With any event that brings about sudden change, humans tend to exhibit a gradual reaction in trying to grasp the situation. Denial usually comes first; then comes shock. During the last three years, independent advisory firms have reacted gradually to the changes brought about by the stock market’s decline. In AdvisorBenchmarking.com’s upcoming study of the RIA marketplace, we broke down this reaction into four chronological phases: Denial, Panic, Restructuring, and Adapting (see chart 1). The last and most current phase is the culmination of the first three, and it is the critical threshold that some firms may simply fail to cross.
Since 2000, AdvisorBenchmarking.com has conducted confidential online surveys of registered investment advisors to help them benchmark their firms, as well as to determine the best practices of the most successful ones. AdvisorBenchmarking, an affiliate of Rydex Global Advisors, followed up on the surveys with focus group interviews over the past year to accurately assess how advisors were coping with this persistent bear market. This article presents a preview of the complete report on the registered investment advisor marketplace that AdvisorBenchmarking will publish this month.
Phase I: Denial
The first phase began in early 2000. Advisors downplayed the market pullback and the potential that the tech bubble was bursting, and instead calmly waited for imminent recovery. When the S&P 500 finished the year down 9%, advisors re-iterated to their jittery clients the virtue of long-term investing and reminded them of the staggering profits they’d made in the prior nine years. From a firm’s profitability standpoint, it was business as usual for most advisors, and, to a certain extent, justifiably so.
At the end of 2000, the financial health of the average RIA firm was relatively intact compared with its state in 1999 (see chart 2, following page). At least that’s the case when taking into account the whopping 40% decline in the Nasdaq composite and technology stocks–which comprised a sizable portion of assets managed by advisors. With average profit margins of 30% and net profits of over a quarter million dollars, advisors’ bottom lines were fairly unscathed, with revenues falling a mere 2.44% and assets dropping just a little over 8%.
Operationally, the picture didn’t change much, either. Client acquisition strategies mirrored those of 1999, where new business came in with moderate effort and at a very low cost. Nearly 70% of new clients originated from unsolicited referrals and less than 4% of total spending was dedicated to marketing.
In addition, competition from wirehouses and other external forces was weak, with the average firm reporting that it was losing a mere 1.25% of its clientele to competition. (Competition data was not surveyed for 1999.)
This attitude of inaction had a significant effect in shaping advisors’ perceptions later on in this cycle, as we will demonstrate. “Once bitten, twice shy” would be an accurate description of its impact.
Phase II: Panic
By early 2001, the economic decline –and its massive layoffs and dot-com collapse–were too visible to dismiss. In the span of 12 months, the Nasdaq composite lost 63% of its value from its March 10 high; the broader stock market was down 24% from its peak on March 24. Then just when we thought the worst was over, the tragic events of September 11 took place. Despite their display of resilience, advisors found themselves in a maze of confusion and uncertainty. The second phase, panic, had begun.
At the heart of this phase was a state of extreme ill-preparedness, especially in dealing with clients who were now asking for constant handholding–an essential service many advisors did not choose or need to offer at any great length during the market’s heyday. Additionally, many advisors who had never experienced a major market decline or a national disaster simply did not know how to reassure clients.
By the end of 2001, fewer than 32% of advisors reported contacting their clients more frequently than in the prior year. Significantly, more than 50% reported calling clients less frequently than in the previous year. Moreover, comprehensive financial planning as a component of advisory firms’ offerings had been in little demand for some years, as the focus was on asset management. Clients were now asking for a much wider array of wealth management services, and for many firms, this was either not an existing element of their offerings nor one that they could incorporate quickly and efficiently.
Despite the growing difficulties in meeting the increased needs of clients, advisors scurried to generate new clients to replace the assets under management lost to the collapsing stock market. Nearly 27% of firms lowered their minimum account size in an effort to cater to investors fleeing from wirehouses as well as former do-it-yourself-investors with now-much-smaller accounts. This hasty decision–not uncommon in a panic mode–later proved to be damaging. Those smaller clients, whose accounts continued to shrink, represented a major drag to the firms’ bottom lines, generating meager revenues while demanding the same level of service and time from the advisor as larger clients. Big or small, profitable or not, clients of all shapes demanded more handholding and broader services.