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UHNW Business Models: The Registered Investment Advisor
Maria Elena Lagomasino and Michael Zeuner
24 October 2019
As part of a continued series from the UHNW Institute, the organization takes a detailed look at the main wealth management business models of the North American industry. With so much debate about the advantages or disadvantages of each, it is particularly important to get a detailed outline of how they actually work. This article is from Maria Elena Lagomasino and Michael Zeuner, managing partners – WE Family Offices. For more detail about the Institute, see here. In addition, a registered investment advisor is uniquely required, under the Advisers Act, to: Advisor vs provider This is where the advisor can come in. Because an advisor can sit on the same side of the table as the family, his or her role becomes one of a financial quarterback: In that role, the advisor will be able to understand the “big picture” and help them to buy, integrate and manage without the conflict that comes with having to sell financial products and services. In all cases, wealthy families need an ecosystem of providers . The key question is do they also need an objective advisor to help them source, research, integrate and manage that ecosystem of providers? What’s important here is that this disclosure makes it clear that XYZ firm, while positioning itself in an advisory capacity, is affiliated with a broader financial services firm that distributes financial products and services. This affiliation is a source of real conflict to the RIAs advisory role. A family that is looking for an advisory firm to represent their interests and help them buy should know that firm XYZ cannot and does not play that role. We know that ultra-high net worth families need providers. The question is do they need an advisor and, if so, how do they identify one that fits the bill? • What support do we need? Investments only? Or broad, holistic wealth services?
In the first installment of this series, Jamie McLaughlin makes the case that there are four distinct regulatory regimes in the wealth management arena: commercial banks; broker-dealers; registered investment advisers ; and trust companies. This installment provides a deeper dive into the RIA regime.
For purposes of this article, RIA refers to a wealth management firm that is registered with the United States Securities and Exchange Commission as an investment advisor. Registration with the SEC imposes a unique and distinct regulatory burden on a firm to adhere to the key tenets of the Investment Advisers Act of 1940, which, according to the SEC website :
“prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business. As a fiduciary, an investment advisor owes its clients undivided loyalty, and may not engage in activity that conflicts with a client's interest…”
“deliver to each client or prospective client a Form ADV Part 2A and Part 2B describing the advisor's business practices, conflicts of interest and background of the investment advisor and its advisory personnel.”
These two core requirements of the Advisers Act help set Registered Investment Advisors apart from the other types of firms mentioned above. Even more importantly, they also form the basis of the prevailing culture in the RIA industry: a strong fiduciary culture of putting clients’ interests first, and an emphasis on the utmost transparency.
That said, this distinction is important, but not enough to help ultra-high net worth families determine whether an RIA is “right for them”. Few families make regulatory status the primary driver of their decision in hiring a wealth management firm. Instead, we would argue that a more important distinction is between business models available in the wealth management industry, and would pose this question: Is the firm built on a provider model or an advisor model?
This distinction makes all the difference. If the firm is a provider, its core role is to sell or distribute financial products or services to clients for a fee. If the firm is an advisor, its core role is to help the family determine which financial products and services and providers are best suited for their needs.
Everything about the two business models is fundamentally different:
• Regulatory framework: Generally, RIA for advisors; bank, broker/dealer or trust company for providers, though many such firms are dually registered or operate separately regulated subsidiaries in tandem in the marketplace;
• Compensation: Asset-based fees generally for advisors, though flat fees or service activity-based fees are beginning to catch on; management or asset-based fees and transaction fees for providers; and
• Client experience: a holistic, comprehensive, integrated relationship based on a complete picture of the family’s overall wealth for advisors; compartmentalized, transactional relationships centered on a piece of the family’s wealth for providers
Nearly all families work with multiple providers for understandable reasons: different providers have different specialties and areas of expertise; different providers bring a diversity of perspectives; concern about telling a single provider “everything” for fear that the information will be used to try to cross-sell a range of financial products and services.
