Watch Out

The swells of change and new competition are alrea

What does the future hold for small, independent financial advisors and planners? Will they prosper? Or will they become victims of a tidal wave crashing down upon those unable to reinvent themselves in order to survive?

Only 15 months ago, we wrote that the conventional view, within and without the planning community, was pretty sanguine. "Independent, technology-wielding financial planners," we said (in the October 1999 cover story "Hard to Swallow"), "will only grow more fruitful and multiply." More recently, however, several industry reports have painted a less optimistic picture. Advisors are being called to task for a host of shortcomings, ranging from ingrained complacency and poor business practices to a myopic view of the fierceness and the variety of competition they now face. Is the new caution a function of changes in the financial services industry since the repeal of Glass-Steagall? The wirehouses aggressively seeking fee-based clients? The stock market's recent decline? Or all that, and more? "You hear things like financial planners are going to be down the drain because this is coming, or that is coming: The accountants, the brokers, the Merrill Lynches, the Bank Ones," acknowledges Madeline Noveck of Novos Planning Associates in New York.

What has struck fear in many advisors' hearts is a string of research reports, notably by Cerulli Associates, Inc. in Boston, and Undiscovered Managers in Dallas. The former, released in November, details the onslaught of full-service brokerages competing with a vengeance in the advice arena, both online and in the independent advisor's very backyard, going after high-net-worth individuals nationwide. The latter report on the future of the financial advisory business, published in September 1999, maintains that the profession is on "the brink of a major transformation." This study was conducted by a team of 10 industry experts led by UM President Mark Hurley and CEO June Slowik, who said it had ignited a "firestorm of controversy." Like many a horror film, a sequel came out one year later, analyzing the possible fallout while providing a road map for smaller advisory businesses to use to position themselves to become niche competitors, one of several survival strategies recommended.

In general terms, the UM studies say that for the independent advisor peddling advice to semi-affluent investors, the good times are all but over. Hurley said in an interview recently that changes in the advisory field are happening "even quicker than we anticipated." During the past decade, advisors were insulated from traditional market forces, facing no real competition. "You just put your shingle out and you got more clients than you needed," says Janet Briaud, of Briaud Financial Planning in Bryan, Texas. "The markets made us look like we're brilliant."

But this flood of business has allowed too many advisors to run their businesses haphazardly. Indeed, UM notes that the success of many advisory firms has far outpaced efforts devoted to planning for the future. It doesn't help that many advisors seem not to care, possessed as they are by what Hurley calls a "sense of invulnerability." There are those, too, he says, "who just prefer to stick their heads in the sand. Maybe 1% of the industry is doing anything to prepare itself for what's coming." His advice to advisors: "Hold your investment in your own business to the same standard that you hold your clients' other investments."

Then there's the "staggering growth rate" of the financial advisory business itself, which has led to the creation of thousands of proprietorships and small partnerships - a growth rate that, according to UM, is unsustainable. The number of fee-based financial planners has grown more than sevenfold in the past decade, from less than 5,000 in 1990 to nearly 25,000.

Two Guys Going Their Own Way
If the road to success is paved with niche businesses, we've found a few planners who have developed niche-inspired strategies well off the beaten track. They seem to be doing just fine.

Steve Thalheimer, of Thalheimer Financial Planning, launched his fee-only practice in Silver Spring, Maryland, only last summer, and had his first client in October. After much consideration - and four years with a traditional fee-only firm - he opted to adopt the business model developed by Sheryl Garrett of Garrett Financial Planning in Overland Park, Kansas. Garrett Planning Network franchisees like Thalheimer don't manage assets, don't require clients to sign contracts, and target middle-income people, charging the same hourly fee regardless of the client's worth.

Thalheimer believes he will be successful using the Garrett model because, apart from the perceived need, there's much interest on the part of persons with less than substantial assets for objective, independent, affordable advice. "There aren't that many people who can serve that market," he says. "Now the trick is getting the volume you need to make this a viable model." He's encouraged by the number of prospect calls and meetings he's had thus far, and estimates that if he can bill 15 to 20 hours per week, his business will flourish.

Thalheimer charges a flat rate of $150 per hour. The initial fee for buying into the GPN is $4,000 for the basic package; $6,000 for the deluxe variety. The former includes a variety of educational and support materials; the latter adds three days of hands-on training with Garrett herself.

