The top five robo-advisors have attracted almost $200 billion in AUM and some projections say that this total could hit trillions in a few years.
Wealth management firms are looking for ways to help their advisors differentiate themselves from the now ubiquitous robo solutions.
As stated in Cerulli's 2017 US Advisor Metrics Report, money management services are at the highest risk of being eclipsed by automated advice. Online providers have been able to emulate advisor offerings of asset allocation and investment selection and scale them by leveraging much of the same underlying technology they use. For advisors whose primary value added is money management, their services must evolve to become sufficiently differentiated in order to the automation threat.
One way advisors have evolved their asset management offering is to enhance them with exchange-traded options strategies.
A study initiated by the Options Industry Council (OIC) found that approximately one-third of financial advisors currently use options in 20% of client portfolios and that usage is expected to increase by 30% over the next three years. The study also noted that employee channel advisors (wirehouse, national and regional broker-dealers) who use options report the highest volume of trades, with 35% executing more than 20 trades annually per account, versus only 21% of independent advisors.
While many wealth management systems have allowed individual advisors to add options to client portfolios, it has always been a manual process requiring orders to be entered account by account. It wasn't scalable and was quite time-consuming, especially when having to calculate the number of options contracts required to create covers call or protective put strategies.
All this is about to change.
I believe this could be a tremendous breakthrough for managed accounts programs beyond just the one-off usage that has existed in Rep-as-PM. For enterprises like wirehouses, regional broker-dealers and TAMPs that rely on centrally-managed investments, the ability to execute options strategies across hundreds or thousands of accounts could be a game-changer.
Vestmark, which recently passed $1 trillion in platform assets, has developed what seems to be an excellent marketing tool against pure robos and hybrid robos who are not able to offer options strategies. These can be especially useful for the higher net worth clients that many advisors covet.
As mentioned earlier, the higher frequency of options trading by employee channel advisors is usually supported by greater centralized support services, especially at wirehouses, which is one reason why they trade more often than other channels. Vestmark's options trading module could both encourage adoption of options strategies and also increase the frequency and depth of use in these other channels that don't have wirehouse resources. Assuming it works as advertised, of course.
According to Cerulli, advisors who currently use options appear willing to expand beyond the traditional use of covered calls, long calls and long puts. Though use of other strategies is less prevalent, many advisors also use option spreads, short calls and puts, cash-secured puts, and collars. Almost 80% of independent RIAs report using protective puts, the highest usage rate among all channels.
Maybe Vestmark, which manages over three million accounts on their platform, might be looking to add support for other options strategies in future versions of the module. (See 10 Towering Testaments from the T3 Enterprise Conference)
Going Under the Hood
Vestmark, based in Wakefield, MA, was kind enough to connect me with two of their senior people, Lauren Hunt, VP of Product Marketing and Vince Pellegrini, SVP of Client Experience. We took a deep dive into how the new options trading module works.
The new feature allows advisors to select options strategies for their accounts and link them to specific equity positions and then enables the home office to centrally manage the strategies across hundreds or thousands of accounts. These shouldn't be considered to be the same as assigning models, since the portfolio rebalancer does not interact with them. As it was explained to me, the attached options should not cause drift alerts or impact the assigned models in any way. They're managed separately from the other securities in the account.
So, in this case, you're not modeling options but they can live inside any advisory program. The system can then roll up the options orders across the eligible accounts into a block trade as set up either by the broker-dealer home office or IBD gatekeeper.
Along with block trading capabilities, the new module includes some automated risk management features that can be configured to:
- Automatically encumber securities underlying the contracts to prevent over-exposed positions.
- Perform pre-trade compliance checks to ensure strategies are permitted according to the account’s access rights.
- Proactively identify any accounts containing expiring options contracts.
Users are able to perform an options chain look up to select the best date and strike price and then leverage the same block trading UI that Vestmark has built for other security types and apply those strategies across groups of accounts. (See Mission: Impossible – Choosing the Right Digital Advice Vendor)
One helpful feature is that the system automatically computes the number of options contracts needed to put on a covered call or protective put strategy based on the total shares of stock across the selected client accounts.
Since they currently only support covered call and protective put strategies, the system automatically lock ups the underlying positions that are linked to the options. In case the options are exercised, the linked shares will need to be sold to the options buyer. Options-related alerts will appear on VestmarkOne's heat map dashboard to let the advisor know when positions have connected options (and cannot be sold) or if they must be sold to satisfy an exercised option.
The heat map will also display alerts about expiring options contracts to prompt the advisor to purchase additional contracts if they wish to extend the strategy. This can replace spreadsheets or other manual tracking methods that advisors and operations staff were using. (See Who Can You Trust When Buying Portfolio Rebalancing Software?)
I can state from first-hand experience how complex and time-consuming tracking these positions via spreadsheets can be. My consulting firm, Ezra Group, developed a piece of custom software for an investment firm that managed hundreds of derivatives positions, a portion of which were covered call/protective put options strategies. Just managing the expiration dates and underlying collateral was a nightmare. If Vestmark's system well, it would be an incredible time-saver and also reduce the number of mistakes made due to human error.
Another annoying aspect of managing options strategies is constantly having to check contract pricing via another service. The constant switching back and forth between browser tabs can be annoying. Vestmark has rectified this by including a real time integrated option lookup chain to provide visibility into the pricing of the contracts from within the portfolio management system.
Options in a UMA
I was trying to drill down into how the underlying technology handles the options trading, and how it would work in a UMA. The most they would say was that the way that VestmarkOne handles sleeves and virtual sleeves and and the way it can tag securities enables it to be able to identify all shares that are part of any assigned option strategy.
The way it is implemented is through a UMA-type construct that does not have the limitations of a sleeve, according to Pellegrini. This would bypass the problems of the options positions having to be included in the model and the rebalancer having to interact with them. (See 3 Trends Helping UMAs Break Through $1 Trillion in Assets)
Who Is Testing?
Pellegrini reported that their new options trading module was being piloted at a wirehouse, but he wasn't allowed to say which one due to their non-disclosure agreement. I'm going to guess it is UBS, since they are the only wirehouse client that uses Vestmark, as far as I know.
The next three beta clients are a regional broker-dealer, an RIA and a TAMP, Pellegrini stated. They are predicting increased usage of options in managed accounts, more so at wirehouses and RIAs than at IBDs and hybrids.
Vestmark Options Trading
In my opinion, this new options trading module could greatly increase the use of options in managed accounts by eliminating much of the manual effort required in planning, implementing and tracking. The ability to automatically combine options orders into block trades will reduce costs and make it easier for the downstream trading and operations teams.
Providing access to options strategies that can generate additional income and provide downside protection can also be a weapon against robo-advisors poaching clients since they do not have have similar offerings.
I haven't seen any additional press releases about this module, so I'm assuming that it is still in beta testing. Hopefully, it will be made available in production to all Vestmark clients and I will be very interested to see if they can quantify the overall time savings and efficiency increases that the software is able to deliver.