PMC Market Commentary: November 21, 2014

The Various Sources of Advisor-Created Value

Much has been made in recent months of the emergence of the so-called “robo-advisor,” which are automated investment services designed to minimize human intervention. While the amount of assets investors have committed to such services is still extremely low, some industry observers consider robo-advisors to be a legitimate alternative to traditional financial and investment advice provided by a professional advisor. While the jury is still out on that issue, and despite the established popularity of do-it-yourself online trading tools, such direct-to-consumer/investor services historically have not proved successful when advice is required. For example, in the late 1990s several online services were established that aimed to eliminate the financial intermediary by providing direct-to-investor access to separate account management by professional money managers. Ultimately, these services ended up being shuttered because investors seek professional advice when making such relatively important decisions about their wealth. Do-it-yourself trading of ETFs in a “mad money” account is one thing; but entrusting one’s generational wealth to a robo-advisor is something not many high net worth investors are willing to do.

Advisors provide a slew of services and benefits that can’t easily be replicated using automation. There are several pillars, or sources, of advisor-created value that can be quantified. These pillars include financial planning; asset selection and allocation; vehicle and investment selection; portfolio construction and systematic rebalancing; and tax management. Advisors generate “alpha” for their clients in each of these areas that is not easily achievable in an automated fashion.

In many respects, the financial planning component of professional advice is the most important of the sources of advisor alpha, as it establishes the framework for all of the subsequent fiduciary decisions made by the advisor and client. In the process of establishing a relationship with the client, a partnership emerges whereby the advisor develops insightful solutions aimed at creating value for the client along several dimensions. In the end, such an “advisor value chain” will do more than simply construct a portfolio which outperforms a benchmark; it can help the client establish a lasting legacy incorporating charitable, philanthropic and generational features.

The initial phase of investment planning is asset selection and allocation. This source of advisor-created value is derived from the advisor’s ability to select from a palette of asset classes, and mold an asset allocation consistent with both the client’s risk profile and investment objectives. Academic and industry research often highlight the importance of the asset class selection and allocation decision. Advisors offer the ability to customize these decisions through the use of portfolio “tilts” or relative over-/underweights, risk mitigators such as liquid alternatives, and tactical or dynamic strategies.

Investment and vehicle selection is also an important source of advisor-created value. Once the asset allocation has been crafted from a palette of asset classes, the next step in the advisor value chain is to breathe life into the asset allocation through selecting the most appropriate vehicles and investments, and then thoughtfully knitting them together to create a perfected portfolio customized to the client’s unique objectives. The advisor assists with such decisions as active vs. passive, separate account vs. mutual fund vs. ETF, and whether to incorporate a fund strategist as part of the allocation.

The combined steps portfolio construction and systematic rebalancing form the bridge from financial and investment planning to the implementation and execution of the strategy. Key elements of this component is asset location advice (i.e., how to allocate assets across registration types) and determining the optimal rebalancing frequency for the client.

After the portfolio has been properly allocated, constructed and implemented, an ongoing source of an advisor’s value contribution comes in the form of tax management alpha. Tax management alpha is the excess return generated through thoughtful management of individual tax lots within and across the client’s accounts.

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Brandon Thomas
Chief Investment Officer

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