The challenges for families who work with multiple providers raise these questions:
• Who’s keeping track of it all?
• Am I getting the highest quality financial products and services that are right for me?
• Who’s connecting the dots across everything I’m doing to be sure it’s done in sync with my objectives and to see I don’t have any overlaps or underlaps in financial products and services? and
• Who’s keeping me updated on the “big picture” and my overall wealth map?
While nearly all firms in the wealth management space will call themselves “advisors”, we would argue that the only way a firm can act in an advisory role is if they are completely disconnected economically from the provision of financial products and services. In other words, they receive fees from the families they serve to help them source the right providers, and that is the only source of fees for the firm. They don’t receive any incentives from providers of financial products and services as this represents a fundamental and detrimental conflict affecting their capacity to advise with impartiality.
This, in our opinion, is the essence of the distinction between registered investment advisors and all other business models. An RIA is hired by families, and paid only by families, to represent their interests, and no one else’s. It’s not just about the regulatory duty of putting their interests first, it’s about serving ONLY their clients’ interests, and no others.
It’s also clear to us that some registered investment advisors and their affiliates do take fees from multiple sources, but as an RIA these fees must be disclosed in the ADV and it’s relatively straightforward for a family to discover that a particular RIA may not be fully acting in an advisory capacity. Here’s a real example of a disclosure in an RIA’s ADV:
To the extent that advisory clients of XYZ Advisors invest in third-party investment vehicles for which XYZ’s affiliate is acting as placement agent, XYZ’s affiliate will typically receive a placement fee from the third-party investment vehicle in connection with such an investment. In addition, XYZ Advisors will also typically receive its agreed upon advisory fees from its advisory clients with respect to the investment. The payment of the placement fee to XYZ’s affiliate creates an incentive for XYZ Advisors to recommend third-party investment vehicles for which its affiliate acts as placement agent to its clients instead of other investment opportunities. To mitigate this conflict, XYZ Advisors discloses when its affiliate is acting as placement agent, performs due diligence on such offerings, and evaluates the suitability of prospective investors for such third-party investment vehicles.
But how can a firm provide a financial product or service and advise on who the optimal provider of that service is? A provider firm’s worldview is focused on being the best provider of that service that they can be, but by definition their job is not to objectively compare their product or service to others in the space and help a family determine which provider’s product or service is the best fit for them.
Before deciding on an advisor, a family should consider which of the following is important:
• Having a clear understanding of the entire wealth picture;
• Ensuring that wealth management activities are aligned with their overall strategy and objectives, and are being conducted in an integrated fashion;
• Creating a comprehensive investment strategy in sync with their goals;
• Sourcing and researching high quality investment solutions for the portfolio;
• Aggregating and reporting investment performance;
• Analyzing and optimizing fees; and
• Helping the family make critical decisions about their wealth – and engaging all the family members in the discussion.
These are all critical activities in a family’s wealth management, but some families may choose to conduct these activities themselves. Alternatively, a family may choose to hire people to work for it directly to conduct these activities and some may hire a firm to support them in these activities. When a family chooses to hire a firm to help them, the regulatory framework of the advisory firm becomes critical.
Essentially, a standalone RIA firm with an advisory business model is the best fit to objectively and effectively serve in this role. If its only role is serving as an advisor without sales of products or services, then the firm is able to serve as a true advisor.
Families can and should ask any firm they are considering whether they take any fees for the provision of financial products and services, and then verify by reading the firm’s ADV. Families should be particularly careful to identify “dual registrant” firms that are authorized to act in both RIA and broker-dealer capacities. Most often, these firms are not pure advisory firms, but hybrid firms in which there is an affiliation with a business that focuses primarily on selling financial products.
Understanding the advisor landscape
Once a family decides to hire an advisory firm to help manage its financial life, and has narrowed the search to RIA firms that don’t provide any financial product or services, it helps to understand the landscape.
