A lower-return environment is forcing advisory firms to reassess client risk exposures and search for strategies to contain costs, Mercer notes in a 2015 practice management outlook analysis. The firm says it has identified a list of priorities that advisers should consider to best serve their clients in the year ahead, and to help them stand out in an increasingly competitive advice marketplace.
Position portfolios for growth in a low-growth environment
Mercer notes that interest rates remain near historic lows, despite the fact that the U.S. is more than five years into an equity bull market. As uncertainty about if and when interest rates will rise persists, Mercer says advisers ought to look beyond traditional investing strategies to consider less constrained funds that can target areas of opportunity, and those with longer perspectives.
Part of this effort will involve determining whether alternative investment strategies are appropriate for a broader group of clients, Mercer says.
“Alternative investments are being democratized and are no longer exclusively available to the wealthiest investors or most sophisticated institutions,” the Mercer analysis explains, urging advisers to evaluate how alternatives can be integrated into clients’ investment strategies to reduce risk or otherwise improve the likelihood of realizing investment objectives. In some cases, there may be a liquid alternative strategy that will help meet client investment objectives, Mercer notes, and in other cases clients may benefit from the illiquidity premium expected of other alternative strategies.
Mercer says 2015 may also be a good year for advisers to consider the impact of socially aware investing as part of portfolio design. Firms have an opportunity to distinguish their offerings by integrating environmental, social and governance factors into their investment process and products, Mercer says. This approach can be difficult in the retirement space, however, due to fiduciary rules prescribed in the Employee Retirement Income Security Act (ERISA).
Adopt a modern client service and communication strategy
Mercer warns that disruptive technology and new business models continue to transform the financial advisory industry. There has been especially rapid development in the areas of cloud computing, client service applications, social media and mobile transaction capabilities.
“Communication and direct access to portfolio information is frequently cited by clients as their main frustration [with their current adviser],” Mercer notes. “Wealth providers can significantly enhance client satisfaction and better manage fixed costs with the adoption of smart technology, but this will require investment to stay ahead of the competition.”
Mercer’s analysis finds rapidly changing markets, technology, regulations and competitive pressures “have shattered the economics of the traditional wealth management business.” Advisers need to review the core skills that provide them with a competitive advantage, and evaluate which resources are best sourced internally versus through an external partner, consultant or other vendor.
Conduct both investment and operational risk assessments
While it’s not exactly a new theme for 2015, Mercer warns that a full understanding of the products that clients are investing in is essential. Mercer says product and portfolio provider risk, from both an investment and operational perspective, is increasingly important and should be fully integrated into the investment decisionmaking process.
Furthermore, risk assessments at the firm level can help to mitigate unanticipated losses for both clients and the firm. Despite this, Mercer says few advisory firms invest the same care in operational due diligence as they do in investment due diligence. Something else to consider is that many industry models that assess product risk are too backward looking in nature and overly reliant on measures of historic volatility, Mercer says.
“Advisers and clients need to place much greater emphasis on forward-looking and qualitative indicators of risk to fully appreciate potential outcomes,” the analysis says. “These factors will also become increasingly critical in client risk profiling. “
As Mercer explains, many advisory firms have lackluster internal monitoring due to limited resources, decisionmaking that is not responsive to the changing investment environment, or “calcified” operating models. Because of this, advisers must proactively evaluate their firm’s governance environment, consider its effectiveness at meeting the needs of the firm and its clients, and contract or develop the resources, data, and processes that are necessary for a robust and fluid governance process.
Ensure clients are getting what they pay for
Fees should be a factor in investment decisionmaking, Mercer says, but the lowest fees don’t necessarily signal the best product choices.
“Some clients prefer the certainty of lower investment expenses coupled with greater use of index-oriented products; others are more comfortable with active fees and the potential for alpha from active management,” Mercer explains. “It is important to help clients to distinguish between alpha and beta and to reserve higher fees for strategies with the potential for higher alpha.”
Mercer concludes by urging advisers to view the New Year as an opportunity to evaluate new business models, services and enhancements that could help reduce costs and improve performance for clients and the advisory firm.
Additional research and insights from Mercer are available at www.mercer.com.