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Rise of the Machines: Are money managers going the way of the travel agent?

Here's what some are doing to avoid that outcome

Feb 24, 2014

by Colleen Biondi


At its core, the financial services industry is based on a simple proposition: that the advice and guidance it offers is worth the price people pay for it. But proponents of passive investing would argue that this is no longer the case – and that it hasn’t been for a long, long time. “The financial industry is based on a foundation of deception and fortune-telling that has no value,” says Dan Bortolotti, a Toronto-based journalist and author of the award-winning Canadian Couch Potato blog about passive investing. “A low-cost, broadly diversified, disciplined strategy is better.”

Bortolotti isn’t alone in his view, and it’s one that’s gaining momentum – and money.

In the first nine months of 2013, inflows for Canadian ETFs topped $4.1 billion, putting the total value of assets under management in those ETFs at $60 billion. That’s nearly double the figure in 2009, when passive investing was more commonly associated with a lazy portfolio manager than a deliberate strategy. According to Michael Robinson, a chartered financial analyst (CFA) and associate professor of finance at the Haskayne School of Business, the reason for this shift is simple: active managers can’t beat the index over the long term. “There is a wealth of empirical evidence to suggest that it is difficult for money managers to consistently outperform the index, particularly with mutual funds,” he says.

“The hardest part about being a passive investor is to tune out the constant noise from commentators and friends who give you stock tips.” – Dan Bortolotti, journalist and blogger at Canadian Couch Potato

Some money managers, like Index Wealth Management’s Ken Serbu, are yielding to this logic, incorporating index funds into their approach and the products they offer their clients. When he started out in the business 30 years ago, the brokerage firm he worked at gave him a desk, phone and a phone book and told him to start dialing. Today, he embraces index funds as part of a suite of services that includes investment management, wills, trusts and estate planning. And while he isn’t entirely comfortable with being labelled a passive investor, he’s found a way to blend its principles with the industry’s more traditional role as purveyors of expertise. “[Passive investing] suggests you buy something and you put it in a shoe box and hope it turns out,” he says. “We are avid indexers.”

Others, though, like Ric Palombi, a portfolio manager with McLean & Partners in Calgary, are less enthusiastic about it. Although he keeps an eye on the inflows and outflows of index funds, his company’s philosophy and style is unabashedly active. “We can dissect the market and look for opportunities and markets that an ETF manager will not do. That is not their mandate. Our mandate is to beat the index. Here you are getting a bigger bang for your invested dollar.” As a result, not much has changed at the company despite the growing industry interest in passive investing. “We are not losing clients to passive investing,” Palombi says. “Clients come here looking for tailored portfolios, not to be in the index.” And fees, he says, are not an issue. “As long as we are delivering, fees don’t come into the conversation.”

Those fees can add up to billions of dollars a year, and in a market like the one investors endured during the first decade of the 21st century they can erode – or eliminate – their returns. And yet, while the passion for passive investing continues to grow on blogs like Bortolotti’s and among a growing number of money managers (most of whom, according to a recent poll, have a significant portion of their own money invested in passive instruments), it still makes up less than five per cent of the $800 billion worth of assets under management in Canada. That means the vast majority of Canadians are still perfectly happy to put their hard-earned dollars into the mutual funds and other packaged products. “Active managers are not going out of business any time soon,” Bortolotti says.

Not yet, anyway. but as a report from the Boston Consulting Group released earlier this year illustrated, they can’t afford to be complacent forever. While the volume of assets under active management has grown in recent years, virtually all of that growth is a result of rising prices rather than new business. And while they have their existing client base and the substantial fees they generate from them, they might not have them in perpetuity. “For most traditional managers, this seemingly guaranteed stream of recurring revenues masks any urgency to confront the hurdles involved in chasing new, faster-growing flows,” the report concluded.

Those flows might be about to speed up substantially, too. Traditional managers like Palombi are about to get hit by a wave of so-called “robo-advisors,” and they could fundamentally challenge (and maybe even change) the prevailing business model in the money management industry in much the same way that sites like Expedia and did for travel agents.

A whole slew of new companies that offer comprehensive passive management strategies at almost preposterously low prices (FutureAdvisor, for example, charges clients $19 a month) are beginning to enter the market in the U.S., and it’s only a matter of time before they arrive north of the border.

More ominous – for traditionalists, anyways – is the fact that these “robo-advisors” are deliberately targeting younger investors. And as Raef Lee, the managing director for the SEI Advisor Network (an adjunct of U.S.-based wealth management firm SEI Investments that has half a trillion dollars’ worth of wealth under management) noted recently, “the feeling goes that this could set an expectation for lower fees for young investors.” Those younger investors, he said, will also expect more transparency and a more technologically sophisticated approach than traditional money managers are accustomed to delivering.

Take Betterment, an online financial advisor and investment management company based in New York. The company provides “democratized” passive investment advice and tracking systems 24/7 via software and algorithm platforms, and delivers it all for a fixed fee ranging from 0.35 per cent of a client’s balance to just 0.15 per cent if they have more than $100,000 in assets (traditional money managers often charge 10 times that amount). Daniel Egan, its director of investing and behavioural finance, says the company more than tripled its assets under management last year (it started 2013 at $100 million), and that it expects that trajectory to continue. “We are climbing pretty quickly,” he says.

Traditional money managers aren’t doomed to obsolescence just yet, mind you. Some companies like BMO and Invesco are switching up their offerings to include mutual funds which invest exclusively in ETFs, according to Andrew Dranfield, an analyst with Investor Economics in Toronto. Over at ATB Investment Management (the wealth management subsidiary of ATB Financial), meanwhile, chief investment strategist Gene Hochachka recommends both active and passive strategies for ATB’s Compass Mutual Funds. They may not be embracing passive investing with the same fervour as its more ardent proponent, but they’re not about to ignore the fact that it’s a growing market.

There’s also the fact that passive investing is far easier in theory than it is in practice. “The hardest part about being a passive investor is to tune out the constant noise from commentators and friends who give you stock tips,” Bortolotti says. That’s one area where money managers still have a value proposition that can – and, in some cases, should – appeal to investors. Yes, it’s a good idea to reduce management fees wherever possible. But if you’re going to sell into the face of every short-term correction and buy the tail ends of the rallies, that one or two per cent you’re saving won’t amount to much. That’s why, at firms like Palombi’s, the ability to communicate with clients and encourage them to exercise patience and discipline can be worth a bundle – and worth paying for.

And if nothing else, there will always be plenty of business available to those in the industry who are able to trade on the underlying optimism that is a common trait among many investors. Part of what makes a market is the existence of people who believe, rightly or wrongly, that they can beat the index, and they aren’t going away any time soon. “It is like buying a lottery ticket,” Egan says. “We know lottery tickets are a bad idea. But there is that thrill. What if it’s me that will do well?”


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