Your Advisor Might Have a ConflictSubmitted by Trace Wealth Advisors on October 22nd, 2019
The wealth management business has always been rife with conflicts. Some of these are easy to ferret out (churning a commission based brokerage account comes to mind) while others are often cloaked in what appears to be the normal course of business but are anything but that. One such hidden conflict is the newly discovered practice of “bring your own assets” (herein referred to as “BYOA” for short).
Chances are you haven’t heard of BYOA and there is a good reason why…some of the largest and most reputable firms in the world undertake this practice and they spend gobs of money to make sure that you can’t understand how it works nor why it has the potential to put you at a disadvantage. Here’s a quick example of how it does:
Say you are an advisory client of XYZ Wealth. You pay them an annual fee (which is probably too high…we’re here to help with that!) and they in turn invest your money for you. In the course of doing so, they buy a variety of different investment products to properly diversify your portfolio. These products (usually mutual funds and ETFs) have fees embedded in them as well. You don’t see these fees because they are taken out of the net asset value of the funds but that doesn’t mean they aren’t there; this is where the game starts to change for a firm like XYZ Wealth since, as luck would have it, they also happen to own a separate asset management business that creates and manages these types of investment products. In the course of its normal business, XYZ then decides that rather than buying those products from a third party, they will just create their own product to put in your portfolio. In doing so, they are now getting paid twice by you: once from the advisory fee and once from the product fee. They’ve taken no risk (since they’re using their your money to seed the product) and have created a brand new revenue stream out of thin air. What a deal…for them.
So what’s the problem, you might ask? As long as the products are competitive (which they often aren’t!), why should you care about this? I’ll boil it down to three different reasons that you may not have considered:
They can lack liquidity: Since these products are mostly owned by one institution’s clients, there may be less trading that goes on in the underlying shares. This is important to understand because this can lead to wider bid-ask spreads (the difference between the price at which an asset is bought and sold) and, thus, a higher cost when the time comes to transact.
For example, many BYOA funds have bid-ask spreads that are around 5 cents per share.This compares less favorably to non-BYOA fund spreads that are usually closer to 1 cent per share.This mere 4 cent differential leads to an added $400 of transaction costs on an order of 10,000 shares.That cost is actually incurred twice: first when you buy and again when you sell.Again, you don’t see it but it’s still there.
They can create a conflict: This one is a little more straightforward. It’s pretty tough to analyze your own product…it’s even harder to fire yourself. The advisors placing these products into client portfolios know that their firm will be more profitable if they use their own products…that creates a hurdle to objectivity and, by definition, a conflict. Advisors engaging in this practice will use all sorts of excuses like insinuating that they have better control over the products or that they have greater accessibility to the managers running the product. While it’s possible that’s true, it often doesn’t outweigh both the explicit and implicit costs of owning these products.
BYOA has become so widespread that it brings up the natural question…which of these firms that engages in this practice actually has an expertise and is the best product sponsor?It can’t be all of them but they all employ this tactic.If they were really being honest with themselves and their clients, many of these products wouldn’t exist in the first place.
They can lack due diligence: Since by its very nature, BYOA relies on using client capital to seed a new product, there is no track record for the product itself. Firms usually get around this by using simulated backtests, showing their product to have a great track record that is anything but real. As I like to say, the best ten years for any backtest is the last ten years!
Having worked at large firms in the past, I can tell you that most wouldn’t even consider an outside product without at least five years of live returns to its credit, let alone one without any track record at all. The exception to that rule is the BYOA fund.
My advice to you is simple: whether it's BYOA or any other conflict, it’s important to understand how your advisor is compensated and what conflicts that may present for them. Putting client interests ahead of our own is something our industry sadly isn’t known for…it’s about time that changed.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.