Wealth Biz Buzz

Well, that is the question – or at least one of the major questions facing money managers today.

For the past few decades the debate over open, versus hybrid, or closed architecture has echoed through the halls of iconic institutions and single-shingle RIAs – through money center banks and community bank trust departments.

On the surface, the options seem pretty clear-cut; remain in complete control over the investment selection and management of the portfolios you oversee, or outsource some or all of that responsibility.

Enter Satan, Lucifer or whatever other devil lurks in the shadows of the all-important details.

Exit foolish consistency.  Let’s remove the “we’ve always done it this way” argument from the get-go and address some of the more nuanced aspects of adopting one platform over another.

Control

Let’s face it; some of us are simply control freaks.  We are responsible for the quality of what we offer our clients and outsourcing opens the kitchen door to those broth-spoiling chefs.

If we manage client portfolios in-house we have complete control over the investment decisions and ultimately performance.  While we might rely on due diligence from others, we pull the “trade-trigger” and decide what is bought and sold.  When we outsource, we have to relinquish some of that control, which for many of us feels uncomfortable.

Speaking of spoiled broth; Chef (borrowed from the French) is short for “chef de cuisine”, or “director of a kitchen”. Complex staffs support the most renowned chefs, recognizing they can’t prepare 300 six-course meals on their own.  They are responsible for managing that staff to not only produce consistently positive culinary experiences, but to make executive decisions such as hiring, scheduling, managing, menu creation, ordering, and plating design.

They are also extremely reliant on scores of vendors and suppliers.  These suppliers, while not on staff, can “make or break” their success.  Poor ingredients lead to poor results.

Control is often illusionary.  We cannot control the markets, human behavior or other risks present in our daily quest to do the best for our clients.  That doesn’t mean we don’t try through the use strong governance and other processes to foster control; it simply means if you are cooking for more than your family you have to rely on other people and other methods to realize scale.

This too is true when considering moving from a closed architecture to an open or hybrid platform.

Scale

The age-old challenge of how to grow without eroding quality is front and center when deciding to outsource most any aspect of your business.  If you plan on catching and cleaning your own fish, sowing, irrigating, and harvesting your own vegetables, you will undoubtedly find this comes at the expense of focusing on developing a diverse and delightful menu and dining experience.  I am quite sure the local fisher and farmer can provide you what you need much more efficiently than you can.

So, the question is not whether to outsource – rather what to outsource.  Like most things in life this is not an all or nothing decision.  Many chefs have small garden patches for fresh herbs and other ingredients that either are not available or simply cannot be replicated by a vendor.

The more discerning and demanding the clientele the more challenging scale becomes.  Yet, if we plan on satisfying our upscale diners, we simply cannot adopt the Cheeseburger, Cheeseburger, Cheeseburger, Pepsi, Pepsi, Pepsi mentality; we have to let our clients” have it their way”.

Which brings us to trying to balance acidity and sweetness, i.e., scale and customization – two words which are seldom used in the same sentence.

Scale can certainly be achieved in both closed and open architecture models, however, scale, with customization is difficult to achieve if you are doing it all on your own.

Customization

In our next post we will discuss the advantages and disadvantages of some of the more common open and hybrid architecture structures, suffice it to say that few programs to date have lived up to their promises of customization and scale.

We were led down the primrose path with many of these so-called customized open-architecture alternatives, which may be why we see a “twice shy” stance in the marketplace.

But markets are dynamic and new products and structures have been making great strides in delivering on the push-me, pull-you world of scale and customization.

It’s possible with the right technology and infrastructure, that you can “have it your way” without paying a fortune.

If scale and customization are not good bedfellows, I am quite sure that price and customization have some differences to work out.

Price/Profit

We can slice and dice, mince, puree or chop pricing and profits, but no matter how you cut it, the end result must be a quality product at a fair price to the client that reasonably rewards you for your efforts.

One argument for hanging onto proprietary management certainly is cost.  Under most any circumstance managing your own portfolios, from a strictly cost perspective, is the cheapest alternative.  Mind you, cheapest does not necessarily mean most profitable.  Volume often trumps margin.

