As competition heats up, everyone is looking for an edge. Some advisors try to gain an edge by outsourcing their investment management to a turn-key asset management provider (TAMP) or third-party fund strategist. But outsourcing is not right for everyone.
This article will help you determine if outsourcing might provide benefits to your firm. It will also explore the different outsourcing business models that are available, how to pick the right outsourcing partner and how to explain outsourcing to your clients.
Setting The Stage
The outsourcing business for independent advisors started a little over 30 years ago.
Based on studies by Cerulli, Northern Trust and TD Ameritrade, it appears that, today, about half of all advisors are outsourcing some or all of their investment management.
Tiburon Strategic Advisors estimates that at least $2.2 trillion in assets is being managed by TAMPs or fund strategists.
Advisors who decide to outsource have a very high level of satisfaction with their decision. Recent studies by Northern Trust and AssetMark show:
- 97% of advisors are satisfied with their decision to outsource.
- 98% say they deliver better investment solutions after deciding to outsource.
- 80% of advisors say they lost no clients or revenues when they made the transition.
- 70% said they grew their client base and/or revenues as a result of outsourcing.
- 86% said outsourcing made them more successful.
- 87% said outsourcing met or exceeded their expectations.
Their clients also have a very high level of satisfaction with the services they receive. Ninety-two percent of advisors say their clients reacted positively to the transition to outsourcing.
Are You A Good Candidate?
Just because there are a lot of satisfied advisors who outsource doesn’t mean it’s right for you. You can determine if you’re a good candidate by asking yourself four questions.
First, what’s your passion? If you became an advisor because you love investing, why would you give up doing something that brings you joy? If you became an advisor because you love helping and interacting with clients, outsourcing could help you do more of what you love.
The next question to ask yourself is: “Am I good at investing?” If you love investing, but have no particular skill in that area, maybe you should consider outsourcing to a specialist?
Or you may have skill in certain areas, but not in others. For example, you may be particularly good at researching and investing in alternative investments, but have no interest or skill in managing a client’s core portfolio. Maybe outsourcing the core portfolio management, but continuing to focus on managing alternatives for your clients is a good solution?
The third question to ask yourself is: “Will I be able to give up control?” You are inevitably giving up some element of control when you outsource. There will be limits on how much you can be involved in portfolio management decisions. In most cases, you will have little input.
Make sure you will be OK with delegating these important investment responsibilities. If not, you’re probably not a good candidate for outsourcing.
The last question to ask yourself is: “What are my firm’s goals?” Even advisors who are passionate about investing and are good at it may have overriding goals that make outsourcing a good alternative for them.
What Are The Benefits?
Why do firms outsource in the first place? What are they trying to accomplish and what benefits do they get?
The first answer to this question is usually “time.” Outsourcing provides advisors the opportunity to gain back a significant amount of time in their workweek.
A recent Northern Trust study suggests the average advisor spends about 28 hours per week on investment management. Other studies by Cerulli and TD Ameritrade suggest that the number may be around 40% of an average work week.
How much time could you get back if you outsourced and how would you spend it? Most advisors who outsource say they use the time to prospect for or serve existing clients. But some use it to pursue what they perceive as higher value activities like financial planning.
Some advisors outsource so they can provide better investment solutions to their clients. They may measure this in terms of:
- credibility they gain by working with a partner who has greater resources
- more consistency in their investment process
- broader choices they can offer their clients
- improved investment outcomes
Others outsource to gain operational efficiencies. Outsourcing allows advisors to off-load the burden of trading, performance reporting, billing and other back-office functions to a TAMP.
Outsourcing can also produce cost savings in both the investment and back-office areas.
Outsourcing can help you institutionalize your practice, so you can sell it or transfer ownership to the next generation. It’s much harder to walk away and realize the value of your firm if you’re the chief investment officer and your investment process is dependent on you.
Outsourcing also allows you to sit on the same side of the table as your client and be more objective about portfolio performance. It’s hard to fire yourself if you’re the manager, but easy to change managers or portfolios if you outsource.
