Brokers with Subpar Investment Returns Escape Indie Firm Oversight–Study

October 11, 2019

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(Updated to clarify number of firms surveyed and add timing of the survey.) 

A significant number of broker-dealers risk lawsuits and reputational damage because of their reluctance to intervene in the practices of advisors who have underperforming managed account portfolios, according to a new survey from Cerulli Associates.

Just over 20% of the 31 firms surveyed, whose customers comprise about 95% of the $1.74 trillion managed account universe, do not monitor investment performance or resist removing discretionary authority from below-average advisors, according to the Boston-based consulting firm.

Nearly all of the firms taking the “hear no evil, see no evil, speak no evil” approach are independent-broker dealers, Cerulli said.

“Their business model is one that allows advisors complete freedom,” said Tom O’Shea, Cerulli’s director of managed accounts. “They have been afraid to even suggest that they’re underperforming because they are worried that those advisors might bolt to another firm.”

A spokeswoman at the Financial Services Institute, the principal trade group for independent broker-dealers, declined to comment on the study.

“They cannot completely wash their hands of representatives under their supervision,” the report says of the independent firms whose brokers are contract workers rather than direct employees.

Cerulli suggests that its asset management clients highlight the risks, using them as an opportunity to market third-party model portfolios that reduce firm and advisor liability.

O’Shea declined to identify the firms, which were surveyed in the second quarter this year, but said that two of the largest independent broker-dealers he has consulted plan to be more interventionist with underperforming advisors.

In some cases, advisors do not know they are underperforming because their broker-dealers do not provide benchmarks or comparative data, he said.

The retail brokerage industry in recent years has been heavily promoting managed portfolios developed by in-house chief investment offices and third-party separately managed accounts in order to create consistency and avoid litigation over poor performance, O’Shea said.

“On average, advisors underperform the home office and third-party models,” he said. “They’re quick to get out in down markets but slow to get into an upmarket.”

Just over 37.5% of survey respondents said they encourage underperforming advisors to use home-office asset allocation models, and 28.6% guide them to third-party models.

Firms are also stepping up requirements for brokers who Cerulli categorizes as “rep-as-portfolio managers.” Around 80% of those surveyed have training requirements, 64.2% have coaching programs to improve performance and 42.9% require a Certified Financial Planner, Chartered Financial Analyst or other designation.

The Cerulli study respondents on average require brokers to have at least 6.2 years of industry experience and/or to work with at least $65 million of client assets in order to have discretion over client investments, the study said.

Assets in rep-as-portfolio manager programs grew 9.1% to $1.735 trillion in the year ending June 30, Cerulli said, and were up 30.1% over two years. The report did not break down how much of the growth represented new assets versus market performance.

Morgan Stanley, Merrill Lynch, UBS and Wells Fargo rank, in that order, as the largest rep-as-portfolio manager firms, led by Morgan Stanley’s $422 billion of assets in RPM programs.

LPL Financial, the biggest independent broker-dealer by headcount, ranked sixth, with $95.6 billion in assets. Independent firms Advisor Group and Cambridge Investment Research ranked ninth and tenth with $53.9 billion and $38.5 billion, respectively, in RPM programs.

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