The vision Thalheimer has of his practice, is this: Maintaining a successful business with zero assets under management; remaining small; finding specific solutions to the general problems that large numbers of previously underserved middle-income clients have; and doing this in the most efficient way for the majority of people, who then do any followup work themselves or hire specialists.

Tom Batterman of Vigil Asset Management Group, in Wausau, Wisconsin, has taken an entirely different approach. Batterman looked at the factors cited in the Undiscovered Managers report, and considered the facts that many advisors seek entry into the trust business in order to provide additional "product" lines, and that many independent trust companies are being affected by some of these same trends. That led Batterman and his firm's new partner, The Trust Company of Louisiana, in Reston, Louisiana, to set up National Independent Trust Company (NITC).

NITC, Batterman says, is designed to allow independent operators to address business issues of "improved operating efficiencies, stronger capabilities through access to improved scale, and exit strategy without sacrificing local control." The trust company will provide the back-office support and other trust infrastructure services to its partner-operators across the country, of which there are more than 15.

Batterman sees NITC as a way for investment advisors to operate more like businesses, expand into trust services, and plan for the long-term future of their practices without sacrificing their independence.

As for how it will benefit his firm, Batterman notes that he has attempted to develop "scale in order to build a stronger, more cost-effective trust infrastructure." He says NITC represents an expansion of his business plan to a national marketplace, "where it can develop much more quickly because there are many other substantial existing businesses just like ours as potential partners in other areas of the country." - Cort Smith

In its report, "The State of the National Full-Service Brokerage Industry," Cerulli examines the impact of newly minted broker-advisors on independent advisors. During the five-year period from 1994 to 1999, fee-based assets under management at Merrill Lynch, Morgan Stanley Dean Witter, Paine Webber, Salomon Smith Barney, and Prudential nearly doubled, jumping from 5% to 9.4% of all assets. Today these full-service shops control 60% of all the assets in fee-based programs, a figure they intend to increase (see "Wirehouses Cut In" on page 42). Undiscovered Managers sees these players in the context of the emergence of what it characterizes as a "hostile, hypercompetitive environment among businesses that today might be coexisting but will be battling for clients and employees tomorrow." And while the UM 2000 report says clients are better informed than ever and are demanding better advice for their often not-hard-earned dollars, many independent planners remain unfazed.

Scott Leonard of Leonard Capital Management, El Segundo, California, for example, views these developments as being beneficial to small planners. "Yes, clients demand better advice," he says. "But is that better advice going to come from an employee of a large firm? If it is, they basically have to give cookie-cutter advice. They can't have their different reps recommending different things."

What will separate one advisor from another is customized service, he maintains, which itself is driven by relationship. "Relationship is transferable from company to company," says Leonard. "A broker moves from Merrill to Dean Witter, they take all their clients with them. You can't commoditize a relationship." As advisor Sam Hull of Northstar Financial Planning Inc., a fee-only advisory firm in Bedford, New Hampshire, puts it, "It's not the company people buy, it's the person."

Leonard argues, too, against the notion that consumers are looking for a one-stop shop, believing instead that consumers are seeking a "one-stop personal relationship, a gatekeeper, a quarterback of specialists, if you will, who can take the best of what's out there and bring it back to them. Small independent firms can accomplish this best."

For some planners, the word "relationship" isn't enough, however, or can be overused. "I would argue that you have to each day ask yourself the question, 'What am I doing and what do I need to be doing to make sure that I keep my clients happy?'" says advisor Briaud. "Don't count on 'relationship.' Someone can say to you, 'I like you very much, you're wonderful, but these returns have been horrible and I need to go elsewhere because Joe across the street is offering me this and this and this.' "

The value of client relationships, in fact, will be tested by the current stock market. With the Nasdaq way down, observes Hurley, "a lot of investors are doing surgery on themselves and have decided they need professional help." But will the clients stick around if stocks stay in the doldrums, as they did in the U.S. during the 1970s and in Japan in the '90s? "If we're in a Japan-style market for 10 years, we're going to have a rough time no matter what," says Briaud.

Another client expectation problem is how much value an advisor really adds. UM says most of the added value comes during the initial stages of a relationship, even though the advisor continues to receive the same fee annually. The report adds that during later years of a relationship, these firms "mostly monitor existing managers or mutual funds."

