Digital connection – to what?
A recent article in Citywire (The suitability race: how to drag firms into the 21st century) set me thinking about how limited in aspiration are the innovations in the way advisers and clients connect digitally. All that’s changing is how you say what you have to say: it’s about access, touch points, the medium. What technology is not obviously altering is what wealth managers actually do and how they do it. But without that change, there isn’t anything new for either party to say as a result of technology adoption and therefore no scope for changing the client’s experience.
When we think about what most changed as a consequence of Fowler Drew adopting technology, it was the nature and content of the conversation with clients. But that was because the technology we applied fundamentally changed the decision process itself, for both planning and managing. In fact, one of the changes it required was to make every portfolio dependent on a plan. As a consequence, the conversation became more relevant: all about the client instead of about investment; looking forward more than back. Whilst everything else about the business is different, the touch points for clients (reports, meetings, communication media) are actually still quite conventional.
When I mentioned this the other day to Chris Drew, with whom I first devised a model to support both goal planning and the management of a goal-based portfolio, he reminded me that in my book No Monkey Business I started with my characters, John and Sally, in a classically conventional financial planning session which was woolly, mystifying and disengaging, Past Preface, and ended with Future Postscript, as they engage digitally with their planner/manager to reassure themselves that they were on course to achieve their planning outcomes. True, but I didn’t mean the digital connection to be the key point of the contrast so much as what they wanted out of the touch point that they did indeed get. For us to change John and Sally’s experience for real, Chris and I knew we needed to build a process that was more about journey management than investment management. That called for radical changes in the way we modelled the journey, took decisions and communicated progress.
Nutmeg, online discretionary manager
The Citywire story focussed on three emerging businesses, only one of which, Nutmeg, has had a lot of venture capital thrown at it. It is a digital business in the sense that the access for both new and existing clients is entirely online. Though much faster, the route from information gathering to a suitable investment solution is wholly conventional, replicating online the logical steps followed by financial planners and business takers-on in offices and branches everywhere. An online decision tree can be faster than a conversation, though whether it is too fast for anyone’s possible good (“You’re 10 minutes away from a professional portfolio’) is another question.
The investment solution that Nutmeg’s decision tree maps to is also wholly conventional: a set of portfolios diversified between asset classes (‘When you create a Nutmeg investment pot, we determine which of the 10 risk-based portfolios that we manage is best for you’). Each of the 10 has its own location on a risk spectrum defined by short-term return volatility, the location being differentiated largely by the exposure to fixed income or bonds relative to the exposure to a set of asset classes with equity-like behaviour. This therefore replicates portfolio structures found everywhere, both on and offline, both managed and advised and even, for DIY investors, on every fund supermarket and platform.
The combination of a conventional route and the conventional destination is what we call the Factory Model: it is both manageable and scalable. Because it’s being churned out of factories all over the country I dare say it is also reassuringly familiar.
What messages to clients does the Factory Model support? Nutmeg, like any non-digital manager, can report the value and change in value of the portfolio and make comparisons with a benchmark index broadly appropriate for the particular location on the risk spectrum. Using that rear-view mirror it can explain itself. It can also express opinions about the markets that justify how it is currently positioned relative to its benchmark or some neutral set of exposures, which logically will later become the subject of the explanations of what subsequently happened. In other words, it can have conversations about markets and investment.
What Nutmeg and any adopter of the Factory Model cannot do is have conversations about the purpose of the portfolio and its likely outcomes at the time horizon(s) relevant to its own purpose. That would require it to construct portfolios differently from the Factory Model, each dedicated to a particular purpose and possibly combining a set of assets belonging to more than one party, with explicit time horizons and planned outcomes, probably within agreed tolerances. Goal-based, outcomes-driven.
If it could talk about customised outcomes then logically a dialogue involving these would have been the means by which, at the outset, they arrived at the right approach to risk-taking, as this would be
direct (instead of the indirect risk-preference discovery process in the Factory Model)
costed (as in the dependent relationship between outcomes and each of resources, time and risk) and
quantified (eg as a quantity in real terms at the planning horizon, rather than a rate of return).
If the outcomes used to plan within and between goals were based on a probabilistic model, and if the probabilities incorporated the effects of following a set of dynamic portfolio construction rules, then it would be possible to talk about what has recently happened (actual returns and values) in terms of the impact on outcomes (changes in projected quantities) and also in terms of the tolerances expressed by the client for those outcomes (such as the chance of exceeding the minimum target or the joint probability of running out of capital and still being alive) – these bits of information being whichever were most important to the client given the nature of the goal and the way they visualised the consequences of uncertain outcomes.
It is because we adopted a stochastic model for both planning and managing the journey systematically (following rules) that we could calculate these numbers, knowing that that is how the money would be managed from start to end of the plan. The technique changed what we were able to talk about. What we were talking about in turn altered our clients’ experience of the journey, providing the reassurance, clarity and confidence that John and Sally were looking for, as is apparent from what clients say about us.
Technology behind the scenes
I’ve chosen to focus on the way technology impacts the client’s total experience because that is the most important. But there are less visible aspects of technology that support the whole process. For instance:
Goal-based investing requires the total holdings of a single client or couple, including possibly non-managed assets, to be assigned to one or more different goal-based but ‘virtual’ portfolios, managed differently, even though in reality they have individual legal owners and sit in different accounts. Most investment accounting systems were never developed to support this and so firms’ existing systems effectively block the route to a better investment approach.
Adopting systematic decision rules within every virtual portfolio calls for these to be integrated with the investment accounting system, to ensure that mass customisation is still economically efficient.
A new step will be adapting fully-customised portfolios to a suite of model portfolios on a platform, where each model is not a discreet portfolio (like Nutmeg’s 10) but rather a stage in a journey that might be used by a range of clients because it matches for a while the asset allocation called for by their own combination of time horizon and risk tolerance. It takes 26 portfolios to capture most of the utility of fully-customised portfolios. This exploits transaction technologies already developed by most investment platforms.
These ‘enabling technologies’ are key to expanding the market segments we can economically serve and to ensuring the industry-wide fee compression we expect cannot hurt us.
We expect digital connectedness to follow in the form of giving the client direct access to the database itself, giving complete visibility about their own portfolios and all related communications between us about both planning and managing. Flexibility means they can define their own reporting template, including both the periodic data and data from inception or from the latest change in planning.