Value – it’s the only thing

– requiring fund companies to have low-cost, execution-only products available directly or from discount brokers;

– mandating the unbundling of trailers, with these fees billed to clients separately:

– imposing a requirement that advisors operate as fiduciaries, putting client interests first in all cases;

– either capping or banning commissions on mutual funds entirely.

The last proposal describes banning commissions as “the most straightforward way to align the interests of mutual fund companies and advisors with [those of] investors.”

I’ve recently received several emails from advisors asking about the impact of some of these scenarios. As one recent email put it: “If you believe there is opportunity in chaos, how do you effectively prepare for the new dawn?”

Regardless of how the current regulatory proposals net out, given the trends in the U.S., Britain and Australia, it’s hard to imagine that we won’t see greater transparency and disclosure on compensation – and not just on mutual funds. Here are some thoughts and some lessons from other industries that went through fundamental changes to their rules similar to the change that the financial advisory industry may be facing:

– How greater disclosure affects your business

Let’s start with a few observations on the impact of greater disclosure on compensation:

First, this isn’t just about mutual funds. I’ve had advisors tell me they’re not concerned because they’ve shifted away from mutual funds to in-house, fee-based platforms or to a discretionary model.

Just to be clear, the conversation here won’t end with any one product. It’s a bigger issue, relating to disclosure, transparency and alignment of interests across the entire client relationship. Once there are changes on one product, they inevitably will spread to others over time.

Second, this isn’t just about regulatory requirements. The fundamental focus on value for money by clients isn’t new or limited to the financial services industry. In case after case, we’ve seen customers shift from deciding who they work with based on yesterday’s relationship to making decisions on today’s value. We need look no further than the impact in the 1980s of negotiated commissions on stock trades and of competition from discount brokers.

That said, regulatory mandates on greater disclosure and transparency are likely to accelerate the move toward greater focus on value that already is taking place. Another contributing factor to this focus comes from the rising profile of exchange-traded funds (ETFs).

I had a conversation with a successful advisor who pooh-poohed the impact of ETFs because none of his clients own them. However, ETFs will continue to play a key role in focusing clients on cost and value for money. Even clients who don’t use ETFs are more aware of lower-cost options (with the media playing a role in this).

Third, transparency on pricing can have a significant impact. Greater openness on compensation can be an accelerant and catalyst for big changes in behaviour. As one example, the practice of law has been transformed in the past 20 years, with pressure on margins for any work that clients view as a commodity.

In large measure, this is because law firms were forced by more discerning clients to change billing from the norm in the early 1990s of one line that read “for services rendered” to itemized billing. In many cases, the same scrutiny will occur in the financial advisory business once clients see exactly what they’re paying more clearly.

– Lessons from retail. What, then, should advisors be doing to position their businesses today?

The retail industry offers some useful lessons. In the past 20 years, the Canadian retail landscape has been transformed. Among the key catalysts have been the arrival of low-cost, value-focused, U.S.-based competitors and, more recently, the impact of online shopping. Costco Wholesale Canada Ltd.’s first Canadian store opened in 1978; Wal-Mart Canada Corp. arrived on the scene when it acquired the leases to 120 stores operated by the failing Woolco division of F.W. Woolworth Co.

Today, retailers fall into three categories: those that thrived; those that failed (including Eaton’s, Simpsons and Zellers Inc.); and the largest group, those that have limped along, able to stay in business but experiencing margin compression and generally not having a lot of fun.

Advisors will fall into the same pattern, with those who thrive falling into the same broad categories as successful retailers:

1. Value-focused, low-cost providers, such as Wal-Mart, Costco, Winners Merchants International LP and Dollarama Inc.

2. Premium and super-premium entries, such as Starbucks Corp. and Harry Rosen Inc. and, further up the price chart, Tiffany & Co. and Louis Vuitton Malletier.

3. Specialty chains, such as Lululemon Athletica Inc., IKEA and Future Shop.

4. Stores such as Target and Nordstroms, which offer a differentiated experience through distinct product offerings and service excellence.

– Winning in a value-driven world. In every case, the winners provide concrete, specific, tangible value. Football Hall of Fame coach Vince Lombardi has been quoted as saying, “Winning isn’t everything; it’s the only thing.”

Advisors who want to ensure future success need to adopt a similar credo: “Value isn’t the most important thing; it’s the only thing.”

The following are tips on how you can ensure you are delivering value to position yourself for success:

1. Look at value through your clients’ eyes.

Successful retailers provide value, not from their point of view but from their customers’ perspective.

An advisor told me recently that he provides outstanding value based on doing financial plans for clients and being in regular contact. That may be outstanding value from his point of view, but chances are his clients may not see it that way.

Here’s a simple test of the value you provide. How would your key clients complete this sentence: “As a result of working with my advisor, I’m better off because…”

In a more forgiving world, you could get away with vague value. In tomorrow’s world, only advisors who provide sharply defined, compelling value will prosper.

2. Specialize to thrive.

A key element in providing superior value is focusing on serving a well-defined niche of clients with common issues and, because you bring specialized expertise, being able to serve them exceptionally well.

If you look at the winners and losers among retailers, the winners tend to be specialists; the losers, generalists. Advisors may have gotten away with being generalists in the past; but today, a generalist positioning puts you at a significant disadvantage when it comes to delivering value.

3. Take a hard look at your costs.

When aggressive competition arrives on the scene and prompts the cutting of prices, incumbents often find that they have to take a hard look at their spending and to make tough decisions about cutting anything that isn’t essential.

There are two kinds of costs in every business: the “good” costs that drive activity in which clients see value; and the “bad” costs, which are everything else.

Some bad costs are inevitable. But the key is to maximize the good costs and minimize the bad, being ruthless about every dollar you spend that doesn’t translate into clear value for your clients.

One final comment on the impact of greater fee disclosure: based on historical precedent, it will be both greater and less than what many advisors expect.

It will be less in the near term, given that inertia is a very powerful force, especially among older clients. So, if you plan to be in the business for only two or three years and are doing a good job on client communication, chances are that you’ll be fine.

In the mid- to long term, however, the impact of greater transparency and disclosure will be more than many advisors expect.

The good news is that you have some time to adapt. The bad news is that the time to change isn’t unlimited, and things may move faster than expected.

Dan Richards is CEO of Clientinsights (www.clientinsights.ca) in Toronto. For more of Dan’s columns and videos, visit www.investmentexecutive.com.

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