Wirehouses Cut In
From Merrill Lynch on down, full-service brokerages have played copycat on the fee-based and financial planning models originally crafted by independent planners and RIAs to gain a foothold in the advice business. They are also threatening independent advisors by providing cutting-edge technologies and specialized teams to offer one-stop shopping from everything from asset allocation to home mortgages and trusts. As a result, "a collision course is ahead for investment advisors," says Judson Bergman, founder and CEO of EnvestNet, a Chicago-based wealth management network that provides services to advisors over the Web. "The technology revolution is changing the landscape rapidly," says Bergman. "Investors will choose from best-of-breed products and technology. Ten years ago, the RIA dominated the marketplace. But now with fee-based services, advisors face competition" from all over. Bergman also notes that to keep up in the race for affluent clients, financial advisors must align with aggregators to offer accounts that provide a full picture of clients' financial affairs online.

But Bergman, former managing director of Nuveen Mutual Funds, says independent planners have competitive darts of their own to throw. The most lethal: the independents' long-held experience in the advice business. This still offers them a leg up against the salesperson-turned-advisor model used by full-service brokerages. Indeed, Chuck Callan, head of The Boston Consulting Group's New York financial services practice, maintains that independent planners have their own strengths. "The brokerage firms are masquerading as financial planners," he says. "They have tremendous marketing capabilities, but their advice does not compare with that given by the independents." Callan notes large brokerage firms are also "fairly narrow and product-centric" in their investment offerings, while independent planners lack product bias. On top of that, "independents have local customer relationships, and they have broader skill sets" than full-service firms.

But the full-service brokerages have significantly increased their competitive muscle by bundling fees with online access, allowing clients to trade and access a financial consultant at will.

Take, for instance, Merrill Lynch's fee-based Unlimited Advantage program. All trading costs are included in one fee based on the size and composition of the account. The program waives per-trade commissions, but clients retain brokers' services. With the fee account, clients also qualify for assistance from insurance, mortgage, and estate specialists. And the program includes discounts on long-term care insurance, grantor revocable trusts, and mortgage originations. At year-end, Merrill raised its fee for managing the equity portion of certain Unlimited Advantage accounts from 1% to 1.5%. Observers saw that as a bid to boost Merrill's profit margins.

Kathy Shanley, a CFA and analyst with Gimme Credit Finance in Wilmette, Illinois, says that by raising prices, Merrill may be looking to avoid deep cuts it made two years ago, which later put it at a competitive disadvantage when markets rebounded. Client assets in Unlimited Advantage rose to $93 billion at the end of the third quarter, Shanley says. While the fee hike could alienate some customers, she says, brokers will maintain some discretion on whether to increase fees for current clients. "Considering the size of its retail account base," Shanley says, "the increase in fees could go a long way toward offsetting declines elsewhere in Merrill's franchise should markets remain weak."

Other wirehouse fee programs are Prudential's Advisor, PaineWebber's InsightOne, and Salomon Smith Barney's Asset One and Asset One Select. Paul R. Marrone, a PaineWebber spokesman, says the firm has no intention of jacking up InsightOne fees, which average about 1% of total assets. "The fee is negotiated between the advisors and the client based on the level of service," says Marrone. "It's collaborative, and allows the broker and the client to take a look at the nature of the relationship, and tailor [the fee] to that unique relationship."

However, Paul Held, a consultant with Boston-based Cerrulli Associates, says that the idea of getting a range of services under one roof is "more powerful than the online account." Clients are not going to be lured away from their independent planner just because of Internet services, he says. But it does become attractive when "Merrill Lynch can say, 'Look, I can provide you with the best online brokerage services, and I can help you with other services like mortgages.'"

The most dangerous development for independent advisors is that full-service firms are building "ensemble practices" to offer services including trusts, estate planning, asset allocation, and insurance, Held says. "The advantage that allows the full service firms to [build these specialized teams] is in-house and middle management" support, Held says.

