All About The Benjamins Basis Points

In the last couple of days there have been a couple of articles about sub-advisors and products (so to speak) that go along with that part of the business. This article from IndexUniverse gives a definition and an explanation. An RIA firm has to do several things to keep the doors open. Existing clients need to be serviced, assets have to be managed, compliance needs to be maintained, new clients have to be sought and the office needs to be run (bills paid, systems maintained and the like).

That is a lot of tasks many of which are full time jobs all by themselves. This is one reason why RIA firms hire a sub-advisor. Another reason could be that for some firms, the skills the partners bring to the table, it makes sense to hire out for portfolio management expertise. This isn't that different, IMO, from a rep at a brokerage firm putting client accounts into programs where the assets divvied up amongst various managers; like maybe one for large cap, one for small cap and one for international.

To read the IndexUniverse piece and this one from Barron's it would seem that sub-advising is big and going to get bigger. As with just about every thing there is good and bad to this. First the good which is to understand that people hire advisors for all sorts of reasons and how they manage a portfolio is not necessarily the first consideration. Financial planning can be a multifaceted task and people have all sorts of needs. To the extent someone builds a practice that focuses on multifaceted it is unlikely they have the time needed to construct and manage a portfolio. In this sort of circumstance finding the right person, whatever that means, makes sense and clients will understand it.

The negatives are potential fees and the adding of layers of people. The IndexUniverse article talks about fees sometimes totaling 2% between paying everyone and then if funds, exchange traded or otherwise, are part of the mix. I think the fees adding up to that much is more common in brokerage firm programs. Obviously if you are reading this as a prospective end user you need to understand the fees you are paying. The idea that X% is always expensive or always cheap over simplifies the topic. A fee needs to be reasonable relative to the situation not some arbitrary figure although I can't imagine someone with a few hundred thousand dollars needing nothing special beyond a diversified portfolio needing to pay 200 basis points.

I view layers of people is a big negative as well. An example I have used often is with brokerage firm programs. A manager in one of these programs receives an account to manage has to assume that the asset allocation decision has been made and fully invest the account. This becomes problematic if the client expects assets will be protected. If the broker is not doing that, in this example, then no one is with the context of protection being raising cash for concern of a large decline coming.

In a circumstance where there are layers of people the advisor has to ensure that it is crystal clear about how the account will be managed and the end user needs to make sure they get it and are on board philosophically.

Where I stand on all of this can only be from how we do things. There are all sorts of products like fund of funds, wrap accounts, SAM programs and more that serve to make things more complicated and usually more expensive. I tend to be leery the more sophisticated something is. I have been a big proponent of simple brokerage accounts using some combo of stocks and funds with as little between the account holder and the manager as possible. A reasonably simple and diversified portfolio is very unlikely to cut in half unless the market cuts in half and that can't always be said for some of these other products. No account holder wants there account to cut in half and no investment advisor wants to have to explain why it cut in half. The simpler a portfolio is the less likely you face this situation.