The golden era of the financial advisory business has come to an end. In the golden era, the market’s extraordinary returns ensured firm growth and client satisfaction. Of greater importance, those excess returns absorbed the high cost of servicing smaller accounts while still leaving a historically attractive return for the client. But the secular bull market and the golden era of excess returns are past. The bar has been raised for advisory firms. Now advisors must do more with the same limited resources: (a) they must work harder to produce growth; (b) they must work harder to meet client expectations; and (c) they must operate more cost effectively. We now operate in an era where managerial skill and economies of scale matter at least as much as an advisor’s financial competence. The era of the independent financial advisor as small business owner is upon us.
As we entered the 1980s, two trends emerged that opened the doors to the golden era of the financial advisory business: first, a twenty year secular bull market began that consistently produced exceptional investment returns, and second, accelerating advances in technology reduced the high cost of back office operations and client service. In other words, comprehensive wealth management could now be delivered profitably to smaller accounts. More to the point, exceptional returns produced steady growth in assets under management without concerted business development and they guaranteed client satisfaction. The secular bull market also optimized the business model from a cost standpoint. Because the markets rose almost without interruption for twenty years, advisors could achieve those exceptional returns with minimal effort using the lowest cost investment strategy available: Modern Portfolio Theory, also known as “Buy and Hold” or “Set it and Forget it”. Moreover, some of the high costs of service including the advisor fee as well as fund, platform, brokerage and custody costs could be easily absorbed by those exceptional returns and still provide clients with a very attractive return. Consider an extreme example where the independent advisor puts a client in a hedge fund with a 2 + 20% fee structure, who gets access to that fund via a consultant or fund of funds who adds another 1% to the fee structure and then adds his own 1% fee. In a 20% return environment, the client nets 12% which is still 20% above the long term historical average of equities. By comparison, in a more normal environment in which equities generate 10% annual returns, the client would net only 4%. The financial advisory business boomed.
With the turn of the millennium came the end of the secular bull market and the excess returns that drove the golden era. That’s not to call the demise of the business but to acknowledge that the easy money has come to an end. The bar has been raised for advisory firms. Now advisors must do more with the same limited resources.
- They must work harder to produce the same level of growth. Investment returns will no longer compensate for weak business development efforts.
- They must work harder to meet client expectations. Investment returns are now running below the level to which clients have become accustomed. Some clients have seen profits erased, or, worse still, losses after two major market meltdowns. And the investment returns needed to achieve their financial plans are looking less and less certain. Advisors not only need to work harder to achieve investment returns and reset expectations, but they must also up their game in other areas of the financial planning process to justify their value.
- They must also operate more cost effectively. Without the benefit of excess returns, it now becomes clear that the cost of building a profitable practice is much higher than we realized. An already time constrained advisor must find more time to pursue business development. To meet client expectations when returns are less exceptional, the advisor must spend more time on other parts of the financial planning process to create value in the eyes of clients. To manage risk and achieve adequate returns in a more volatile and lower return investment climate, advisors must spend more resources (time and money) on risk management. As Ken Solow, Chief Investment Officer at Pinnacle Advisory Group, puts it in the title of his book: “Buy and Hold is Dead (Again)”. And to add insult to injury, the government is increasing regulatory and compliance costs in the wake of the financial crisis.
The era of the independent financial advisor as small business owner is upon us. To compete effectively and build a profitable practice, the financial advisor’s business acumen is at least as important as his competence as a financial advisor. And, in that vein, an important consideration is that economies of scale matter again.
- First, consider that there are a growing number of large firms that are achieving economies of scale and are using that advantage to offer a broader and deeper set of products and services for the same price. Many of these firms have dedicated resources to support advisors in specialties like retirement planning, tax planning, estate planning, insurance, business transitions, divorce planning and investment management. Consider Pinnacle Advisory Group. Our advisors have been relieved of most back office and investment responsibilities so they can focus on client facing activities and business development; and we spend more on our centralized investment management function each year than most emerging firms generate in revenues. These competitive advantages are a growing concern among some of the emerging advisors with whom we are meeting. More to the point, these large firms are growing.
- Second, time studies show advisors are time and resource constrained. It is becoming more evident to everyone that emerging advisors cannot do everything by themselves. Operating like a “Jack of All Trades, Master of None” is becoming a more precarious proposition. Of course we don’t talk about it in those terms. Instead, we talk about how little time there is for personal activities if we run a lifestyle practice or about our inability to grow or about our fears about client retention when markets are volatile or about rising compliance burdens.
So what are emerging advisors to do? They are to act like business owners. They must determine where to most effectively invest their time and money to achieve their business goals. For many of the emerging advisors with whom we are speaking, that means finding outsourcing solutions (financial planning, investment management, back office operations, compliance) that will free their time for client facing activities and business development … the very activities that get them paid and ensure sustainable growth for their business. Others are choosing to merge firms or find partners to enable a division of labor. And still others are choosing to join larger firms that already possess economies of scale and will allow them to focus on the piece of the business they enjoy most.
At Pinnacle Advisory Group, we are betting that the entrepreneurial spirit of many emerging advisors will lead them to choose outsourcing solutions that allow them to maintain their independence and increase their effectiveness. Accordingly, we have created a new division called Pinnacle Advisor Solutions to provide outsourced investment management and back office solutions as well as strategic business advisory. For more information, please contact Peter McGratty, VP of Business Development, at (201) 919-4838 or [email protected].