So how do you provide clients with the most services and capture the largest share of clients? Through group practices and back office support, Held says. "I'm not ringing the death knell for independents, but the national full-service firms are combining human advice and technology better." Boston Consulting's Callan disagrees: "Many conversations that wealthy individuals have include a variety of questions, and the larger brokers can't provide certain answers," he says. "If you call a broker and say there is a change in tax law, or you are buying a house, or ask what the implications are for a retirement plan, their answer is asset management," he says. "[The large brokerages] may say they have teams, but they have not been able to work together in a seamless way. People don't want a team, they want an individual." - Melanie Waddell

The perception, spreading among investor-clients, is that the advisor is not doing much to earn his or her keep. Technology, in the form of online investment management services provided by companies like Financial Engines and Morningstar, only contributes to this perception that clients can competently perform much of the work themselves. Advisors, though, argue that these services benefit their businesses as well. Hull, who uses Waterhouse and Vanguard to custody client assets, encourages his clients to use these firms' online resources for college planning, fund research, and just to learn. "The understanding of the information is the value that I give," he says.

The notion, however true or far fetched, that clients may be paying more for less is a chink in the small fee-advisor's armor not unnoticed by competitors, who for this and other reasons have begun to offer what Cerulli originally termed "scalable advice." By this is meant the delivery of a range of service offerings under one roof with prices scaled accordingly. How powerful is the concept? Cerulli found, in another report published last year, "Market Update: Registered Investment Advisors," that just as asset allocation was a defining concept of the 1990s, scalable advice will be the defining model for financial distributors in the coming years.

Add to these perceived independent-advisor woes the fact that the investment world is witnessing a shift from the use of mutual funds to alternative vehicles such as separate accounts. The result, posits Cerulli, is that independent financial advisors may be "forced to either adopt a new business model and skill set or get out of the discretionary money management aspect of the business altogether and focus on creating financial plans." It is interesting to note the firm's finding that the less assets under management that an RIA controls, the more likely that firm is to consider itself a financial planner.

The challenge that status-quo independent advisors face, adds UM, is not so much that of losing clients to larger competitors, but that the latter need only "change the smaller firm's pricing structure" and life at the smaller firm will become much harder. In other words, "they're going to be in business but they're not going to make a lot of money," Hurley says, adding that owners may see their compensation cut in half. This is based on the simple assumption that increased competition and advancing technology will raise the small advisor's overhead. That will force the advisor to constantly improve, or provide more services at a lower cost, while the big firms and institutions will continue to enjoy economies of scale.

Making matters still worse is that advisor fees already are under pressure. UM, citing Cerulli data, notes that while many advisors initially charged 1.5% to 2.0% annually of assets under management for their services, the median fee level over time has fallen to 1% on average. UM notes that most firms now offer price breaks for larger accounts. They will even discount their published fee schedule in order to capture a new client - a practice that will only intensify as the industry becomes more competitive.

Since coupled with these factors is the big companies' ability to earmark substantial capital for marketing, it would seem that the small guys won't stand a chance. Not so, cry the independent advisors. "There is one thing that size, economies of scale or marketing dollars cannot create," says Leonard, "and that is smart, caring and thoughtful individuals whose relationships with clients is interchangeable." Hurley, though, maintains that "there are a lot of other people in the industry who are getting much bigger who do the same thing."

Hull admits that for pure money managers, economies of scale are valid. But no independent fee-only financial advisor will admit to being a pure money manager. In fact, a number of advisors have stated that the entire UM report, for example, "isn't about them" because it is about money managers. Hurley, however, doesn't see the validity of differentiating between money managers and wealth managers and independent financial advisors and planners. "There's this tendency in the advisory business for people to say, 'I'm more pure than you.' Well, we're all talking about the same business, as much as people are rue to admit it."

It also is reasonable to assume that small firms lack the vast resources to effectively build their own infrastructure. Not so, again. "The beauty is that with where tech is going," says Leonard, "we outsource everything." He doesn't need to build that infrastructure because somebody else is doing it, enabling him to job-out all Centerpiece, accounting, and legal work, reducing his overhead. "The fact that tech is becoming a total commodity is more an advantage to a small firm than a big firm."

Planners such as Leonard don't see the absence of marketing as being very significant, either, maintaining that affluent individuals tend to respond less to marketing and more to referrals. The UM reports are also critical of small advisors who persist in giving away trade secrets, and forming loose affiliations. But Briaud believes this sharing is a good thing, and that it will probably continue. "For one thing, it makes you a whole lot larger than you [really] are," she maintains. As for lacking the cash flow necessary to expand their firms, Leonard reasons, "Who's assuming that I want to expand?"

