ETF Trends
ETF Trends

By Chris Shuba, Helios Quantitative Research

A few years ago, I heard about this cool new business called Netflix. I could go online, pick a movie and, within a couple of days the movie was at my door. Moreover, I could keep it as long as I wanted. An incredible thought hit me the day my red envelope arrived: Blockbuster is dying.

Looking back on that day, I know why I remember it so clearly. That was the first time I saw the downside of industry disruption. Ironically, five years before Blockbuster filed bankruptcy, Netflix tried to sell itself to them. Blockbuster declined the offer. They chose instead to stay the course and stick with an outdated strategy that failed to understand fundamental changes taking place in their industry.

For years there had been talk of the internet and how it would completely remake industries. For me, holding the red Netflix envelope in my hands made the long-predicted internet revolution real. Why, because Netflix used a scalable business model to deliver a better experience at a lower price. The Blockbuster idea was legacy; the Netflix concept is today.

“Disrupt or be disrupted. There is no middle ground.”

The Financial Services industry is in the middle innings of a multi-phased and disruptive process that began in 1993 with the first ETF, and jump-started in 2008 with the first “robo advisor.” These two disruptive events continue to put enormous downward pressure on the fees charged by mutual fund companies and individual Advisors.

This article is for the 20% of Financial Advisors who, unlike Blockbuster, understand that their industry is being remade. Moreover, it is fueled by a small army of Advisors who embrace the inevitable changes in how and what their clients pay for advisory services.

Just last week I was in a coffee shop in San Francisco’s Embarcadero when another “Netflix Moment” happened for me. A traditional Financial Advisor was complaining to another gentleman about industry-wide issues disrupting his business:

• The challenge of fee compression

• Increasing regulation

• Lack of time to spend with high-value clients

• The sameness and repetition of advice given

• The lack of a strategy for intelligent risk mitigation

He then said, “The best way forward for me is to convert my business to a flat fee practice.”

I listened to him outline a more profitable and efficient use of discretionary models to manage his firm’s assets (like a robo advisor) and provide client meetings only when requested. He went on to say, “I can differentiate myself, create a loyal client base and spend more time competing for clients. Plus, with larger client base I can drive more revenue through insurance and financial planning.”

When the Message and Messenger are the Same

It would be easy to dismiss this conversation as a one-off. However, five years ago this conversation never would have taken place. These little examples of real-world disruption are always the signposts along the road of change. You can bet this conversation is happening in coffee shops all over the country. Just like Netflix, concept becomes reality.

I do not believe financial services is racing toward a flat-fee model. However, the pace of fee compression will accelerate as clients have more low-priced options from which to choose. The end-result is enormous pressure on traditional Advisors to justify their higher prices and deliver an asset management solution more sophisticated than buy-hold-rebalance.

Using history as my guide, 80% of Advisors will dismiss the business risk I just outlined. They will say: “never going to happen,” “doesn’t affect my client base,” or “I’m going to sell before that happens.”

Perhaps there is some truth in those statements, but is it worth the risk of ignoring?

How to Become a Quant Advisor

At Helios Quantitative Research, we help build a new breed of financial professional we call a Quant Advisor. This type of advisor is the blending of a robo-advisor’s highly efficient, discretionary, model-driven process combined with the specialized knowledge and relationship management of a qualified professional Financial Advisor.

A Quant Advisor can thrive in a low or flat fee environment because of scale and efficiencies. There are six key steps to becoming a Quant Advisor:

1. Develop a small but powerful set of investment models that are both unique and compelling. If the models are not both, then there is no competitive advantage. As an example, we only work with a small number of Advisors in an area to create and keep a competitive edge.

2. Have discretion on client accounts. The real value of using models is the ability to affect many client accounts at the same time to create efficiency and scalability. Building scale is the only sustainable way to overcome fee compression.

3. Communicate. Most clients simply don’t need or want to meet with their Advisor four times a year, but they want regular access to bite-sized information about what their Advisor thinks. Creating valuable, but short-and-sweet communications keep a client happy and informed. Generic newsletters do not count (because no one reads them).

4. Create multiple channels for a client to engage. Most traditional Advisors have a simple fee grid based on assets. A Quant Advisor will have a service menu that provides options from super low-cost investment-only relationships all the way to complex financial planning solutions. Due to scale and efficiency, any of these service levels can be highly profitable. Maybe one of the options is aflat fee only service level?

5. Sell more than advice. A Quant Advisor sells financial advice/planning and asset management services. Traditional Advisors only sell advice/planning and pay someone else to provide asset management (such as managed accounts, SMA’s, mutual funds, etc.). By having a unique and compelling asset management capability in-house, Quant Advisors do not have to pay someone to do it for them. That creates a new revenue source and the ability to capture a higher percentage of the total fees paid by the client. As fee compression continues to eat away at advice/planning prices, having multiple services to sell a client creates a more stable revenue stream.

6. Be hyper-transparent. Clients are more afraid of what they do not know than what they do. By proactively talking about and disclosing fees (including the hidden ones), risk and performance the relationship can blossom based on a new level of trust and understanding.

Depending on your point-of-view, industry disruption is ugly, complicated and emotional. However, it is also a time of tremendous opportunity.

Like Netflix, continued success is the reward for giving clients better options at competitive prices. As more and more flat fee or low-cost alternatives compete for a limited pool of customers, will they drive traditional Advisors with low levels of scale out of the marketplace? Will basis points die a long, painful death or will it be quick?

The real question is this: Will you disrupt or be disrupted?

This article was written by Chris Shuba, founder of Helios Quantitative Research, a participant in the ETF Strategist Channel.