Assessing Your Investment Process and Portfolio Performance: Broker vs. Advisor Approach

Investment portfolios and overnight cash positions have grown significantly at many financial institutions due to a recent surge in deposits and slower portfolio loan demand.  With record low interest rates, carrying excess cash on the balance sheet has been costly.  These factors are forcing executive teams to re-focus on the investment portfolio to help relieve net interest margin pressure from declining earning asset yields.   

In general, financial institutions have two options for managing the investment portfolio.  We will refer to these as the Broker and the Advisor approach. 

The Broker Approach 

An institution’s financial executive (CFO, President, Portfolio Manager, etc.) has the option of working directly with a variety of brokers/brokerage firms to make investments for the portfolio.  Usually, brokers will present different products for consideration often via frequent email distributions.  Some of the communication is individual and some is “mass mail”.  Entertaining and building personal relationships is often a key ingredient in the way brokers “win” ongoing bond business.  An institution’s financial executive is ultimately responsible for fully understanding the investment, determining how it best fits on the balance sheet, determining relative value, and ensuring best trade execution. It is caveat emptor – buyer beware. The broker is compensated through trade commission. 

The Advisor Approach 

A second choice for managing the investment portfolio is partnering with an investment advisor.  This is a co-management approach where the institution’s financial executive and the investment advisor work together on strategy development and execution.  Effective investment advisors consider the entire balance sheet when making investment portfolio recommendations and commit time to client education. Advisors are typically independent and are often compensated via an advisory fee. 

Neither approach is universally right or wrong, but one could be a better fit for your institution.  

Evaluating your Current Broker or Advisor 

A common mistake financial institutions make is failing to properly monitor/oversee their broker(s) or advisor.  For those institutions, it is important to periodically evaluate these relationships, to make sure that the investment process is running well and also complementing overall balance sheet objectives. 

If you have been relying on your brokers for investment ideas and managing the investment portfolio.  How are they doing?  Have their recommendations resulted in above-peer or below-peer performance?  Has your advisor been delivering on their value-add proposition?  Click here to get a Performance Snapshot of your institution’s investment portfolio performance vs UBPR and State.  If your portfolio yield is average or underperforming peers, and/or your brokers/advisors cannot clearly articulate how the investment strategy fits the overall balance sheet, it may be time to consider a change.   

If you are considering a change from a broker approach to an advisor approach or switching advisors, below we discuss seven benefits and/or best practices of working with an investment advisor to improve portfolio and balance sheet performance:  

  1. Investment Management from a Whole Balance Sheet Perspective – Financial institutions’ bond portfolios should never be managed as a stand-alone group of assets.  Instead, it should be viewed in concert with the overall balance sheet, serving as a key component alongside loans and deposits. Not only what to invest in but how much.  Investment advisors that are also balance sheet experts have a clear edge over investment-only professionals/advisors and brokers that know little to nothing about the balance sheet. 
  1. Accountability & Transparency – An investment advisor is a fiduciary that is completely aligned with your institution’s objectives.  Portfolio returns are advisors’ report cards, and they are accountable to their clients.  In contrast, securities brokers are rarely held accountable for portfolio performance, are not fiduciaries, and have an inherent conflict of interest from commission-based compensation.  These commissions are often opaque and can vary significantly depending on the bond.   Investment advisors, on the other hand, are not broker/dealers and have a clear and transparent fee structure. 
  1. Strategy and Relative Value Analysis – Astute advisors have a wealth of market and investment product knowledge.  They constantly analyze relative value of various sectors and utilize this information when making portfolio-specific recommendations.  Advisors spend a lot of time and energy identifying good-performing securities to improve your institution’s portfolio returns.  Conversely, some investment brokers are tempted to choose the path of least resistance and optimize commission payout with least amount of time/effort.  For example, it is very easy for a broker to sell new issue callable agency bonds because they are simple to explain and are widely available.  However, this asset class has historically had poor relative value and performance profile. 
  1. Exclusive Product Access – There is a misconception among executives that all brokers have access to any investment in the market.  This might be true for callable agency bonds, but not for all investments. Often, certain bonds might not be widely available, yet offer superior attractive risk-return characteristics. Select investment advisors with a proven track record bring their clients access to a wide network of deal underwriters and have significant purchasing power to drive favorable deal structure and get their clients’ orders filled. Competitive deals that a broker/dealer does not win leave investors empty-handed.
  1. Staying in Control – Partnering with an independent investment advisor may feel like a sacrifice of control but that is far from the truth. However, the key is in finding an investment advisor that acts in a co-management capacity enabling you to let go of time-consuming, tactical tasks, while retaining important strategic decisions such as asset allocation, duration and credit profile. The relationship can be viewed as a partnership that provides your institution with increased operating efficiency, while leaving you in complete control of the process. Some investment advisors can incorporate existing brokerage coverage into the investment process so important relationships stay intact yet reduces transaction costs of the institution.
  1. Reducing Transaction Costs and Improving Execution – Investment advisors utilize a wide network of securities underwriters and dealers to improve trade execution.  Expansive investment technology and daily market participation allows experienced investment advisors to achieve pricing transparency.  It is not uncommon to lower transaction costs (bond’s purchase price) by 0.25 to 1.50 points on securities trades, which can equate to savings of $2,500 to $15,000 per $1 million traded, respectively.  For each $10 million in trade volume, this can amount to $25,000 – $150,000 in savings.  Improved trade execution improves portfolio returns and liquidity over time.  
  1. Redirected Productivity – CFOs and other executives often have limited/insufficient time available to devote to managing the investment portfolio. For example, trying to field frequent brokers’ calls and responding to endless emails can be time-consuming.   Investment advisors are dedicated to the oversight of this earning asset, which normally comprises a meaningful portion of the balance sheet. Managing the investment portfolio should not be a part-time job and the larger the investment portfolio is, the more impactful its performance is to the bottom line. 

Taylor Advisors Take 

With weaker loan demand and growing overnight cash balances, investment portfolios are playing a more important part in overall profitability.  Many financial institutions have relied heavily on the broker approach for investment advice but should be aware of the hidden costs and potential conflicts of interest.  One of the main reasons institutions partner with an independent investment advisor is to improve portfolio performance within context of risks unique to the balance sheet.  Executives should understand where their institution’s portfolio yield ranks compared to institutions in their market or UBPR peer group.  A low or below-average portfolio yield may indicate a strategy/process that needs adjustment.  Click here if you would like to receive a complimentary assessment of your portfolio’s performance.

Taylor Advisors helps executives by providing  strategies and expertise  to effectively manage the investment portfolio.  Please visit our website for additional resources including investment  success stories  or to  ask us a question  about your investment process and how we can help.