by Amy E. Buttell
Deciding how to handle investment management is one of the most important decisions you make as a financial planner, and the choices aren't black and white-you can outsource, handle it in-house or combine both approaches.
FPA's 2010 Trends in Investing survey of more than 400 planners reveals that more than half of all planners handle their investment management responsibilities in-house, while one quarter outsource the job. The remainder combine the two approaches. Whatever your decision, it's not a lifetime commitment; many planners switch approaches over the course of a career. In fact, more than half of those surveyed who now outsource have managed their investments in-house at some point within the past five years.
For planners, the decision to outsource investment management or not hinges on a number of factors including control, costs, diversification and investment philosophy. The good news is that there is no right or wrong decision. The bad news is it's not a decision that anyone else can make for you-you must weigh the pros and cons to decide for yourself, and you'll likely need to continually revisit your decision to make sure it still works.
For Robert DiQuollo, CFP®, CPA, founder and president of Brinton Eaton Wealth Advisors in Madison, N.J., the decision to manage client investments in-house was pretty simple.
"We handle it in-house because we think that we can do a better job and have more control over the investment process when we do it ourselves," says DiQuollo. "We decided that when we looked at outside managers, it wasn't worth the cost, because the outside managers were going to have their fees and then we would have to charge something, and we felt that the client was going to be paying too much."
For John Wolff, CFP®, CLU, ChFC, senior managing director of Capital Fiduciary Advisors in Leesburg, Va., the decision to outsource came just as naturally.
"We're a pure, fee-only RIA," says Wolff. "That means we're paid exclusively by our clients, which sort of leads to the concept of outsourcing money management. Really, it's born from a philosophy that we're not dedicated to and focused on portfolio management. We don't have a team of analysts. I spent the better part of a decade as a stockbroker, which was where I learned the pitfalls of trying to buy individual securities."
Issues of Control
For planners who handle investment management in-house, the ability to control the client's investment management experience and react quickly on their behalf is important.
"I've decided to handle investment management in-house based on what I think my clients are looking for in regard to the financial planning experience," says Evan Shorten, CFP®, founder and president of Paragon Financial Partners in Los Angeles. "By handling their investments myself, I know that their goals and my goals are aligned, and I might not be as comfortable with that if I outsourced investment management and used different providers. I have the ability to provide the client with an in-depth approach to their situation and have the ability to move quickly, if need be, on their behalf."
DiQuollo agrees on the importance of maintaining control, saying, "We believe we can pick stocks and certainly bonds for the long term and do well. At one point, we reached out to people who helped us analyze bonds and we found we were getting better prices and better deals than outside managers who trade a lot."
There's no doubt that outsourcing investment management can add an additional layer of costs. And that's an issue that deters many planners from outsourcing investment management; they want to keep their clients' costs as low as possible.
"Costs are one of the major reasons why we handle investment management in-house," says DiQuollo. "We believe that every basis point we save a client in expenses is just another dollar that grows in their portfolio and generates more of a return."
Shorten agrees, saying, "I'm fee-conscious, which helps me stay on the same side of the table as the client. I think that's one of the value propositions that I bring to the table. It's crucial."
Of course, not every outsourcing option is expensive; in some cases, it can be less expensive to outsource investment management than to handle it in-house. If your outsourcing option adds enough value in the form of additional returns or avoids a costly plunge in the value of client assets during a downturn, the fees you are paying to outsource may very well be worth it. The key is explaining to clients what the costs are and how your decision to handle investment management, whatever it is, adds value and helps them achieve their investing goals.
Michael Kay, CFP®, president of Financial Focus LLC, a financial planning firm in Livingston, N.J., points out that handling investment management in-house can be more expensive than outsourcing, not only in terms of trading and investment costs, but also in terms of your time.
"For us to go and off-load or partner with the [investment management] firm we have, I feel we've got the absolute best in terms of cerebral capital," says Kay. "We're able to spend our time getting to know what our clients really care about, and build excellent, close and intimate relationships with them, which pays greater dividends than spending time combing through research reports of dubious reliability."
The sheer size of the universe of investing options and opportunities is one reason many firms, including RMB Capital Management in Chicago, decide to outsource, although RMB does handle some of its portfolio management in-house.
