From the July 2007 issue of Investment Advisor • Subscribe!

People Who Need People

Many firms are thinking about creating achievable human capital plans

At a time when advisory firms are experiencing unprecedented demand for professional advice, many do not have the physical capacity to capitalize on the opportunity. Nor do they have a human capital plan in place to ensure they can keep good talent once they've attracted them. As a result, advisory firms are spending more in total dollars on people-related costs in order to keep pace while they continue to search the landscape for people who can make an immediate impact on their businesses. While it takes time to realize a return on this investment in human capital, the good news is that apparently those firms who made a conscious decision to add capacity over the last few years are now bearing fruit from the seeds they have sown.

For this year's just-completed Moss Adams Compensation & Staffing Study, sponsored by SEI Investments and JPMorgan Asset Management (www.mossadams.com/surveys/advisor/compstaffing.aspx), we looked at key trends over the past five years to try to understand how this retrenchment and investment is manifesting itself. There were some compelling indicators: Compensation expense as a percent of revenue is down slightly, but compensation as a percentage of total expense is taking a bigger piece of the pie.

Since our 2003 study, average firm revenue has grown at a compounded annual growth rate (CAGR) of 14.13%. Surpris-ingly, total expenses grew at only 13.27% CAGR. However, non-professional salaries (dedicated management and administrative, support, and technical staff) grew at a rate of 18.65%, and total benefit costs grew at a rate of 20.3%! Apparently, financial advisors are finding efficiencies in their organizations, which come through achieving critical mass in operations. But the one wild card is total employee cost.

Especially intriguing in looking at this data is that professional staff compensation grew at a rate below revenue growth, 12.41%. One conclusion we could draw from our experience in designing compensation plans for advisory firms is that the method of reward is shifting toward a fixed-based structure, veering away from variable components (see table, Five-Year Trend, at www.investmentadvisor.com).

One of the more compelling developments in this assessment is how advisory firms have effectively translated the cost of labor into an investment. By dividing operating profit by total compensation expense (both professional and non-professional staff), we are able to define a return on labor (ROL) metric that is worth noting. From 2003 to the present, the average advisory firm has improved its ROL from 28.4% to 33.9%. Such a small percentage increase may not seem significant, but in light of the greater size and greater investment in the business and its people that advisory firm owners are making, it is a very encouraging development.

Hire or Perish

The hiring trend appears to be continuing unabated. Fifty-four percent of respondents in our annual study completed a hire in 2006, hiring an average of 2.6 employees. For 2007, 58.1% of respondents expect to hire additional staff.

In another recent study, one commissioned by Pershing Advisor Solutions called Uncharted Waters: Navigating the Forces Shaping the Advisory Industry, we modeled a projection that shows a huge jump in the number of professional staff within RIAs alone over the next five years--as many as 9,000, for a total of 52,000 advisors! And this is just RIAs. We did not look at the expected growth in independent broker/dealer advisory practices for this study, but we presume it will also affect the talent shortage.

There are many elements driving this growth besides the obvious. Clearly, there are more clients experiencing liquidity events or who are retiring from employers with 401(k)-type retirement plan rollovers. But most who view this opportunity are focusing on asset growth rather than individual client growth. It is this point that has ramifications for the typical advisory practice.

Assuming you are not a transaction-based practice or just living off of trails but are providing some form of financial planning or wealth management services in addition, we find that the typical advisor can effectively manage somewhere between 60 and 150 active client relationships. The more sophisticated the type of client one is dealing with, the more complex their needs, the fewer relationships one can manage--that ratio may in fact slip down to 35 or 40 active client relationships in firms with more complex clients. A lead advisor can raise the number by surrounding himself with other professional staff who can play an active role in providing advice, but then the question becomes, "What skills set will their professional staff need to possess?"

Parasitic tendencies

As firms grow through different life cycles, they are confronted with choices of how simple or complex they feel they need to make their business. Implicit in this development is to focus on retention and development as well as recruiting. Where many emerging practices become vulnerable is when they do not provide direction, development, or devotion to their best people, who then get recruited away.

Firms who prey on others remind me of brown-headed cowbirds, which are brood parasites that have completely abandoned the tasks of building nests, incubating eggs, and caring for hatchlings. Instead, each female deposits as many as 40 eggs per year in nests that belong to other bird species.

For smaller advisory firms who have not developed a strong proposition for keeping good talent, they often become victims of the parasitic approach--they invest in the development of good people in their early years when the productivity is low and the learning curve is big. All they are doing is incubating the talent and caring for them until these "hatchlings" are ready to fly on their own. We can only imagine how maddening this must be to the warblers and sparrows that wasted their time nurturing these "tuneless ingrates" to maturity.

Avoid these Foibles

No firm wants to be merely the incubator of talent. In a perfect practice, the return for all that development and training is professional, experienced, loyal staff. But this means becoming an employer of choice--a firm where people stay for the same reason they came in the first place. As the adage goes, companies hire people; managers lose them. The key to tackling this challenge is to understand, then avoid, the common "Foibles of People Management:"

  1. Approaching selection and hiring in a haphazard manner;
  2. Assuming your people are trained and qualified;
  3. Assuming your employees know the firm's strategy;
  4. Failing to evaluate and measure performance;
  5. Failing to provide appropriate feedback and counseling;
  6. Assuming your clients are happy working with your staff;
  7. Treating employees as a cost to be controlled.

Many advisors have been scarred by their experiences in hiring and developing people. After you lose the first few, you begin to complain about the lack of commitment and work ethic. While you are saying, "What happened to loyalty in this country?" your recently departed staff are saying, "What happened to opportunity in this country?" It's a tough business to select the right people, match them to the right jobs, and create an environment in which they will flourish. But the numbers from our study validate that the investment of time and energy in a meaningful human capital plan will position your business to capitalize on the growth in available clients, not just read about them.

A People Plan

The implications for advisory firms will be to execute a human capital plan that is in alignment with their business vision. The talent wars are just beginning at all levels and in all markets, and there is no sign that this will abate soon as waves of clients seek out professional advice and demand a high level of attention.

This means doing the following:

  • Anticipate hiring needs--when you are at 80% of capacity, add another person.
  • Use all tools to recruit and screen prospective employees--don't rely solely on resumes and interviews; use psychometric tests to help evaluate motivation, ability, interests, and personality for the job.
  • Structure compensation to reinforce desired behavior--think about what the person should have to do to earn more money, but don't use money as a substitute for active management.
  • Be disciplined about your employee evaluation process--ultimately, people need to feel valued, and the paycheck only gets you so far. Constructive and consistent written and oral evaluations can transform your culture into a place where motivated people will want to work.
  • Hire slow, fire fast--be diligent in your selection process to ensure you have the right match for both the job and the culture you are trying to create. But if you have someone who will require too much rehabilitation to get to an effective level of performance, counsel them out of the business. It will be better for both of you.

These are the lessons that the firms who have invested in talent and are now producing a high return on labor have learned. In our opinion, these are also the advisory firms best positioned to capitalize on the flow of new money and liquid clients into the marketplace.

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