Taking such a position doesn't necessarily indicate a condition of stagnancy. None of these planners is doubting that their profession is in transition, or that, as Hull puts it, the "thundering herd" - Merrill Lynch et al. - is moving down the road very fast. "If you stay where you are, you'll die," he says, adding that the trick for the small guy is to continue to make the value in the relationship more than simply providing information, by providing wisdom. Planner Noveck admits that she has lost a client "here or there" because she did not have the imprimatur of, for example, the Bank of New York. But she believes that many more clients are drawn to "this very personalized environment, so that if a planner can establish their credibility, then they have clients."

Briaud cautions against underestimating the eventual impact of the big institutions. Brokers-turned-advisors are busy working at moving from a sales culture to one of dispensing advice for a fee, she notes. "They'll have to retrain, and it will be a while before they get there, but when they do, they'll be good at it."

Faced with all these obstacles, what's an independent advisor to do? Undiscovered Managers offers three options: Do nothing; try to become a dominant competitor; or find a niche strategy. Amazingly, doing nothing is an approach the report says most advisors will adopt. Of the rest, not many advisors will be able to, or even want to, become dominant competitors. UM predicts the emergence of a small group of 40 to 50 companies that will capture "a disproportionate amount of the industry's future growth," each firm to acquire at least $15 to $20 billion of assets under management, many with more than $50 billion. They predict also that a large group of small firms - including thousands of businesses in communities nationwide - will compete with these large organizations. For these small firms to make it, or as the second report states, "for advisors who lack the ambition or resources to become dominant competitors," creating a marketplace niche will allow them to remain relatively small yet profitable.

Undiscovered Opportunity
Mark Hurley and June Slowik of Undiscovered Managers say they encountered two distinct reactions from the advisory community to their first research report, published in September 1999. "A large number of industry participants hear our forecasts and feel like their businesses and livelihoods are in danger," they wrote. "A smaller group has considered our prognostications and sees opportunity."

In fact, the authors say the next five years will offer some advisory firms "a once-in-a-lifetime opportunity." The authors maintain that while it is possible for advisory firms to remain modest in size and still prosper, they cannot remain the same. "Only a handful of niche businesses currently exist," write the authors. "Literally hundreds of niche segments lie waiting for the taking." Successful niche competitors will:

o Create the perception that they possess the expertise necessary to solve the most complex problems shared by a select group of individuals.

o Continuously improve the quality of their services and communicate these improvements to their client bases.

o Anticipate their clients' future problems so they will be able to meet their most complex needs over the long term.

o Develop efficient operating structures that include alliances with partners and vendors that enable them to provide comprehensive solutions to their clients in addition to their special expertise.

o Achieve sufficient scale within the niche (in most cases at least $400 million of assets) to defray fixed costs.

o Capture a dominant share of the market for their special expertise to create a barrier to entry into the market segment by potential competitors.

The report, however, states that most advisors aren't prepared to go niche. But according to Guy Cumbie of Cumbie Advisory Services in Fort Worth, Texas, who in January began his tenure as president of the Financial Planning Association, many independent financial advisors already are there. Cumbie considers "niche" in the larger context of what he terms "meaningful differentiation," the lack of which will cause maladies such as margin compression. He sees the personal planning profession as having emerged more than 25 years ago from the larger arena of the retail financial services industry as something profoundly different. In this regard, small firms today don't have to reinvent themselves to become specialist organizations: that is exactly what they are; rather, it is larger firms that must become more like the small firms. Not that there isn't room for improvement, since the independents must stay ahead of the curve by differentiating ever further.

UM considers a niche to be a specialized business. Again, some planners say that has always been their model. In Janet Briaud's case, college professors comprise a large part of her practice, a situation that came about naturally, just as another planner might have an affinity for physicians or computer engineers.

Planners may or may not be alarmed by the findings of Cerulli or the prognostications of the initial UM report, but the firestorm of controversy UM created opened a dialogue among planners that has continued for more than a year. Briaud feels if the report and ensuing debate about the future of independent financial advisors has done anything, it is to "make people a little more aware, and make sure they stay razor sharp instead of sitting back and saying, 'I've got it made.' It's good to have a healthy fear about the future," she concludes.

Cumbie agrees that dire predictions serve a useful purpose. "There are complacent cages out there that need to be rattled," he says. As for Hurley, he is confident that those advisors who simply see danger will not do very well, while those who see opportunity will in five years be among the most successful in the business.

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