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Part 2 – The Post-Fund Future Hits Advisors

Published on

March 7, 2019

Thanks and credit go to Michael Kitces, as our conversations have significantly shaped my thinking on the post-fund future for advisors. Kitces first described the post-fund paradigm shift in 2014.

Funds are dead. Advisors are the beneficiaries. In Part I, I described the death of funds and the emergent post-fund paradigm, executed via DCIs (Dynamic Custom Indexing). This view was also summarized in InvestmentNews, and wonderfully described as “The Great Unwrapping” last month in, and in the opening plenary of the annual conference. The “Post-Fund Paradigm Shift” will transform the industry. But what are the concrete implications for financial advisors? It’s a three-fold opportunity: one, cut fees and taxes; two, sell your own factor portfolios; and three, personalize your offering. In sum, financial advisors will move from building portfolios with cinder blocks (funds) to 3D printers (software) and their own models, which will significantly benefit their bottom line.

A list describing the top 5 reasons financial advisors switch to Dynamic Custom Indexing technology.

So forget crypto. Forget robo. We are discussing secular shifts. For savvy advisors, the switch to “asset management as a service rather than product” may be the defining opportunity of their careers. (If that’s not of interest to you, stop reading here.) What Is It? As transaction and other costs decline, coupled with new infrastructure, the entire rationale for ETFs will dissolve in the next several years. They will be replaced by DCIs. As I have written elsewhere:

A DCI is essentially a dynamic separately managed accounts (SMA) engine which is replicating indices by directly purchasing the underlying stocks. The software maps the correlations across the balance sheets of all the tradable securities in the selected universe. It allows custom changes to be made to the portfolio. It then responds dynamically by breaking apart and rebalancing the portfolio in-real time, ensuring tight tracking of the index. Here is a short video that graphically represents how this works. Finally, a DCI typically has an integrated front-end to allow relationship managers and clients to interact with the software and leverage its capabilities.

I’ve used the metaphor of the digital transformation in the music industry, whereby the record labels (i.e. asset management) realize they’re not selling compact discs, but music. In the financial space, those can be beta or alpha. But these portfolio rules and rebalances will not be consumed via clunky, inefficient funds. As was recently written in Barron’s:

“Index providers and active managers could one day directly provide investors with their portfolios, and improvements in trading technology will allow them to trade those portfolios as a single unit if they want—their own ETF. Imagine a day when you can stream Jeffrey Gundlachs’ ideas straight into your portfolio…No wrapper fee. No platform fee. No gatekeepers. Just better technology.”

This is where the metaphor ends. Finance is not music – where everyone’s opinion is valid. This streaming, post-fund future needs a DJ, and that’s you. Here are your turntables.

Laptop and iPad screens showing OpenInvest's Optimus software. The device show the screen for Cause selection and the screen displaying backtests for a modeled portfolio.

DCIs tend to be vertically integrated. They connect straight into brokerages on the back-end, and directly into advisor interfaces on the front. In a client meeting, an advisor can now whip out an iPad and input her allocation mix, including both passive benchmarks and her own or others’ alpha models. By bypassing the fund manager, she can easily enable tax-loss harvesting, add additional factor tilts, add/remove ESG values or individual securities, and hit “go.”

Cut Costs & Taxes

First, to be clear, YOU, the advisor, are not the middleman. Most everyone else is. In the equities value chain, the truly human, subjective, value-add rungs consist of: clients, relationship managers, research and shareholder engagement in some cases; and corporates (stocks). Everyone else is just 1’s and 0’s, and that software can be consolidated. Despite their essential role, financial advisors have functionally been treated like salespeople. They are often seen as the distribution arm for fund families, who make money by driving maximum volume to their suite of products.

Now let’s imagine a world where funds are replaced by software. Here are the cost benefits:

  1. Cut the ETF and mutual fund fees. Instead, directly “stream” indices, your strategies, or other people’s strategies.
  2. Help push down marketing fees ultimately charged to your customers. Those consist of 12b-1 fees on mutual funds (underlying fees that are typically used as commissions for salespeople). Meanwhile, ETFs are engaged in the even more dubious practice of paying behind the scenes for access to your distribution platforms. But why should you pay for CD covers and shrink wrap if you can just stream the music?
  3. Perhaps most significantly, deliver all the same strategies… plus a tax alpha.

Most ETFs are tax inefficient compared to direct indexing. They do not allow tax-loss harvesting at the individual equity level. With a handful of funds in a client portfolio, there are limited opportunities to harvest losses or gains (which is typically a manual, cumbersome, annual process). When you can harvest at any frequency across all the individual securities in the universe (a process only fit for software, not humans), there are far more opportunities to generate a tax alpha.

According to Roshan Weeramantry, Director and Financial Consultant at Rina Wealth:

We are both a major regional CPA firm and an RIA for HNW families. Dynamic Custom Indexing allows us to open up whole new frontiers for tax and other optimizations to better service our clients. Specifically those who have high exposure to individual positions with large tax consequences and sectors they may not be passionate about. Given the OpenInvest tools now available to service these unique needs, we can more efficiently serve our clients and better align their portfolios with their personal situations and beliefs.

Obviously, the benefits go beyond tax-loss harvesting, and include handling individual and inherited brokerage exposures, gains harvesting, etc. It’s ultimately about treating clients holistically to reach an untapped efficient frontier.