What Are The Options?
There are five different outsourcing business models that you can consider.
The first is the “traditional TAMP” model. In this model, the TAMP offers in-house investment management services. The portfolios are managed on a discretionary basis by the TAMP itself.
Traditional TAMPs charge a fee for their services, although some have created proprietary mutual funds and derive their compensation through the expense ratios of those funds.
The second business model is the “platform TAMP” model. Platform TAMPs offer access to portfolios or investment products from many firms.
Platform TAMPs usually charge two fees. The first is a “platform fee” that covers services such as due diligence, trading, performance reporting and billing. The second is a fee that covers the investment management services of the managers who are accessed through the platform.
The third outsourcing option is the “model marketplace.” Advisors are given access to model portfolios from multiple asset management firms referred to as “strategists.” Marketplace sponsors create virtual marketplaces of portfolios and products from other firms.
These model portfolios are often available without any strategist fee since, in many cases, they’re comprised of proprietary products managed by the strategist.
Model marketplaces don’t offer many of the services offered by TAMPs. They offer access to models, but they don’t take discretion of the account. The advisor is responsible for trading, performance reporting and billing—services handled by both traditional and platform TAMPs.
Since advisors are responsible for model implementation, they can freely modify those models. This is not an option that is widely available from traditional or platform TAMPs.
The fourth option is to subscribe to models directly from firms that offer them for a fixed annual fee. Advisors who subscribe are fully responsible for implementation of the models. This leaves advisors the administrative burden and fiduciary liabilities of portfolio management, but gives them the option to make modifications to the models without limit.
The final model is the OCIO model. Here you can retain the services of an outsourced chief investment officer to work with your firm to build and manage portfolios. The nature of these arrangements can vary quite a bit, but the OCIO usually will work with your firm to provide a flexible set of consulting and management services.
What Services Do You Receive?
The nature and quality of the services offered varies quite a bit.
Traditional and platform TAMPs offer a complete suite of services that typically include:
- Discretionary portfolio management
- Account administration
- Performance reporting
- Billing services
- Marketing material and proposals
- Ongoing market commentary, research and whitepapers
- Tech tools
- Practice management and educational programs
- Service support
Model marketplaces typically offer little other than the models themselves, although the models are very often integrated into the technology offerings of the firms that provide them. This facilitates the advisor’s ability to trade, generate performance reports and perform other functions related to account management and administration.
Model subscription services typically provide models and research to support the advisor’s ability to understand the models and explain them to their clients, but little else.
Firms that offer OCIO services offer a wide variety of support. Usually, it is very focused on the construction and management of the portfolios themselves and less focused on ancillary services like marketing and tech support.
How Do I Pick A Partner?
Once you decide to outsource, you still have a lot of work to do in identifying a specific outsourcing partner. Not all TAMPs are created equal.
Here are five factors you should consider in making your choice.
- Portfolios. The heart of any outsourcing offering is asset management. Do the same extensive due diligence you would on any other asset management offering.
Make sure the portfolios are consistent with your philosophy and approach to investment management. Look for a disciplined process that you understand and can explain to clients.
Ask about open architecture, objectivity and the use of proprietary products. Some firms adhere strictly to an open architecture approach. Others offer portfolios comprised of proprietary funds. Make sure you understand any relationships that influence fund selection.
- People. Check the experience, reputations and credentials of the people behind the firm. Also pay attention to the intangibles like attitude, responsiveness and flexibility.
You are choosing a long-term partner for your firm. If the chemistry isn’t there, walk away.
- Service and Services. Make sure you understand what services are included in the TAMP’s offering. There is great variation among TAMP offerings.
Keep in mind that the selection of a TAMP is a fiduciary decision. You’re selecting a firm to manage your clients’ assets and, one way or the other, those clients are paying for it. Don’t use client assets to pay-up for services that benefit you, but not them.
