A growing number of financial advisors have switched their strategy of actively helping their clients choose investments to one where they take on a more passive role. The thing is, they're still charging the same fees.
This newer strategy is less time-consuming, as the financial advisors deploy a hybrid method of identifying specific mutual funds managed by high-performing portfolio managers or other passive investments such as target date funds.
"Many financial advisors have "moved away from the direct management of client investments to a more hands-off role often referred to as a 'manager-of-managers,'" said David Twibell, president of Custom Portfolio Group in Englewood, Colo.
Instead, these advisors allocate their time and efforts on identifying "outstanding" mutual fund managers and allocating the client's capital to them, usually according to a series of risk-based asset allocation strategies, he said. These advisors also rebalance the investor's accounts back to these strategies periodically, depending on movements in the market.
The benefit for advisors is that this approach emerges as an efficient one since they do not focus their time on identifying individual investments. Instead, they can allocate their time on garnering new clients and maintaining their current ones, both of which have a large impact on "bottom-line growth," Twibell said.
While advisors find this to be advantageous, investors may not find that this approach will boost their returns or help them take a position in the market. This passive strategy also does not help investors save money on fees, which can add up to hundreds of thousands of dollars over two or three decades.
The drawbacks of this approach is plentiful, including the additional layer of expense for investors who are paying a fee to their financial advisor, but also a series of outside fund managers. The combination can add up to total fees of over 2% per year, he said.
This task can be replicated by low-cost robo advisors which use automated computer programs to identify the funds while rebalancing portfolios at a "fraction of the cost of a traditional financial advisor," Twibell said.
"That's putting increasing pressure on these 'manager-of-managers' to either reduce their fees to match these robo advisors, offer clients additional services like comprehensive financial planning or shift their focus back to directly managing client assets," he said. "It's a tough spot for many advisors, since all of these options involve either reduced revenue or additional costs."
This trend is not likely to disappear, but clients are becoming more sophisticated as they demand greater transparency, lower costs and more value from their advisors, Twibell said.
"For many advisors, that means they either need to offer broad-based planning services or a unique and effective investment approach that adds value and can't easily be replicated by a computer program," he said.
While passive investing has emerged as a popular approach for many financial advisors, it is "simply a strategy that has worked very well in a bull market and advisors should use caution," said Edison Byzyka, chief investment officer of Hefty Wealth Partners in Auburn, Ind.
This investment strategy is not likely to produce long-term growth for investors and could turn out to be a bubble, he said.
"All strategies work some of the time but no strategy works every time," Byzyka said.The active approach will generate better returns after a correction and mitigate more risks.
"Everyone thinks they need to own the S&P 500 passive ETF until it corrects by 20% and takes a year or two to be whole," he said. "If passive investing was such a hot craze pre-2008, it would have taken investors until late 2013 to be whole -- adjusted for inflation -- and they would only be enjoying three years of the current bull market. Any correction at this point will only derail that sentiment."
During periods of volatility in the market, investors need to examine how much risk they want to take on, Byzyka said.
"Most active managers tend to do better in such an environment," he said. "Rational active management is risk centric, which means beating the index is not always the primary goal as long as the manager can deliver on downside protection."