Sell Your Own Factor Portfolios

Imagine being able to easily build factor portfolios that only you offer.

Most advisors are still selling alpha, at least at the tactical allocation level. Why keep shipping so much of your fees, and your firm’s best thinking, to other parties? DCIs puts this all back in your pocket, unleashing new frontiers in differentiation, segmentation, and customization. Advisory firms, individual advisors, as well as asset management shops, can maintain tight fidelity to either indexes or their existing alpha strategies, while becoming producers of factor portfolios.

Think the portfolio should favor value tech stocks, or perhaps tech stocks with strong security protocols? Select your starting universe(s), your views, and go. You don’t need quantitative expertise, a team of ESG analysts, or a trader. The portfolio is modeled with a few clicks, without the distortion of stock-picking. Rather, you are operating at the quantitative rules level. Meanwhile, the data feeds, updates, and execution are automatically managed by rules-based systems on an ongoing basis within a specified tracking error budget. Run it and sell it right off the platform, so you can quickly return to client facetime.

Adrian Jones is Executive Vice President of Mirador Wealth Advisors, a San Francisco Bay Area RIA. He is both a heart attack survivor and a passionate advocate of healthy living. He has used DCIs to build an indexed “heart healthy portfolio” for doctors, nurses, health organizations, and more. “Developing a Heart Healthy Portfolio has allowed me to differentiate on a factor I’m truly passionate about, while maintaining strong portfolio fundamentals, and relating to key clientele who share these values.”

Because you control both the strategy and the relationship, and are running on a DCI platform, you’ve opened up a new frontier for the bottom line. You’ve helped sustain your alpha pricing by making it customized, and owning that margin. You’ve made your relationships stronger. And while you’re at it, you’ve also made a grand entry into the ESG market without having to launch a cannibalistic new product that’s outside your core competency.

DCIs mean you get to keep doing more of what you do best – building relationships and applying your best financial thinking — at the best pricing.

From “Strategic Enhancements” to Full Personalization

What if an individual client wants a tweak? In a recent conversation I had with Michael Kitces, he whimsically referred to these as “flavor boosts.” I call them Strategic Enhancements. Maybe a client loves your portfolio, but doesn’t want oil stocks (sector tweaks), or she inherited a bunch of GM stock and should really reduce her exposure (individual names).

Simple. Just select your index, alpha strategy, or existing portfolio. Then add these enhancements as you encounter client preferences. The system automatically rebalances the  portfolio quantitatively to ensure tight fidelity to your core strategy.

No two people have exactly the same values. Technology is the key to bridging the gap between customization for individual clients and maintaining discipline across an investment firm with multiple financial advisors.

Or you can go whole hog, customizing with ease at each account level. Tom, Grace, and Avi all have different goals, situations, and values. So why should they have the same cookie-cutter portfolios? Grace wants your expertise; but she has special tax exposures, cares about gender diversity, and doesn’t want Facebook. That’s a few clicks, review the updated models, hit go.

DCIs enable personalization with ease.

This is not for every advisor all the time. But it is extremely powerful for some, including those offering values-informed investing (ESG/SRI), servicing next gen clients and UHNW.

The reality is that most advisors will want to maintain a mix of DCI features in their arsenal, deploying as appropriate – whether it’s at the firm level, client segment level, or individual account level. From Adrian Jones again, Executive Vice President of Mirador Wealth Advisors:

Values-based investing through Dynamic Custom Indexing has allowed us to customize portfolios for our clients with ease.  Additionally, this approach has opened up new channels and segments, while providing us with an innovative solution for existing clients that have strong opinions on the types of companies in which they invest.  In turn, it allows our advisors to speak passionately with clients about the things they – and we – care about, which transforms our relationships. It’s a game changer.

Most advisors will deploy tax harvesting across their entire taxable wealth portfolios. They may then build and sell their own, or their firm’s models, applying tweaks to quickly add personalized value on a case-by-case basis. And finally, they can deploy full customization where they see special needs.


Marc Andreessen famously stated: “Software is eating the world.”* Finance can’t escape this digitalization. But the disruption is not what many imagined a few years back. Software attacks repetitive tasks and basic distribution—exactly the work advisors don’t want to be doing! These are tasks for which indexers and wholesalers are better suited.

Instead, you’d rather be focusing on the most elevated, human tasks. It’s also where you make more money. Personal relationships. Developing your best financial thinking. Growth. And yes, cutting costs, taxes, and investing in new tools where appropriate.

The post-fund future is coming. For advisors, that future is bright. Instead of selling 10 funds, you will be selling 10 strategies – each with tightly bounded variations based on the client’s unique profile. This more flexible approach will enhance relationships, differentiation, and margins. Particularly for early movers, these are core advantages that will constitute the wave behind the next set of leading financial advisory firms.

*Disclosure: Andreessen-Horowitz is OpenInvest’s largest investor.

Investment in securities involves the risk of loss. Past performance is no guarantee of future returns. One cannot invest directly in an Index. Any opinions, estimates and forecasts offered in this document constitute judgment as of the date of the materials and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information contained in this document to be reliable but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only and it is not intended to provide and should not be relied on for investment, accounting, legal or tax advice. OpenInvest may not have verified (and disclaims any obligation to verify) the accuracy or completeness of any information herein that has been provided or obtained by third parties.

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