A straightforward way to narrow down the search among advisory firms is to first decide what the family needs, and then look at the services offered.
Is the family primarily looking for investment support? Or does it need more holistic, broad services to include their investments and other functions such as wealth planning and structuring; tax planning; risk management; and family governance and multi-generational support, among other things?
There is no right answer – every family needs to determine what type of support they are looking for.
Once a family determines what kind of wealth management support they need, they can begin to search for the firm with the best match.
The easiest way for a family to identify a firm that is more narrowly focused on investment advisory versus more broadly focused on wealth advisory is to look at how the firm charges fees. If the RIA charges a fee that is a percentage of assets under management it usually means they are focused on investments, offering other services as incidental. If the RIA charges a flat retainer fee, or some other fee that is not based on assets under management, it’s a strong signal the firm is focused more broadly, offering wealth management advisory services.
If the family is seeking a firm to manage its entire financial life going beyond investments, a firm that charges a percentage on assets may not be optimal. That firm most likely will see all the other critical wealth advisory services as secondary to the investments. A firm that charges a non-AUM based fee should be able to solve the family’s broader wealth challenges and goals more efficiently.
And finally, decision time
In summary, while ultra –high net worth families face a multitude of options ; and trust companies) a family can choose whichever option is best for them. A summarized list of things to consider may be helpful:
• Who will manage our ecosystem of providers?
• How does this firm get paid? A fee on AUM? Or a retainer fee?
• Are there potential conflicts of interest disclosed on the ADV?
In all cases ultra-high net worth families need an ecosystem of providers . The core question is do they also need an advisor to help them source, diligence, integrate and manage that ecosystem of providers; one that is objective and able, because of its business model, to supervise and help the family select the collection of providers that is right for them. If they seek to not play the advisor/integrator role themselves but instead to seek an outside advisory firm to support them, a RIA is often the right answer.
Once they’ve made a decision to hire an RIA, then the question becomes which type of RIA is right for them, and how can they identify an RIA that fits the bill?
Often, understanding the firm’s fee model percentage of AuM-based versus retainer or other fee that is not based on AuM) is the best way for a family to know whether the RIA they are considering hiring is a match for what they are looking for. Finally, even if a family chooses not to hire an advisor to help assemble and oversee the right collection of providers, there are certain advisory activities the family must take on itself.
Relying on providers for advice is akin to asking the fox to guard the chicken coop. In our experience a typical provider has too many competing agendas to be able to objectively provide advice that is solely in the interest of the family. A family should make sure the only agenda being considered is its own.
As part of a continued series from the UHNW Institute, the organization takes a detailed look at the main wealth management business models of the North American industry. With so much debate about the advantages or disadvantages of each, it is particularly important to get a detailed outline of how they actually work. This article is from Maria Elena Lagomasino and Michael Zeuner, managing partners – WE Family Offices. For more detail about the Institute, see here.
In addition, a registered investment advisor is uniquely required, under the Advisers Act, to:
Advisor vs provider
This is where the advisor can come in. Because an advisor can sit on the same side of the table as the family, his or her role becomes one of a financial quarterback: In that role, the advisor will be able to understand the “big picture” and help them to buy, integrate and manage without the conflict that comes with having to sell financial products and services. In all cases, wealthy families need an ecosystem of providers . The key question is do they also need an objective advisor to help them source, research, integrate and manage that ecosystem of providers?
What’s important here is that this disclosure makes it clear that XYZ firm, while positioning itself in an advisory capacity, is affiliated with a broader financial services firm that distributes financial products and services. This affiliation is a source of real conflict to the RIAs advisory role. A family that is looking for an advisory firm to represent their interests and help them buy should know that firm XYZ cannot and does not play that role.
We know that ultra-high net worth families need providers. The question is do they need an advisor and, if so, how do they identify one that fits the bill?
• What support do we need? Investments only? Or broad, holistic wealth services?