Open Architecture Vs Proprietary Products - A High-Stakes Debate

Charles Paikert Family Wealth Report Editor New York 9 February 2010

Open Architecture Vs Proprietary Products - A High-Stakes  Debate

In the US wealth industry, debate continues on whether open architecture or proprietary business models deliver the best investment performance.

The great debate rages on, with billions of investment dollars hanging in the balance.

Open architecture, the investing platform/philosophy that allows a financial advisor to pick and choose asset managers for their clients without restriction, continues to gain momentum in the US, especially among independents.

But firms that sell in-house proprietary investment products have hardly fallen by the wayside, and in fact include thriving industry heavyweights such as Bessemer Trust, BNY Mellon Wealth Management, Alliance Bernstein and Wilmington Trust.

The open architecture approach to investing, according to its proponents, is above all objective and conflict-free.

“Using outside managers is the only way you can truly eliminate conflicts of interest,” said Jim Berliner, president of Westmount Asset Management in Los Angeles. “A firm with proprietary products has an obvious interest in selling their own products.”

“We’re trying to create a good decision-making environment, and proprietary products shoots that down,” said Rob Francais, chief executive of Los Angeles and San Francisco-based Aspiriant. “If management is attached to a product and their objectivity is compromised, it’s very limiting to a client’s ability to make a good choice.”                                        

Not so fast, counter purveyors of proprietary products.

“Trying to pick the top quartile asset managers in every asset class can’t be done,” argued Robert Elliott, senior managing director for Bessemer Trust. “It’s a regression to the mean and becomes a zero sum game.”

“In theory, owning the best investments in every asset class is flawless,” said David Lamere, chief executive of BNY Mellon Wealth Management. “In reality, the challenge is being able to execute it well.”

Choice versus customization

Open architecture advocates say advisors can choose from an unlimited number of asset managers, investment managers and styles.

“We’re able to help advisors choose from a wide range of managers and strategies that otherwise wouldn’t be available to them,” said Gary Carrai, senior managing director, Fortigent, LLC, an outsource provider for open architecture platforms.

“It’s like instead of walking into Macy’s and only being able to buy there you can go into a mall and buy from any store you want,” said Barry Glassman, president of Glassman Wealth Services, LLC in McLean, Va.

But many wealthy clients want and need customized investment products that open architecture can’t provide, say wealth managers selling in-house investments.

“A lot of our clients are looking for customized products, and if you outsource you lose the ability to customize,” said Eric Propper, president and chief operating officer of Atlantic Trust Private Wealth Management.

“Clients like to see what they have and be able to talk to the person who is doing the buying,” said Rex Macey, chief investment officer for Wilmington Trust.

Outside versus inside

While open architecture advocates flaunt the use of “best in class” managers as a sign of strength, competitors maintain it’s just the opposite.

“Open architecture means you’re incapable of doing [the investing] yourself and you’re passing off the responsibility to someone else,” said Michael Casey, president and chief executive of Pasadena-based Whittier Trust Company.

What’s more, being in the market makes them better wealth managers, executives selling proprietary products argue.

“We call it ‘rational architecture’ because to make good asset allocation decisions for clients you have to have people running money,” said Mr. Elliott. “You have to have intelligent people making day-to-day decisions, not just picking managers. That’s what gives you ‘in the market knowledge.’”

“Managing money internally makes us better prepared to evaluate external opportunities,” said Mr. Propper. “When we bring in our investment professionals to meetings, we get a lot of helpful information that can be used in making the right decisions for our clients.”

Taxes and fees

Internal asset managers also maintain that clients in an open architecture firm ending up paying additional fees to accommodate all the different outside managers and more taxes because of the volume of buying and selling.

Steve Lockshin, chief executive of Convergent Wealth Advisors, dismisses both claims.

“Nothing prohibits open architecture firms from going with managers who have low turnover, and that’s what we do,” Mr. Lockshin said.

If fees are an issue, he continued, firms need to “find managers who add values in excess of their fee. Or, given the size of their client base, they can get a discounted fee.”

Passing along an outsider manager’s fee is justified by the value it brings, said Mr. Berliner.

“It’s worth it for clients to pay for independence to get objective advice on asset allocation and manager selection,” he said.

Room for both?

Third-party observers say both sides of the debate have merit.

Outside asset managers may be stars, but if they’re having personal problems that affect their work, a wealth manager isn’t going to know about it until it’s too late, said Jeff Spears, chief executive of the San Francisco-based consulting firm Sanctuary Wealth Management LLC.

“The weakness of open architecture is lack of control of personality risk,” Mr. Spears said. “Problems don’t show up on weekly reports. A closed system is more controllable, but you can argue they don’t have the best managers, because if they were that good, they would go out on their own.”

Clearly, there appears to room for both approaches. Most firms selling proprietary product also use outside managers.

Roughly 60 per cent of Bessemer’s investment products, for example, are internal, according to Mr. Elliott, and focus on “core asset classes,” such as large cap U.S. equities fixed income and commodities.

Outside managers are used for hedge funds, private equity and real estate, he said.

“At the end of the day, there’s a place for both,” Wilmington Trust’s Mr. Macey said. “The important question to ask is why is a firm doing one or the other, or both?”

Whatever the answer, the great debate shows no signs of abating. In fact, two recent reports from the UK-based wealth management research and consulting firm Scorpio partnership threw more fuel on the fire.

One survey, released in January, showed a sharp rise in the number of investors around the world preferring to use in-house products rather than those manufactured by outsiders.

But earlier this month, another Scorpio survey revealed that wealth managers in Germany, Switzerland and the UK are moving away from a strictly in-house approach to investment research as more than a third of the firms surveyed believed the in-house model has resulted in gaps in their coverage.

Both sides, no doubt, will claim more arrows for their respective quivers – and sales pitches.

For further discussion on this issue, see the latest Opinion of the Week column by London-based WealthBriefing editor Tom Burroughes: “Making The Case For Staying In-House”. To view the item, click here.


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