A firm that has a great list of available services may be terrible at delivering them. Interact with the individuals who will service your firm. Get referrals from other advisors. Make sure your outsourcing partner cares as much about your clients as you do.
- Cost. The variation in TAMP fees is very wide. Higher fees reduce returns. Even differences that appear small can make a huge difference in your clients’ wealth over time.
Most traditional TAMPs charge on a percentage of AUM basis. But there are variations. Our firm, for example, charges a low, flat annual fee with a household cap.
Ask about add-on charges for extra services and the internal expense ratios of the portfolios. Find out if trading costs are included in the TAMP’s fee and, if not, how much they will be.
- Fit. Every firm has a target market and a culture that determines what your experience will be in working with that firm. Make sure your firm will be welcomed and valued.
Ask what gets your potential partner going every day and why they’re in the business. Look for an outsourcing partner that shares your approach to doing business and serving clients.
Addressing The Objections
Remember, about half of all advisors don’t outsource any of their investment management and here are the primary reasons why.
- 47% say the fees for outsourcing are too high.
- 45% say that investing is key to their value proposition.
- 34% don’t outsource because it limits their ability to customize portfolios.
The cost of outsourcing is a legitimate issue. Some outsourcing solutions are not worth the fees they charge. But there are some great alternatives that give good value for the fees charged.
In a recent Northern Trust study, 53% of the advisors who made the transition to outsourcing said the transition had no impact on the fees their clients paid. So, outsourcing doesn’t necessarily mean higher fees for clients.
But the real issue is not what you pay; it’s what you get in return. If your clients get better investment outcomes and you have more time to serve your clients, then everyone wins. Focus on fees, but focus even more on the value clients receive.
Some advisors don’t outsource because they think their clients want them to do the investing themselves. In a 2019 study by TD Ameritrade on investment outsourcing, 71% of advisors said they believed that their clients prefer that they personally do the investment management.
However, the TD Ameritrade study found that 57% of clients had no preference about who performs the investment management “as long as my investments are secure and performance is satisfactory.” The study also found that 83% of clients who had 70% or more of their assets professionally managed had no preference regarding the advisor’s personal involvement.
The reality is, most clients don’t work with their advisors because they believe they are gifted asset managers. Instead, they value the relationship with someone who knows their goals and objectives, helps them with financial planning and coaches them through difficult times.
The facts show that the transition to outsourcing is rarely an issue for clients, and their satisfaction levels after the transition are consistently high. Remember, 92% of advisors said their clients reacted positively when they made the transition to outsourcing and 80% said they went through the transition without losing any clients or revenue.
If you like to customize each client’s portfolio, outsourcing is probably not for you. But TAMPs can often handle special situations that require some level of customization to deal with unique client situations. Check with any TAMPs you are considering to determine their capabilities.
If you really want to keep your hands on the steering wheel, you should consider options like model marketplaces or an OCIO relationship where you can adjust portfolios when you want.
How To Explain The Change
One question that often comes up when advisors are deciding about outsourcing is how to explain the change to clients. This usually turns out to be easier than advisors think it will be.
Northern Trust research suggests that over 90% of advisors use one of four basic approaches.
The first focuses on increased advisor attention and professional asset management:
“Outsourcing enables me to devote more of my time and expertise to focusing on your needs. We are using expert specialists to manage your money under our supervision.”
The second approach focuses on objectivity and better alignment of interests:
“In our effort to make certain that your money works as hard as it can for you, we’ll be in a position to hire some of the best money managers and replace them if we ever need to.”
The third approach focuses on service enhancement:
“We will be able to offer you the same level of services and technology capability as the very largest firms offer.”
The fourth approach focuses on cost reduction:
“Outsourcing enables us to do more with fewer in-house resources and we can pass the savings onto our clients.”
Deciding whether to outsource your investment management is a highly personal decision. Just because the world is trending toward outsourcing doesn’t make it right for you.
There are certainly many benefits that outsourcing can bring, but you should make the decision based on what’s best for you, your clients and your firm.