This past year, we surveyed over 1,000 registered investment adviser (RIA) firms about their operations, technology, and portfolio management styles. Our earlier posts highlighting key findings from the study noted that RIA firms that aggressively adopt technology and offer financial planning services are growing assets under management (AUM) at a faster pace relative to their peers. In addition, we also observed that advisory firms that manage portfolios actively may be at more risk of growing at a slower pace relative to peers due to the risk of client investment portfolios under-performing. And most recently, we noted that our study showed that RIA firms on average charge a 1.03% annual client advisory fee. This new post examines the survey data to answer the question: What percentage of investment adviser firms outsource client portfolio management?
The chart below indicates the percentage of investment advisory firms in 2014 compared to 2013 that manage portfolios internally or "in-house" across different assets under management (AUM) segments:
As illustrated in the chart above, our two most recent survey results both indicate that overall, 82% of RIA firms manage client investment portfolios internally. On the other hand, 18% of investment advisory firms are utilizing a third party to outsource client investment management. The responses also indicate that firms with less than $50 million in AUM are more likely to outsource asset management. The fact that smaller firms are more frequently using a third party asset manager makes intuitive sense given that such firms may feel that they do not have the internal resources to focus on portfolio management.
When outsourcing portfolio management, firms are often using a turn key asset management platform (TAMP). These platforms fall into many categories and include traditional providers that may provide access to a unique investment platform such as Dimensional Fund Advisors (DFA) mutual funds or the newer breed of automated investment platforms that are beginning to serve RIA firms. In addition, there are also a growing number of larger, traditional investment advisory firms that now offer these services to smaller firms.
RIA Firms Outsourcing Investment Management Based on Year of Establishment
The chart below looks at the percentage of firms first registered in a given year that are managing client portfolios in-house versus outsourcing to a third party firm:
The chart above reveals that firms most recently registered in 2014 are outsourcing investment management much more frequently compared to firms established in prior years. 30% of firms started in 2014 are outsourcing portfolio management compared to 18% of firms overall. It will be interesting to look at the results of this year's upcoming survey to see if this recent uptick holds steady or begins to decline as newer upstarts gather additional assets. In general, we see a growing number of attractive third party outsourcing options and suspect that the recent shift towards newly formed firms more frequently using a third party money management firm will continue.
RIA Firms that use Passive Investment Management are more likely to Outsource Portfolio Management
The graphic below illustrates that firms that use a passive investment management style are more likely to outsource the portfolio management function compared to firms that use an active investment management style:
There is quite a significant gap in the frequency of portfolio management outsourcing when looking at passive versus active investment management styles. To provide some perspective, our earlier analysis on the percentage of investment adviser firms managing portfolios passively vs. actively revealed the following results when looking at all firms regardless of AUM:
- Exclusively Active: 43%
- Exclusively Passive: 19%
- Both Active and Passive (Hybrid): 37%
However, each year our survey continues to reveal a rising number of firms using an exclusively passive portfolio management style. If that trend sustains itself in future years, it's possible that there will also be a coinciding steady increase in the number of RIA firms using a third party platform to manage investment portfolios. In general, it seems logical that firms with a bias towards passive investment management are more likely to outsource investment management given that such firms are often more focused on holistic wealth management rather than marketing client portfolio returns that "beat the market." This assumption is explored a bit further in the next depiction.
RIA Firms that Outsource Client Portfolio Management are more likely to offer Financial Planning
As the graphic shows below, advisory firms that use a third party asset management firm are much more likely to offer financial planning services:
In general, our studies have continually revealed that firms that use a passive portfolio management style are more commonly also offering financial planning services. As such, the above graphic coincides with these previous findings and continues to articulate that the advisory firm characteristics of managing portfolios passively, using a third party asset management firm, and offering financial planning services are highly correlated. It should also be noted that our analysis has also consistently revealed that RIA firms that offer financial planning services appear to more frequently succeed compared to firms that do no not.
What types of RIA Firms should consider using a Third Party Investment Management Firm?
As our survey results revealed, outsourcing portfolio management can often be an attractive option for smaller or even larger investment advisory firms that may not have the internal resources or desire to manage client portfolios in-house. When considering whether the third party asset management option makes sense, firms should consider these key questions:
- Do I feel that my firm is capable of delivering a professional investment management experience?
- What are the total costs of the in-house vs. third party options for my clients and for my firm?
- Does my firm's investment philosophy properly align with the third party firm?
- Does the third party firm offer any other type of practice management or technology support in addition to portfolio management?
- What types of interactions will this third party firm have with my firm's clients?
In addition, it is very important that advisory firms perform the proper due diligence on third party asset management firms from a compliance and information security perspective given that the third party firm will likely have access to non-public private client information.
Lexington Compliance and RIA in a Box LLC are not law firms, investment advisory firms, or CPA firms. Lexington Compliance and RIA in a Box LLC do not provide legal advice or opinions to any party or client. You should always consult your relevant regulatory authorities or legal counsel if applicable.