Issues with the Wealth Management Industry

Wealth management, as an industry, needs to be more than just about wealth, which sounds paradoxical.  The term “wealth management” is itself a misnomer.  We are not managing wealth.  We are managing people.  Wealth is a consequence of managing them.  Because of this inherent disconnect, we have this situation where the interests of clients is not always aligned with the interests of wealth managers because of the way the system is set up, and this requires a bit of a paradigm shift to address.  This is especially important in an era where people are becoming more discerning, and yet, miseducated.  There is a lot of information to be found, not a lot of truth. 

The system at banks and financial institutions incentivises scale versus personal service.  This is wealth management on an industrial scale.  The least amount of service is done per client to avoid complications.  That means as long as the client does not ask, they will not tell anything beyond the absolute minimum or reporting requirements.  This makes most financial consultants in these institutions reactive, not proactive.  This can be seen in financial consultants who claim to have hundreds or thousands of clients.  This is obviously unsustainable if they are actually servicing them. 

There are 365 days in a year.  There are about 260 weekdays.  Take away holidays, sick days, off days, vacation days, and we are left with 220 days.  Assuming it takes at least one entire day in a year, to service the average client, if we compile the hours, that would mean the average financial advisor can only fully service 200 or so clients, because some of them will have complicated portfolios and require special services.  In insurance, that would include claims.  Handling more than that would mean the financial consultant is being reactive to client needs, rather than proactive.  There is little scope for personalised service and customised portfolios despite what may be claimed.  Good financial consultants work at getting 200 quality clients, unless they have an entire team to service a larger number.  Regardless, face time with the senior consultant is a rare thing. 

Another issue with the industry that needs addressing, is that too much time is spent on marketing and business development as opposed to the actual consultancy.  Starting it, it makes sense that people need to build that network and market themselves.  But perhaps, we should relook this system, especially for tied agencies.  Wealth managers, financial consultants and such, should be experts in their field.  This includes the product, the market, and the client.  The problem with the current system is that it promotes the best salesmen, and not necessarily the best consultants.  Sales and consultancy are actually two distinct skills. 

The market is evolving, and the system in agencies, financial advisories, banks and fund houses should evolve as well.  This is especially so for the insurance industry.  There should be investment in a distinct salesforce, and a distinct agency force for serving clients and advising on wealth management, risk management and fund management.  Otherwise, we end up recruiting and developing the wrong talent, which is detrimental to long-term market positioning. 

In many financial institutions, when we consider it, consultants are incentivised to offer new or niche products, which may not be in the client interest.  This is especially so for banks and fund houses, where the compensation structure sometimes prioritises products that make them money, as opposed to making the client money.  Clients, no matter how wealthy, do not need everything.  They need a portfolio that fulfills their specific needs, such as making more than inflation over an extended investment horizon, or mitigate risk, or reduce tax liability.  A lot of products on the market do not actually do that, especially those that are derivatives-based.  This represents needless risk exposure.  Another issue, is that because financial consultants and wealth managers are often incentivised by overall asset under management, they are more likely to recommend a loan to meet expenses rather than a partial withdrawal of some assets to meet those expenses.  This represents a long-term cost on the client which should be avoided. 

One of the consequences of the above is that too many portfolios are overdiversified, making them needlessly complex.  When I talk diversification here, I am not referring to monies in a portfolio diversified across different funds.  I am referring to a portfolio diversified over five, six or even more classes of investments, from municipal bonds, index funds, high yield bonds, distressed assets, international funds, hedge funds, real estate, venture capital, and whatever is the flavour of the season.  When a portfolio is over-diversified, it becomes complicated to manage, requiring a large staff of analysts specialised in the different asset classes.  The cost of the analysts alone would be substantial.  Those analysts require compliance and management oversight, risk analysis, and an entire supporting structure.  How many family offices, trusts, ordinary portfolios actually need all that? 

This leads to the next reason why these portfolios are over-diversified.  Complicated portfolios have complicated fees structures, and they are never, ever transparent.  While there are the stated management fees, there are also fees for underlying assets under management, and other forms of underlying charges.  Most financial consultants themselves have no idea what they amount to, and it takes work to actually tabulate them.  There are fees for fund switching, custodial and trading, portfolio balancing, investment advisory fees, investment management fees, and a thousand other things hidden in those charges.  Simplifying portfolios make it easier to track those hidden costs. 

The final major cost of an overdiversified portfolio is actually taxes, what we call the tax drag.  Places such as Singapore do not have capital gains and estate taxes, and low corporate taxes.  But while the holding entity is here, and has minimal tax exposure, much of that portfolio is diversified all over the world, and there is a tax liability there.  This is often ignored.  There is taxes on property in a real estate portfolio, there may be exit taxes for specific classes of investments, there will be income and other types of taxes that may not be apparent.  There is also the hidden tax of inflation for specific classes of investments.  Much of that cost is hidden by the turnover of the portfolio, but unless someone actually takes a closes look, clients have no idea how much tax exposure they have, despite claims of tax mitigation. 

As can be seen, the industry is incentivised in the wrong direction, and that leads to a consequential overdiversification of portfolios.  These bloated are a major cost, and serves only to justify the large support teams and significant management costs.  Financial consultants are pushed to continuously find new clients, which feeds a cycle of acquiring asset under management to justify the entire system.