They said it wouldn't happen. In 2002, my colleagues and I at Moss Adams predicted that advisory firms would triple in size over the next five years. The industry trade press was skeptical. One reporter solicited comments from advisory firms for reactions and the expressed belief was that tripling was a fantasy and the creation of dominant firms was an illusion. One doubting Thomas, who shall remain nameless (his name is not really Thomas), said tripling is unlikely and that firms couldn't handle that growth. His firm proceeded to quadruple during that time frame.
According to the Moss Adams financial performance studies of financial advisory firms, the average advisory firm did close to the same, growing in excess of 20% compounded since 2002. The drivers of growth each year since 2002 were quite similar. For example, in 2006 alone, the average advisory firm grew by 24%. Of that growth, 12% came from new clients; 8% came from market appreciation; and 6% was derived from additional contributions from existing clients. A decline of 1% came from clients lost, and another 1% decline came from distributions to clients.
I am reluctant to gloat because it is one of the few times that I've been part of a forecast that even came close to being right. But many of the conditions that existed in 2002 are holding fast or re-emerging in 2008.
The U.S. economy and esprit are being sucked down by the wars in Iraq and Afghanistan, the weak dollar, the subprime crisis, and to a degree, a culture of fear fomented by terrorists and our collective reactions to them. Whatever one's political views, there seems to be a mix of enthusiasm and apprehension about who the next U.S. president will be or whether Congress will be overhauled again. When our world is viewed in aggregate, many are finding the fetal position to be their best strategic move.
In two thought-leadership pieces that Pershing Advisor Solutions, LLC commissioned in 2007 (Uncharted Waters and Fast Forward),* we asked the analysts at Moss Adams, LLC to reprise their forecast for the next five years. Using a model of probabilities, Moss Adams looked at the correlation between a growing pot of investable assets, the various advisory practice platforms that they have been studying for years, and the strategic decisions advisory firms made in 2003. The significance of that year, of course, is that advisors were coming off the Millennium Market Crash and the residual horrors of 9/11.
For many firms, there has been an overreliance on passive referrals for new client growth, and a substantial reliance on market appreciation for another big part of that growth. What would happen if the market were neutral or negative or your centers of influence for referrals aged along with you and were not replenished? What would happen if more clients took distributions and if your service offering evolved to something more labor intensive with less emphasis on investment management? So far in 2008, these questions are not speculation but real issues. Many advisors have not yet restructured their businesses to face these challenges, let alone be positioned to capitalize on a growing market for advisory services. Indifference and complacency are infections caused by past successes.
But taking a longer view of the advisory business, there appears to be an oversupply of clients needing professional help and an undersupply of advisors providing it. By extrapolating the 4.8% compound annual growth rate in investable assets since 1982, an additional $5 trillion more in investable assets could be created in the next five years, resulting in $35 billion of new revenue opportunities for financial advisors of all stripes. Retiring baby boomers and the move toward self-reliance for one's financial future are driving this growth. One can dispute the actual number, but meaningful growth quite likely will come with a meaningful impact on those prepared to grab it.
How Did they Do It?
Unfortunately, managing a business is not a stochastic exercise or a model built on probabilities. Informed decisions have to be made and manageable risks have to be taken for advisory firms to grow successfully. Looking back on how advisors dealt with the changing marketplace five years ago helps us to understand what moves fast-growing firms deployed. Further, those decisions give us insight into what growth-minded firms will have to do in the next five years in order to stay ahead of the pack. Advisory firms were bunched into different growth characteristics:
- 50% of the advisory firms grew at a rate equal to the industry--based on the past five years, the average advisory firm grew at a compounded rate of 20%;
- 25% were stagnant, meaning they grew revenues less than 10%, which is remarkable considering how the market performance has driven so much growth;
- 20% of the firms accelerated through the average growth rate at a clip in excess of 30%. These are the ones we refer to as "Fast-Forward Firms."
It would be easy to conclude that the fastest-growing firms were those who were smallest, or had the lowest baseline. The striking statistic from our study was that advisory firms with between $500 and $1 billion of assets under management (AUM) grew at an annual rate of 22% compared to 4.1% for those with under $25 million of AUM. The vast majority of Fast-Forward Firms were in the larger-firm category, many having more than $1 billion of AUM. Why did they beat the averages?
They invested in capacity. Those firms that were stagnant during the past five years had maxed out their own ability to serve many more clients, while the Fast-Forward Firms invested ahead of the curve. Those willing to make informed decisions and take managed risk recognized that there is an 18- to 24- month incubation period for new hires before they become fully productive and decided to make that investment in people before market momentum gave them lift.
As most advisors recognize, the impact of being out of the market for periods of time can have a material impact on one's investment return because it will cause the investor to miss major upswings. The same concept is true in one's business. While it is impossible to know when the market will recover, based on the history of markets, we know it will. Irrespective of market upswings, the bubble of liquid wealth is about to explode over the face of the industry and only a select few advisors will be in position to lap it up.
But having numbers of people alone will not position firms for success.
Implications for Advisors
The implication is that the advisory firm of the future will have both quantitative and qualitative strains and benefits. More revenue, more clients, more people, and more income will come to those who invest in their businesses. But for many firms, the magnitude of the change is underestimated. Cultural disruption will come to those who do not recognize that dramatic growth brings a different dynamic.
This is one of those years when the temptation is to be tactical and responsive to demanding clients and ignore the long view. The Fast-Forward Firms will take time to think more broadly and strategically about the opportunities and threats that face their businesses, what strengths they have to build upon, and what weaknesses they will need to shore up.
For example, while many people were added to advisory businesses over the past five years, there is still an acute talent shortage. It is not uncommon for people to change companies to improve their career situations, so many firms are vulnerable to having their best people recruited away. This will force some to respond defensively with more money or offers of ownership without a context for how either should be awarded.
For those associates who stay, owners will need to think about the training these associates will require to become more proficient as advisors, operations staff, or managers. It may turn out that the profession does not suffer a talent shortage, but rather a talent development shortage.
In addition to the physical limit on the number of client relationships one can manage, there is a physical limit to the number of staff one can directly supervise. Which will suffer if no change is made? How will this gap be closed?
Is this the time to create a laddering of staff in terms of experience and responsibilities so that each person on your team can gain better leverage in how they use their time?
Do you have a concentration of people within the same age and experience range and not enough at lower or higher levels? How will this impact your future staffing plan, the timing of new hires, and the focus of where you will recruit them from?
How will you address new client growth going forward? Is it time to shift expectations to associates to build their centers of influence for the firm as well, to replenish the sources of referral that have been your lifeblood?
The current turmoil in the market is taking big chunks out of the earnings engine of most advisory firms who rely on asset-based pricing and random referrals. With such a setback, this will cause many practices to cover their heads and wait for the storm to pass before investing in their businesses again. The best-managed firms will be those who can manage the risk and be positioned for future growth.
*(Copies of the white papers, Uncharted Waters and Fast Forward, published by Pershing are available by e-mailing Kdellarocca@pershing.com).