This year marks the fifth release of the annual FA Insight “Study of Advisory Firms.” The five-year history of the studies underscores the resilience of the advisory industry. During this period, notable for a global financial meltdown that shuttered major Wall Street firms, advisory firms struggled to maintain their footing. Trying times forced firms to tighten management controls with a new level of discipline that appears to have held through a return to stability.
In 2012, the typical advisory firm achieved the highest profitability and greatest level of owner income of any FA Insight study year. While resurgent equity markets deserve a share of the credit for the turnaround, performance indicators also point to improved management practices, especially those relating to controlling costs and the more effective use of people.
Across all of our annual studies, one conclusion is irrefutable: Well-designed people practices accelerate growth and provide insulation against periods of adversity. “The 2013 FA Insight Study of Advisory Firms: People and Pay,” the third FA Insight study to focus on human capital, underscores the influential role that people play in the resource mix of an advisory firm. Unlike any other business asset, a firm’s investment in human capital is a complex but crucial foundation of sustainable growth.
This article provides an overview of key findings from the 2013 study. It is the first of a four-part series featuring highlights from “People and Pay” that will be made available in the coming months through collaboration with our media partner, Investment Advisor. The complete study, which includes detailed industry compensation data, is available for purchase at www.FAInsight.com. (Visit www.ThinkAdvisor.com/Tag/People-and-Pay for all of FA Insight’s articles on the People and Pay study.)
Comeback Nears Completion
In 2012, advisory firms continued to shake off the worst economic stress since the advice industry first took hold more than 30 years ago. Firm owners are optimistic about positive performance continuing through 2013.
Client numbers increased 5.5% in 2012, a slower pace than in 2011 but much healthier than the less than 5% rates of growth at the depths of the recent economic recession. Stronger client growth is expected through 2013. A return to double-digit AUM growth in 2012 offset more sluggish new client activity. Buoyed by AUM performance, firm owners expect the rate of revenue growth to increase in 2013 (see Figure 1).
Firms Haven’t Forgotten Hard Lessons Learned During Recession
In years past, even slim growth expectations often lulled firms into lapses in management discipline. A close examination of financial performance suggests this time looks different. Five years of FA Insight study data show that firms have not yet forgotten hard lessons learned during the recession. While firms are clearly benefitting from the current recovery in security markets, their financial results suggest that management practices have also improved (see Figure 2).
Operating costs, as measured by overhead expenses as a share of revenue, tied a five-year low in 2012. Productivity in terms of revenue per professional nearly matched the five-year record set in 2011. Profit per client reached a five-year high in 2012, a level more than double what firms achieved in 2009 and a one-third increase relative to one year prior.
Cost control, combined with solid productivity and rapidly increasing client profitability, supported record income and profits for advisory firm owners in 2012. Typical advisory firms logged profit margins in excess of 20% in 2012, the highest in the survey’s five-year history. Most important for shareholders, median total owner income hit a five-year high, with growth in owner income significantly outpacing growth in firm revenue.
Staying Committed to a Firm’s Greatest Resource
During an extremely challenging five-year stretch, firms managed to control costs without shrinking payrolls. Most firms maintained or expanded their teams, and compensation levels increased across a broad spectrum of positions. Figure 3 shows the five-year history of median full-time equivalents (FTEs) from current and past FA Insight studies, as well as expected FTEs for 2013 based on the latest study responses.
As signs of recovery emerged and advisors acted on deferred hires, median FTEs increased in 2010. Firm size in terms of FTEs remained largely flat from that point through 2012. With security markets and the economy demonstrating more strength, the typical advisory firm expects to expand its team from six to seven FTEs in 2013.
Better Growth Through People Management
Clearly, people continue to be a prominent component in the delivery of advice. People-related expenditures dominate as a share of all expenses, averaging 75 cents for every dollar in costs during 2012. Given the influential role of people in the resource mix of an advisory firm, maximizing the return on investment in this resource is critical.
