The recent volatility and big capital gains distribution announcements have forced advisors to revisit their client portfolios a bit more frequently than their regularly scheduled review times.  For advisors who use models, this task is simpler and less cumbersome that those who don’t.

Based on recent conversations, it seems that more and more advisors are using (or beginning to use) models, but I still run into quite a lot of advisors who are building a custom portfolio for every client.  Frankly, with the difficulty and the risk involved, I have to ask: Why?

Model definitions and challenges

I am by no means an expert, but I think there are two basic ways of creating models:

  1. A standard 3-6 models of varying equity and fixed (and alts?) that run up the efficient frontier¹. Advisors have the option of putting a client into one of these standard 40/60, 60/40 or 80/20 etc. models that fit most (if not all) clients.
  2. Equity and fixed pools. This method allows advisors to simply adjust the allocations per client, while the underlying investments are the same.

Either way, the benefits can certainly outweigh the challenges of running individual portfolios – and there are many challenges.

Let’s look at just a few of the issues surrounding individual portfolios:

  • Time. This should be obvious.  When dealing with individual portfolios, there is no scale or leverage in running the investment side of your practice.  Each individual portfolio has to be monitored, rebalanced and reviewed.  This may be feasible when you have a few clients, but as firms grow and start to add clients, advisors are tied to the operations and investment side of the business instead of the planning side, which clients value more.
  • Net revenue per client. While it is common to want to work with larger/more complicated clients, the promise of individual, customized portfolios for everyone means that advisors may end up spending more time on the less profitable clients.
  • Evolution. New ideas, new strategies and changes in style typically lead to advisors making changes in a portfolio.  Making that change can be very cumbersome for a firm with 100 or more accounts.  And *not* making the change for all your clients opens you up to regulatory risk. (More on that in a bit.)
  • Client consistency. Delivering a consistent client experience is important in building the reputation and brand of your advisory firm.   Lots of one-offs means that balls can be dropped, experiences can vary and clients can be left disappointed.
  • Regulatory risk. In our growing fiduciary world, we all know that putting our clients’ best interests first (and proving it) is the mantra. The challenge, of course, is if we make a change in investment thinking, manager selection or process for one account, we probably need to make the changes in all our accounts.  “If it was a good move, why not make the move for everyone?” is a question I would expect to hear from regulators down the road.  I don’t think the answer can be, “I only made the changes on my more profitable accounts; the ones I look at more often.”

Given more time and more space, I could probably come up with a few more reasons, including a potential reduction in the firm valuation based on the ease of a buyer transition into the firm and an increase in the non-client facing staff required to run the operations of the firm resulting in reduced profitability.

Facing the imposter

One of my favorite podcasts was Michael Kitces interviewing Carl Richards.  In their conversation, Carl discussed what he called the “imposter syndrome” – the idea that we need to complicate our business more because we’re afraid that if we make it “too simple” for us, someone will call us out for not being worth the fees that we charge.  There is no need to overcomplicate a business, especially when it comes with risks such as reduced client satisfaction, regulations and operational issues.

As we close in on year-end, the struggle continues for the custom portfolio advisors.  Year-end capital gains issues and huge volatility in the markets have clients asking about their investments.  When speaking with your clients, do you have to do a mad scramble to figure out how they are invested – or can you reflect on their model(s) and speak confidently about how you are monitoring what they have?

Legal Note

¹ The efficient frontier is the set of optimal portfolios that offers the highest expected return for a defined level of risk or the lowest risk for a given level of expected return.

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