ETF investing directly, as lower-cost products compromise revenue and profitability.”

This interplay will be important for guiding product development in the coming years, Cerulli speculates.

“Cost is the driving factor behind the popularity of ETFs, and use of the vehicle has been reinforced by an accommodating market environment,” Sweet concludes. “However, it is possible that a change in market direction and risk environment could encourage investors to rethink their portfolio exposures … In fact, more than 75% of advisers surveyed by Cerulli agree that in volatile markets, active managers can offer downside risk protection through tactical trading.”

The Cerulli report goes on to suggest that smaller broker/dealers, in this environment, may consolidate to produce fewer entities that operate more efficiently. Similarly, consolidation and partnership among advisers may be helpful to deepen service offerings to clients and allow cost savings in meeting regulatory requirements.

Information on obtaining Cerulli Associates research is at www.Cerulli.com. 

The Markets November 29, 2016

Investment Action Considerations for DB Plan Sponsors

Advisers can use suggestions from Willis Towers Watson to engage DB clients in thinking about investment actions in 2017.
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Willis Towers Watson has suggested the top 10 investment actions it thinks defined benefit (DB) plan sponsors should take in 2017.

First, the firm suggests DB plan sponsors assess critical resources and fiduciary risk. Willis Towers Watson notes that all investment committees must prioritize their activities, but not all investment committees are created the same—plans, staff, budgets and expertise vary drastically. “Consider how your governance structure impacts your ability to focus on high-impact decisions, and identify areas where you may require additional support,” the firm says.

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Willis Towers Watson suggests DB plan sponsors leverage an array of tools to evaluate financial strategies. Technology can enable DB plan sponsors to assess their governance; monitor and project the plan’s financial status to manage pension costs and risks; quantify the impact of different diversification, hedging and active management approaches; and explore new high-conviction investment manager opportunities.

According to Willis Towers Watson, DB plan sponsors should better align their strategy and time horizon. The firm says whether the sponsor intends to terminate the plan, offload it to an insurer or manage it for the foreseeable future, it is important to identify the goal and associated time horizon, risk and cash needed to achieve this goal.

DB plan sponsors should reduce nonstrategic activities such as short-term manager return monitoring. “It is easy to focus on manager performance because it is tangible; every quarter, or even every month, we can attempt to gauge whether hiring and firing decisions paid off by looking at past returns. But there are many other areas that deserve our attention as well, some of which we believe will have a much larger impact than short-term excess returns. Reallocating time spent on manager return. Focus your monitoring activities relative to strategic goals,” the firm says.

Plan sponsors should also define, evaluate and monitor key funding risks. The firm also recommends plan sponsors to gauge how current levels of risk and return, expected contributions and evolving pension liability regulations (such as mortality improvements, funding relief and rising PBGC premiums) may impact the plan’s long-term success, and link these findings to the plan’s broader risk management strategy to help plan sponsors act decisively at the most opportune times.

NEXT: Other suggestions for 2017

Other suggestions provided by Willis Towers Watson include:

  • Diversify traditional portfolio exposures into less macrosensitive markets - A diversified portfolio can better withstand adverse market events such as capital market drawdowns and should reduce the volatility of contributions.
  • Assess and utilize all paths to implementation - Better implementation helps reduce costs and prevents headaches down the road. Fees can potentially be saved via renegotiation with managers, by using smart beta approaches in areas where active management has become more limited and expensive, and by streamlining the investment program’s operational and administrative aspects. Every dollar saved through improved efficiency is one less required from contributions or portfolio returns.
  • Improve the risk/return profile with options - Straightforward derivative strategies may help cash holdings avoid drag and maintain market exposure, reduce or eliminate tail risk or hedge your liability while freeing up additional assets to generate returns.
  • Be purposeful about timing interest rates - While the reasons for or against hedging are often client-specific, hedging exposure is not a decision that should be taken lightly. Interest rate risk is, by far, the most significant risk for most pension plans, with its impact dominating that of active management decisions. Skillful market timing requires knowing that rates will go up, when and by how much they’ll increase, and if and how an increase differs from market forecasts.
  • Define how different environments impact your liability-driven investment (LDI) portfolio - As markets move, motivations for the LDI portfolio and the desired mix of hedging instruments may change. In an environment where low interest rates are the new normal, it is worth considering the correlation of corporate bonds with the equity portfolio and the hedging efficiency that can be achieved via government bond exposure, both physical and synthetic, relative to corporate bonds.

More information is here.

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