In 2012, our annual study focus was “Growth by Design,” which took a unique look at the drivers of scale and why so many firms are yet to experience advantages of the scale created. Study findings in that year revealed that growth can bring about positive people-related benefits. Growth could have a downside for people as well, however, including increasing dependency on key individuals and challenges in defining career opportunities. As a result, a key objective of this year’s study is to guide firms in minimizing the negative outcomes and accentuating the positive results that affect team members when firms grow.
Organizational Structure Continues to Be a Challenge
Amidst the positive results, the 2013 study also casts light on significant challenges for firms related to their use of people. The majority of firms remain weak in regard to their positioning of people and general organizational structure planning. This shortcoming afflicts even study participants deemed Standouts.
Why is this so important? The design of roles and responsibilities and the way in which each role interacts within the organizational structure is a baseline building block for productivity, efficiency and the delivery of the client experience.
This practice has consistently escaped the majority of firms. Nearly 80% have no documented organizational plan for the future. More than half of firms lack documented and up-to-date position descriptions, and more than two-thirds fail to define their organizational structure in a way that effectively supports hiring decisions. These figures represent an improvement since 2011, but more progress is needed.
Wide Gap Between Lead and Junior Advisors
The gap between lead and junior advisors is another critical issue affecting how firms organize and manage their people. Many firms remain overly reliant on their lead advisors and are ill-prepared to replace them upon retirement. Across the industry only three support or associate advisors exist for approximately every five lead advisors. Additionally, a staggering 85% of firms do not have an ownership distribution plan in place. These findings are a disturbing result for young industry talent as well as mature shareholders.
For the 20% of firms considered solo practitioners and the 24% of firms that organize service delivery under a silo or sole professional structure, the internal development and succession challenge is particularly acute. The industry’s largest firms, where equity concentration remains uncomfortably high, are also vulnerable. For large firms, equity concentration combined with increasing firm value hinders and demotivates promising young talent who seek ownership.
Allow Self-Motivated Individuals to Shine
In tandem with addressing the need for more disciplined organizational structure practices, our analysis reveals ample potential for firms to better empower their brightest and best team members and enable self-motivated individuals to shine.
The declining use of incentive compensation compounds concerns for sustaining and motivating talent. The share of firms making incentive pay available to professional positions declined from 56% in 2009 to 52% by 2013. While it is only one of many levers for motivating talent, incentive pay is perhaps the most quantifiable stimulus. Despite this, the apparent advantages seem to escape many firms that tend to view incentive compensation as an expense rather than an effective way to boost performance.
Standouts Represent a Distinctive Human Capital Advantage
Firms looking for help in meeting these pressing challenges can draw useful lessons from the FA Insight study. For the fifth successive year, FA Insight distinguished Standout firms from other study participants based on their ability to grow revenue and generate income for their owners. Responses this year reinforced a strong correlation between superior performance and prudent use of people.
The study’s Standout firms spend less on people—they employ relatively fewer people and pay out less per capita for compensation and related expenses. Nevertheless, on a revenue per FTE basis, Standout firms exceed the productivity of other firms across every development stage, largely because of the way people are deployed. In all but the smallest firms, Standout professional productivity is higher as well (see Figure 4).
How do Standouts achieve an advantage through their people? The answer largely lies in the arrangement and composition of talent. Professionals include the positions of lead advisor, associate advisor and business development specialist. For all but those in the smallest development stage, Standouts use more non-professionals to leverage the capacity of their professionals. As a result, a professional’s time is more effectively allocated to the work that directly generates revenue: managing the firm’s most valued relationships and actively pursuing new business.
To further maximize their talent pools, Standouts are more likely to provide access to formal training programs and maintain development plans to support team members in their progression along a career path. Training and development is central to leveraging less expensive team members and combining them in a way that most efficiently and effectively delivers to clients.
Much more can be said regarding specific considerations for advisory firms to better maximize their investment in human capital. Successful people management requires a firm to think deliberately about the type and timing of new positions. Successful people management also includes putting effective processes in place for attracting, developing and motivating a sufficient supply of people who will work to drive the firm in the right strategic direction.
To assist with achieving this success, Investment Advisor readers can look forward to more detailed human capital guidance with the continuation of this series in the months ahead. Coming articles will examine best approaches in organizational design, servicing structure, compensation and employee motivation.