The trend toward outsourcing portfolio management is growing in near-perfect harmony with expanding access to various model portfolios and turnkey asset management platforms that let financial advisors essentially hand over the keys so they can focus on other things, like prospecting for new clients and new assets.
Despite the fact that most financial advisors charge fees pegged to client assets, the case for outsourcing portfolio management has never been stronger. With the investment management piece of financial planning morphing into commoditized, low-cost, easy access to simple blends of mutual funds and ETFs, handing over that part of the job just makes sense to a lot of advisors.
And in most cases, the clients don’t know the difference, or care, as long as the portfolios stay within acceptable guardrails.
That background raises the question of why some advisors resist the trend and insist on rolling up their sleeves to spend time and resources to manage money in-house.
“By managing our own portfolios, we’re adding value,” said Ryan Johnson, managing director at Buckingham Advisors, a $725 million advisory firm.
Like most RIAs that manage client portfolios in-house, Buckingham’s focus on individual securities is mostly limited to the equity side of client portfolios.
For the fixed-income side, it’s more efficient to use mutual funds and ETFs. Buckingham will build portfolios of individual bonds for households with more than $3 million.
But any client with more than $100,000 allocated to equities will benefit from Buckingham’s individual stock picking for the large-cap stock allocation. For small-cap, mid-cap and international equity investments, Buckingham still relies on ETFs.
That’s right, Buckingham is using valuable resources to squeeze out a benefit to clients in the world’s most liquid and analyzed asset class.
“I know it’s unusual to say we’re adding value in large-cap stocks, but we feel we have a lot of control with individual stock selection, especially when it comes to tax planning,” Johnson said.
Tax management isn’t always the first reason advisors cite for in-house investment management, but it is part of a recurring theme, primarily because in-house portfolios tend to be more concentrated and have less turnover than do portfolios on outsourced platforms.
At RIA Blue Chip Partners, where the equity portion of the firm’s $1.1 billion under management is managed in-house with individual stocks, portfolios hold between 25 and 40 stocks, and the average portfolio turnover rate is under 20%.
“We’ve found that the sweet spot is between 25 and 40 securities, and that’s a level backed up by historical data,” said Daniel Dusina, Blue Chip’s director of investments.
With more concentrated portfolios, Dusina said, “You get credit for high-conviction ideas but you’re still able to diversify.”
Blue Chip Chief Executive Robert Steinberg said even though the portfolios of the firm’s more than 700 households are similar, the clients are more involved when they see the individual companies they own.
“Everybody is getting the same model, but different weightings of stocks,” he said. “Clients are more involved, it’s easier to tax-loss harvest, they know what they own.”
Steinberg acknowledged the effort involved in managing money in-house, but said that’s part of the value proposition that the firm promotes.
“It is a lot more work and most firms aren’t willing to make that investment, but it’s a differentiator and clients get it,” he said. “Clients are more engaged in meetings. They’re talking about planning and also talking about stocks.”
A 2020 research report from InvestmentNews cited a host of reasons for turning the work of asset management over to an outside provider, with freeing up time, accessing institutional-quality capabilities, and accessing strategies beyond an advisor’s expertise topping the list.
Those are all good reasons for outsourcing, but some advisors still see portfolio management as a core component of financial planning.
The InvestmentNews report also listed the top reasons for not using an outside service for portfolio management, which included, in order, investment research strength, flexibility and cost.
Most RIAs don’t adjust their fees to compensate clients for the underlying fees associated with outsourced portfolio management or fund expense ratios. So even if it only adds up to a few basis points, it’s generally safe to assume clients are paying lower total fees at firms where the asset management is done in-house.
“Any time you layer on financial products, the cost to the client has to be higher,” said Paul Schatz, president of Heritage Capital, a $110 million RIA that builds client portfolios using stocks, bonds, ETFs and mutual funds.
Like a lot of advisors still building client portfolios from scratch, Schatz said, “Control is a huge driver.”
“Right or wrong, I’ve always wanted to have ultimate control of our net exposure and you can’t do that if you outsource,” he said. “I’m so focused on the markets and would have a difficult time seeing a negative view and being in a model that is fully risk-on or fully levered long.”
As a 34-year veteran of financial services, Schatz recognizes the uniqueness of resisting the temptation to outsource asset management, and he makes sure his clients understand his position.
“In the first two or three meetings with new clients, I repeatedly mention that we manage our own portfolios,” he said. “In the last 10 to 15 years, outsourcing has exploded and I’ve never seriously considered it. I have a trading background on Wall Street, and I love it. I just don’t trust somebody to be as all in as I am for my clients. The TAMPs have commoditized asset management to a few basis points. That’s not for me.”
Jordan Kahn, chief investment officer at HCR Wealth Advisors, understands the appeal of outsourcing for an advisory firm but he doesn’t see the long-term value for clients.
“I think [outsourcing is about] the ease of management for the end advisor,” he said. “The average advisor is moving more toward putting clients in these models and focusing more on going out there to try to get more clients.”
Kahn estimates that up to 40% of HCR’s $1.4 billion in client assets is managed in portfolios of individual stocks.
“We think a portfolio of individual stocks is best for our clients,” he said. “With most of the outsourcing, they tend to hold closet index portfolios with hundreds of stocks. Our portfolios are made up of 20 to 25 of our best ideas.”
Kahn said HCR often leads with its individual stock portfolios when meeting with prospective clients.
“As more investment advisors use funds and ETFs, the prospects that come to our office, they still like the idea of owning individual stocks,” he said. “That’s my whole background. I started as an equity analyst, as a stock picker. It’s in my blood and for me it’s not extra work. A lot of younger advisors are just expected to raise assets and put clients in models.”
With the continued commoditization of investment management, most advisors running their own portfolios make that a major part of the conversation with prospective clients.
“When we onboard people, we talk about that,” said Matt Wilson, president and chief financial officer at Keen Wealth Advisors. “Mutual funds and ETFs increase costs, and our internal expense ratio is lower because of the way we manage portfolios.”
Of the RIA’s $755 million under management, about 70% is in equities, and half of that is managed in portfolios of individual stocks.
“We want to run these portfolios in a tax-efficient manner that’s customized to the client,” Wilson said. “In the wirehouse, where I came from, we used third-party money managers a lot.”
When Wilson left Wells Fargo in 2014 to join the independent advisory ranks, the asset management was moved in-house “because we wanted to make adjustments more quickly, especially when markets are volatile.”