Build Customized Bond Portfolios: Take Your Registered Investment Advisory Practice to the Next Level (2005)

EXECUTIVE SUMMARY * FOR HIGH-NET-WORTH CLIENTS with fixed-income investable assets over $500,000, firms might consider designing customized bond portfolios that meet each client's unique financial goals and risk tolerance. * IN ADDITION TO SERVING THE BEST INTERESTS of clients, CPAs introducing such customized fixed-income portfolios also add value to their firm by broadening the relationship with the client, boosting overall revenue, contributing to stabilizing the firm's revenue profile and increasing the firm's ability to compete. * CPAs/RIAs CAN CREATE A CUSTOMIZED portfolio for a client by acquiring bonds with stylized characteristics (such as different credit qualities, AMT status and call features) and by choosing either municipals or taxable issues (or both depending on the client's tax concerns). * A FIRM THAT CHOOSES TO BUILD internal infrastructure instead of outsourcing must establish cost-effective relationships with broker-dealers; invest in the managerial overhead necessary to create an operational fixed-income service; and train staff about customized fixed-income portfolios. ********** Firms seeking to broaden client relationships and increase revenue can meet both objectives by expanding fixed-income services to include laddered and other types of individual bond portfolios. During the past decade, many CPA firms have created fee-only registered investment adviser (RIA) affiliates in their firms or outsourced the function to RIA specialists, building the assets under their management by cultivating investment philosophies that appeal to high-net-worth clients. In this article, CPAs will find suggestions for offering clients specialized fixed-income platforms. In particular, advisers can offer high-net-worth clients the opportunity to move from bond mutual funds to individual customized bond portfolios. The article also discusses some of the obstacles firms might encounter when introducing new fixed-income services. ELEMENTS OF A CUSTOMIZED PORTFOLIO Relying on bond mutual funds usually is the most prudent strategy for portfolios under $500,000, but for larger amounts, firms should consider designing a bond portfolio of individual securities that meet the unique financial goals and risk tolerance of each client. Bond funds and a portfolio of individual bonds are not the same. If a client invests the fixed-income portion of a 60/40 portfolio worth $2 million in a bond fund with a 0.50% annual fee, the portfolio loses value paying for expenses such as commissions and portfolio turnover. And the bond fund holdings don't reflect the client's specific income needs, tax situation and risk tolerance. But a client with an individual bond portfolio through a fee-only RIA typically pays only a charge per transaction for bond purchases and sales. (This does not include any markups or markdowns on the bond price, discussed later in this article.) There are two broad ways a portfolio can be invested--actively or passively. Active investors assume that the market is generally inefficient so they regularly exploit opportunities when holdings are trading for more or less than they are actually worth. For investors to succeed at active investing, opportunities need to be of sufficient frequency and value to cover the cost of consistently seeking and executing trades. A passive investor, on the other hand, assumes that the opportunities to exploit inefficiencies are too few and far between to effectively pursue. There is a great deal of academic evidence indicating that the collective wisdom of all market players results in highly efficient markets that reflect fair pricing almost instantaneously upon release of any news that might affect a holding's price. Adopting a passive approach to fixed income lets firms minimize the management costs incurred by clients. In actively managed fixed-income programs, the portfolio manager attempts to beat the market by trading bonds he or she believes the market has under- or overvalued, or timing the direction of future interest rate movements. …