We frequently hear stories of the exorbitant costs associated with outsourcing, particularly related to SMA and mutual fund wrap programs.  The costs quickly add up when you consider administrative, custodial, portfolio management and other internal expenses and then there is your part of the fee.    Tales of 225 to 275 basis points of total expense abound.

Yet, this too has evolved and today there are multiple options for substantially reducing these expenses, therefore offering a better price to your clients, improved margins or a combination of both.  The UMA, if appropriately established and adopted is one such animal.  We will cover the benefits of UMA in our next post.

Suffice it to say, investors and regulators are becoming increasingly aware and leery of fees, calling for more transparency.  When they peel back the skin of your pricing onion, what will they find?

Many see this is a reason to continue with straightforward, in-house proprietary management, eschewing the open architecture model.  While we agree, that outsourcing part of the investment management may create a bit more of a hurdle when trying to reach complete transparency, we also believe you can reach that transparency with very little effort and that this argument is shortsighted in the broader scheme of the client’s best interest.

Jack-of-All-Trades

You may be the absolute best pâtissier or saucier, but it is unlikely you are both.  So, your success in a certain niche does not mean you are going to be consistently the best manager, from around the globe, in multiple asset categories.

And beware, if you live by performance, …

It is becoming increasingly clear to affluent clients that they can hire the best and brightest.  Of course, so can you.  You can engage the greatest talent in our business on behalf of your clients.  And, when a manager appears to be slipping, instead of the client firing you; you fire the manager.

Locally Grown

There are enormous benefits to going local and this too holds true in the investment management business.  Access to a local portfolio manager is often a huge help in both closing new sales and managing existing relationships.

This is difficult to achieve in a totally open architecture model, however, the use of local managers within this structure or using a hybrid model affords you the best of both worlds.

The “F” Word

For far too long we have heard the argument that one must manage the portfolio internally to meet their fiduciary duty.  From our perspective quite the opposite is true.  The CIO or portfolio manager typically proffers this obfuscation in an effort to create job security. We’ve heard tales of all sorts of regulatory damnation and client mismanagement that will occur if any part of the investment management process is outsourced.

Again, while control and governance are critical, wouldn’t outsourcing to a customizable, scalable, better value, lower expense platform with transparent fees and the best managers from around the globe actually be seen as acting in the best interest of your clients?

There is no one recipe for success in investment management as no two people have identical palates.  Business models, target markets and the manner of delivering service differ from firm to firm.

Yet, the importance of using just the right amount of the right ingredients, in the right combination is indisputably necessary if you are to create a world-class dish.

So, too is this important in structuring your investment management offering.  Closed architecture offerings allow you to use only those ingredients you cultivate on your own.  This is great for a family meal, but hard to scale over time.  Plus, what if your clients want a dish with the finest Kasmiri saffron or exotic truffles and these are not indigenous to your area?  The time spent on farming, fishing and raising livestock could be used to fine-tune your menu, décor, and develop new clients.

Moving away from a proprietary investment management platform to a more open model does not have to be an all or nothing proposition.  You may have developed a strategy and niche that serves you quite well.  Think of Bill Miller or Bill Gross.  If the only place clients could get such management was through your firm, you would certainly have created competitive distinction.  So why not allow your clients to access your personal talents, intertwined with other professionals who fill different niches.  This enables you to create a unique product with a competitive advantage, while still broadening the appeal of your offering by not limiting it to your style alone.

Hybrid architecture, for many, is the best of both worlds.  In this model, you combine those investment disciplines in which you excel with other managers to bring a world of opportunity and flavor to your clients.  You might grow those few hard to find or transport herbs in your own garden, having a local portfolio manager present, while also using the best ingredients and chefs from around the globe to influence your menu.

Most importantly, open and hybrid models do not mean you have to use someone else’s recipe.  You have full control over developing and managing the allocation models, incorporating your investment disciplines with chefs from around the globe to create that unique blend of herbs and spices that will leave your clients commenting – C’est Magnifique!