"We have a lot of expertise in managing domestic equity and fixed-income portfolios and have a long/short equity based alternative investment, all of which we manage in-house," says Paul Joyaux, CFP®, a vice president at RMB.
"Our other skill is looking at the entire asset allocation picture and trying to figure out what other asset classes we should own," Joyaux adds. "That's the primary reason why we outsource, because there are always going to be other asset classes that we want to own that we may not be able to manage in-house, because we don't have the expertise."
Wolff agrees, noting that the firm his company uses to find external managers helps him identify the managers who have the greatest probability of superior performance going forward. Then, Wolff can mix and match the best investment managers in each asset class in a "core and satellite approach, so where the markets are a little more efficient and where we can compress costs, we use a passive strategy, and where it makes sense and there's more value, pay additional dollars or fees to employ an active manager."
For David Yeske, Ph.D., CFP®, founding principal of Yeske Buie, a financial planning firm in Vienna, Va., and San Francisco, the decision to handle investment management in-house stemmed from a deep-seated belief in passive investment management.
"I have two degrees in economics and a degree in finance and have looked at the evidence systematically," says Yeske, a past president of FPA. "There is no evidence that individuals can beat the market. If you attempt to, you're just layering on an extra level of expenses and aren't adding value."
At Yeske Buie, the investment management approach uses passive investments from firms such as Vanguard and Dimensional Fund Advisors. According to Yeske, the strategy is based on an evidence-based financial planning approach, which incorporates a rigorous research-based approach. For example, Yeske Buie hasn't added alternative investments to their clients' portfolios because Yeske says the new approaches haven't been empirically validated.
Yeske's staff participates in what he calls "Yeske Buie University," where they study the theory behind investment management and investment management philosophies, including Harry Markowitz and modern portfolio theory. Yeske wants to make sure that all financial planning staff members understand the theory behind the firm's investment management philosophy.
Kay is also a proponent of a passive investing strategy, but he outsources investment management after handling it in-house for a few years.
"Like many people in the industry I started off trying to create portfolios and doing research in an effort to produce better results for my clients," says Kay. "But I got frustrated because there was so much conflicting information about investment management in the marketplace."
A Final Word
Outsourcing investment management and handling it in-house are two sides of the same coin: managing investments for the ultimate benefit of your clients. All planners have some skin in this game, whether it's handling the whole process or deciding the most appropriate asset allocation mix and picking the most suitable outside managers.
Amy E. Buttell is a freelance writer and regular contributor to FPA publications.
If you're considering outsourcing investment management, here are a few tips from planners on how to find the best managers and complete your due diligence.
Work with a professional. John Wolff, CFP®, CLU, ChFC, senior managing director of Capital Fiduciary Advisors in Leesburg, Va., says his firm works with two companies to help select external managers.
"We work with two groups that help us source our external managers and continue to do the sort of ongoing due diligence on managers that's necessary," says Wolff. "They have a database of 1,500 money managers, 8,000 mutual funds and countless funds-of-funds and alternatives."
From that gigantic pool of options, the investment management consulting firms give Wolff and his partners a list of five to a dozen investment managers in various structures for every possible asset class.
"Part of it is a science, and part of it's an art," says Wolff. "The science part is what these groups do for us; then the art part is marrying the appropriate management with the allocation with the goal of helping the clients meet their goals and objectives."
Scout it out yourself. Michael Kay, CFP®, president of Financial Focus LLC, a financial planning firm in Livingston, N.J., heard about the investment outsourcing firm he now uses and was initially impressed by the rigor of their academic approach to investing. He wanted to learn more, so he went to California and spent a few days learning about what they do.
"Philosophically, it was absolutely in alignment with my values and my thinking," says Kay.
Paul Joyaux, CFP®, a vice president at RMB Capital Management in Chicago, uses databases of external managers to find the best managers for the portions of his firm's portfolios that are outsourced. Combing through databases, he narrows down the list by eliminating those with less-than-stellar performance records, fees that are too high or high investment minimums.
"Once we get down to a list of five managers, we start the process by interviewing individual managers," says Joyaux. "How long has each manager been with the firm? What is their stock selection process, and how does it complement what we do?"
Another important factor for Joyaux is how the potential new manager's methodology correlates with the investments the firm already has-they seek as low a correlation as possible to bring as much diversity to client portfolios as they can.
-Amy E. Buttell