Lessons from 20 years of investment management

When I co-founded the investment advisory firm Northstar 20 years ago, the advisory business was truly a cottage industry. There were only three advisors in the Denver-area that had assets of more than $500 million under management. Most investors took advice from stock brokers or their local bank’s trust department officer.

Today, there are more than 20 advisors in Denver alone with assets of $500 million or more (including Northstar) and thousands of registered investment advisors nationwide.

Not only have the number of investment advisors grown, but the entire field of professionals offering investment guidance has expanded as well – ranging from financial planners to insurance agents to accountants. The vast array of choices, however, can often leave investors confused and unsure about where to turn for investment advice.

Here’s a look at some of the trends I’ve witnessed during my 20 years at Northstar and what they mean for consumers:

• A shift towards asset allocation– Under the registered investment advisory umbrella, you have wealth managers, who simply focus on figuring out how to allocate a client’s assets among a plethora of managed funds, and money managers, who research individual stocks. The number of advisors who perform in-house research and select equities for their clients’ portfolios themselves is rapidly shrinking because of the time involved. Instead, many advisors have shifted towards picking managers and often have no idea what companies are in their clients’ portfolios because these portfolios are based on asset classes, not the underlying businesses themselves. This approach can be expensive for the client because the client is in essence paying a double fee. The client pays the registered investment officer a fee based on their assets under management and then the manager of their mutual funds a fee too. At Northstar we actually buy individual stocks for our clients after extensive research, which is part of our underlying fee.
   
• The use of alternative investments. Essentially more and more investors are putting money into hedge funds, which are being marketed as “alternative investments.”  A hedge fund by definition “is a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains.” One of the downsides of these alternative investments is that they are incredibly expensive. Most hedge fund manager’s charge a 2 percent management fee and clients have to share 20 percent of any upside when there are positive returns. The other problem with alternative investments is liquidity. Typically, investors can’t get out of these investments for years. During the financial crisis in 2008 this was a real problem. Clients couldn’t cash out of these investments even if it was an emergency.
   
• The Fiduciary standard. The Fiduciary Standard has become more important than ever. President Obama recently brought this issue to the forefront with a proposal that would require brokers and other financial professionals to adhere to the fiduciary standard when advising clients on retirement accounts. The fiduciary standard requires registered investment advisors such as Northstar, to put their clients’ interests above their own. Brokers have been held to a lower standard, allowing them to make recommendations they believed were suitable for a client’s income, investment objectives and risk tolerance. Since brokers are compensated by commission and selling products, this can lead to an inherent conflict of interest. While it’s too soon to know how the proposal will play out, after the Bernie Madoff scandal and other high-profile Ponzi schemes, investors deserve more assurances about the trust they place in the people who manage their money. Applying the fiduciary standard universally would be a step in the right direction.

• The invention of Robo advisors. A Robo advisor is an automated program that will provide portfolio management online. While the ease of use is appealing, the lack of human interaction can be problematic. Who is going to tell the client not to sell into a panic, which is usually the worst time to sell or at market lows? I am not sure who investors actually talk to you when the market is falling when they call their Robo advisor – maybe Siri’s sister?

Selecting the right investment advisor is really important. You need to find someone who is honest, hardworking and trustworthy. It sounds easy, but it really isn’t. The best way to find a good person to work with is to ask for a referral from a trusted source who can tell the difference between an advisor, who truly has your best interests at heart or a broker or agent who is simply trying to sell you something.