“Multi-Family Office”, “Independent Asset Manager”, “External Asset Manager” – Confusion Reigns in Asia

Whilst Sun Tzu’s quote was directed at military strategy, his quotes resonate throughout many aspects of business and personal life. However, meet an independent asset manager (IAM – which we will use as the broad term for a multi-family office, independent asset manager or external asset manager) in Asia, and the first ten minutes of a meeting is spent with a long explanation as to how they differentiate themselves from and are a better proposition than private banks – it can be confusing!

The reality is that apart from balance sheet and custody, there can often be little difference, and worse, IAMs who are operating 100% to the perceived role, are placed in the same basket as those who adopt a less transparent and conflicted approach.

Let me explain.

By: Mark Smallwood TEP

The Pitch

In the IAM community, the “pitch” is that the IAM acts in the best interests of the client. Indeed, a pitch may almost extend to the representation of acting as a fiduciary – but not quite. The client typically maintains their assets in their name with separate custodians such as private banks and online brokers, and authorises the IAM, under a limited power of attorney, to manage the assets (but not remove assets from the account). For this and other related services, the client pays the IAM a transparent fee in the belief that the IAM is acting in an unconflicted manner on behalf of the client. At least that’s the pitch.

The Reality

The reality is that some IAMs do indeed adopt this approach, whilst others do not. So broadly there are two categories of operator in the same space:

1.      Firstly, the IAM that charges a fixed fee which is usually broadly based on the Assets Under Management (AUM) it is managing. This IAM will negotiate the best possible pricing for custody and execution, and will not be conflicted in their choice of product to the client as they will receive no financial inducement to pick one product over another.

2.      Other IAM’s will charge fees, as in the case of the first example. However, they will also receive financial inducement for the use of certain products on the custodian’s platform, and this inducement will take the form of a fee sharing agreement with the custodian who will share a portion of the fees generated. This might extend from artificially high custody and transaction costs, through to retrocessions on active mutual funds, structured products and other high margin products.

The result is two-fold.

Firstly, the regulated IAMs, who operate in the same space, are not playing on a level playing field. The transparent, client centric operators who are working in a fully disclosed capacity with their clients, are placed in the same field as the operator who has created the illusion of doing this but is not actually operating in this manner.

Secondly, the client is confused, and remains suspicious. How can the client differentiate between the two, and indeed how can the client be confident in a system that allows what must bluntly be called a deception to take place.

Regulation

As with most businesses, the issue comes down to regulation. In a highly competitive landscape, business operators will always seek to push to the envelope of the law in their search for profits.

In the wealth management space, the issue almost always boils down to “fiduciary duty”, which is a legal obligation to act in the best interests of another person or entity. Unless there is a specific requirement to act as a fiduciary, a grey area is created in which a much softer definition of duty such as “suitability” or “fair dealing” is used which creates the avenues to exploit weaknesses in the system and ultimately the client.

In the spirit of not re-inventing the wheel, these matters have often been addressed elsewhere, whilst Asia continues to lag. In the United States for example, there is a clear regulatory differentiation applied to these operating models.

1.      Firstly, the pure fee-based advisor in the United States, is typically regulated as a “Registered Investment Advisor” or RIA (at the firm level, whilst the employees are Investment Advisor Representatives). These firms and their representatives must adhere to a fiduciary standard of care which is laid out in the Investment Advisers Act. The result is that they can only charge fees for service and are bound by a much higher duty of care to their clients in the form of a fiduciary duty.

2.      The alternative is the broker-dealer, which is a firm that can buy and sell securities on behalf of its clients (brokerage services) or indeed for its own account (proprietary trading). Broker-dealers will also offer other investment products such as mutual funds, ETFs, and so on. The key point however is that they are not required to act as a fiduciary – they are required to act with the principle of “Suitability” – that being open to some interpretation, and under which they are able to generate non-transparent fees in the form of spreads on transactions, retrocessions and so on.

The reader will immediately pick up on the fact that the IAMs in Asia, do not follow the broker-dealer model. They cannot typically custody assets themselves and they operate under the model of managing assets placed with a segregated custodian by the client through a limited power of attorney. However, one must look beyond the “form” and reflect on the “substance” of many of these arrangements.

Many of the IAMs to all intents act in the manner of a “broker-dealer” in a hybrid set up. These firms utilise the custodians, generally the private bank external asset manager desks, who enter into arrangements with the IAM where they agree to re-imburse the IAM a percentage of fees and revenue earnt from custody and transactions fees and retrocessions from various products. The private bank (which is to all intents the broker-dealer), in effect becomes the nominee broker-dealer for the IAM.

The result is that without proper disclosure of this to the client, the IAM is motivated to negotiate poor fees with custodians (which are then shared) and to utilise costly product which whilst being sufficient to be deemed “Suitable” are far from suitable in the context of what a fiduciary would execute for a client.

The Solution

When it boils down to it, there is no problem with either the “Suitability” or the “Fiduciary” route. If a client chooses to deal with a firm that operates under the “Suitability” umbrella, then the client needs to exercise his or her right to “beware”. However, the client should know what he or she is dealing with.

The problem occurs when the industry, through soft regulation, is allowed to misrepresent the nature of the relationship. If an IAM is able to represent that they operate on a fee basis but is not required to disclose to its clients that it receives what are politely called “retrocession” fees (or less politely “kickbacks”) then there is clearly at best a lack of honesty, and at worst outright deception being undertaken.

The ultimate question is, is this an honest way to do business with the client, and is it fair to the client and to the IAM that is operating on a fully disclosed basis?

The solution is for regulators in Asia to re-visit the regulation of IAMs and to bring in clear lines of demarcation between the suitability and fiduciary roles. The current set up is not in the best interests of the client or the many IAMs that work on a fully disclosed basis with their clients. It is time that they can differentiate themselves for the full transparency that they strive hard to present, on similar lines to the RIA in the United States.

Clients should be one’s friends, not as Sun Tzu put it ”the enemy.”