The markets have had a tremendous amount of uncertainty with global economic risk, high unemployment, and political risk. Clients certainly see the volatility and many have stopped putting new money into the markets or are expecting advisers to time the market. As fiduciaries we are constantly trying to understand and manage the clients’ interests, but in times like these clients are often changing their behavior.
“Know your client” is not only a requirement by CFP Board but also a requirement by the SEC and FINRA. Economic volatility has created a very dynamic situation for advisers as client thinking is changing with the market. This volatility has created a unique opportunity for advisers to know their clients better and satisfy regulations.
If you ask a client what they want, they will tell you they want low risk with a high guaranteed return. As we all know, it is impossible, and ultimately we must assess a client’s risk tolerance and project returns. I have seen many methods over the years, from advisers using their own risk tolerance questionnaire to sophisticated financial planning products. Although creating your own product can work, I find there are many technology solutions that work better.
Many advisers use the questionnaire provided by the asset management technologies provider. Although many do a good job, there are a few items of concern. Some advisers tend to be driven by the technology, instead of the questionnaire satisfying the adviser’s ability to manage client expectations. Questionnaires provided by the tech companies that I have reviewed are created so they are easy to adjust and score. Instead of relying on the technology to provide you the right questions, I suggest looking at questionnaire samples and determining what works best for your practice. Then find the technology that works best for you.
There are products in the market that specialize in the questionnaire process only. (Of course, there is financial planning software, but most advisers find it overburdening for risk tolerance needs.) Some products specialize in the risk process by asking questions related to financial needs and human psychology. I tried to fool the system once, but in the end I was assessed less risky than I thought. After reading the results carefully I was very surprised how correct the assessment was. I find that technology specializing in assessing risk does better in that particular function.
The other question to ask about questionnaire technology is who is responsible for how the assessment scores—the creator of the software or the adviser? The adviser should take the time to understand and agree with the methodology used. Remember, technology companies are not fiduciaries. Some of the technology that specializes in questionnaires can be very sophisticated, so take the time to understand how it works.
Lastly, is the technology solution you are using customizable? Flexibility is very difficult for a technology company to offer without charging the adviser a labor cost. For most independent advisers this can be impractical. Instead, see if they have a forum where you can get other advisers to request the same changes. If enough advisers ask for the same change or feature, most technology companies will make the change for a future release.
Asset Allocation and Investing
I find that most advisers follow standard asset allocation models. In times of volatility, monitoring those models may become very difficult. There are many outsourced models available. Although the model developer may be taking on the risk of creating these models, the adviser, as a fiduciary, must be familiar with the logic.
As for technology there are three areas where a little sophistication can help immensely in managing a portfolio: allocation management, attribution analysis, and trading.
One feature in allocation management I feel is important is simply the ability to view portfolios that are out of balance from their ideal allocation. The system will alert you to any portfolios that are out of balance, including any securities that may be over-weighted. The alerts allow you to speak to clients about the over-allocation and take appropriate actions.
A second feature is attribution analysis. There are tools available that have various attribution analyses to determine the overall portfolio risk based on the risk of the underlying investments.
Lastly, most trading tools will allow you to change allocations on a model or portfolio and simply execute the block trades. Some tools have gone further to define rules when to make the trades. For instance, defining not to execute a trade if it has a certain period of time remaining to change from a short-term to a long-term gain.
No matter which system you choose, ensure there is a notes section so you can note specific conversations with your clients.
Although CRM systems are typically used for sales-related functions, they can be helpful in knowing your client. A CRM system can help you develop a consolidated notes system for your company, especially useful if there are multiple people in the office managing clients. A central location for all communications with a client is helpful when making future decisions.
Data integration is one of the hardest items to successfully execute as an independent adviser. All software tools are wonderful in the furtherance of knowing your client, but most are made by different companies. It was only recently that the major custodians, as well as some large turnkey asset management programs, started buying these tools and integrating them into their platform.
Some vendors have gotten to the point where they receive direct updates from custodians, making the process seamless for advisers. Check with your custodian for vendors that work with the custodian data. If you have multiple custodians, ask the vendors if they are integrated with the various custodians.
Another area where data integration can be helpful is in understanding the client’s total financial picture. For instance, gathering bank information and monitoring cash to ensure clients have six months of cash at all times, if that is your policy, is critical. The ability to receive all of a client’s data efficiently in one area is getting closer with time.
Performance statements I find tricky. If advisers have a good “know your client” system, most will find that the performance statement is a conclusion statement to the conversations that have transpired throughout the period covered.
From a compliance perspective, an adviser must have some type of storage mechanism for performance statements and other documents. Many are converting to electronic statements, but some still like to maintain a hard copy of account opening forms. It is not a bad practice to maintain some type of hard copy, but be careful if you use a storage facility. Many have good security, but many do not. There is only a lock, that can be easily cut, that protects that personal data.
Electronic Storage Breach Plan
As the “know your client” process is improved with technology, many of the vendors you use will have your client data in their server. Although now it has a fancy name, cloud computing has been around for a long time. Before working with a vendor, have a list of security questions ready. [See Bill Winterberg’s article “How to Stay Safe When Using the Cloud” from the July 2012 Journal.]
The client will ultimately hold the adviser responsible for a data breach. Although you never want this to happen, you should be ready for the worst. A breach plan should be part of your policies and procedures.
Knowing your client to satisfy regulations is great, but a tremendous number of tools exist that can help you comply with regulations and have better relations with your clients and increase business. Unfortunately, with more technology there is more maintenance involved and more responsibility.