This is the second in a two-part series from PracticeEdge

that provides a synopsis of independent financial advisor performance

in 2003 based on AdvisorBenchmarking’s May survey of 1,095 RIA

firms. In this issue, we address profit margins and new trends in

client management.

Asset Growth–Just the Tip of the Iceberg

In

last month’s Practice Edge, we shared the good news–average

RIA firm assets under management (AUM) rebounded last year to 1999

levels, rising nearly 23% to $87 million on median at the end of 2003.

Advisorbenchmarking’s research shows that the amount of assets

under management per client also rebounded in 2003, reaching $312,000

on median compared to 2002′s $258,000. But there’s more to

this story. Taking into account this robust AUM growth, the profit

margin decrease during the last year was surprising. Indeed, in 2003,

the median profit margin of advisory firms decreased 2.1% to 25.85%

from 2002′s levels. Since a firm’s profit margin is defined

as net profit divided by revenue, the profit margin decline can be

attributed primarily to faster revenue growth relative to growth in

profit. To illustrate, in 2003 revenue rose 15.35% to a median value

of $917,000, while net profit gained just 12.86% to $237,000. Although

this was the highest level of profit in the past three years, revenue

growth was much stronger than profit growth. Therefore, profit margins

suffered.

Chart 1: Median RIA Profit & Profit Margins

(2001-2003)

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height=”359″ width=”776″ border=”0″>

What Affected Profit Growth?

In order to determine

why the profitability growth did not move exactly in step with assets,

let’s take a look at the expense side of the equation. After a

brief halt in 2002, expenses shot up a staggering 10.76% in 2003 to

$710,000 on median. With inflation for the year measuring a moderate

2.27%, this increase was substantial. Much of the increase was due to

an average 4% rise in compensation for staff members, from 21% of

total firm expenses to 25%. With staff levels remaining constant from

the prior year, this increase may reflect RIAs’ desire to reward

staff following a few lean years. Two other areas that saw an increase

in expenditures were legal and compliance expenses, and conferences,

travel, and entertainment.

Chart 2: RIA Expenses

(2002-2003)

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height=”311″ width=”613″ border=”0″>

Taking Care of the Client

In the last year, many

advisors–especially larger ones–seem to have reached

capacity in accommodating new clients. Over the past two years, the

average number of clients remained relatively flat–from 275

clients per RIA firm in 2002 to 272 clients in 2003.

As Chart

3 below shows, advisors spent more time in 2003 servicing their

existing client base than in 2002 (35.5% vs. 30.84%). They seem to be

shoring up these current client relationships rather than seeking new

client relationships. This is illustrated by the lack of client growth

and their choice of how to spend their time. They seemed uninterested

in expanding their client base, with the median time spent on

marketing activities declining to 16.5% from 20.76% in 2002. In the

area of portfolio management, advisors became more involved in

managing money, allocating nearly 20% of their time to this activity

compared to just 15.87% the year before. They were likely devoting

additional time to bringing in more solid returns for current client

relationships.

Chart 3: How Advisors Spend Their

Time

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height=”306″ width=”498″ border=”0″>

Overall, advisors have strengthened current relationships with

clients, which puts them in a good position for pursuing additional

relationships in 2004. When considering client base expansion,

advisors will need to determine how to tackle the capacity issue, as

well as how to grow the number of clients while keeping an eye on

maintaining healthy profit margins.

Maya Ivanova is a research analyst with Rydex AdvisorBenchmarking.com,

an affiliate of Rydex Investments. She can be reached at <a

href=”mailto:mivanova@advisorbenchmarking.com”>mivanova@advisorbenchmarking.com.