The registered investment advisor marketplace has rebounded in recent years, with advisors building assets under management and revenues returning to pre-dot-com-crash levels. Yet new and evolving challenges face RIAs as they work toward increasing their businesses’ profitability. Those challenges include an uncertain market and economic environment, rising costs for compliance, an aging customer base that needs healthcare and retirement rollover products, and a more competitive climate.
Rydex AdvisorBenchmarking recently surveyed more than 1,000 RIAs on investment and practice management issues. Our results, gathered by phone and online surveys, highlight critical trends that will affect RIA profitability, client retention, and business success over the next several years. We’ll explore some of the issues that leading-edge investment advisors are currently dealing with, and propose strategies for turning these challenges into opportunities.
Market conditions have improved for advisors, with strong stock performance in 2004 and an overall recovery in assets under management. Our research found that the three-year decline in median assets managed by RIAs reversed itself in 2003, more than making up for losses since 1999 and outpacing gains in the S&P 500 Index.
Advisors themselves are moderately optimistic about the market outlook but remain concerned about the long-term implications of a rising federal budget deficit and a funding shortfall for Social Security. Asked to forecast the U.S. equities markets over the next three years, half (50%) of the advisors polled expected a long-term secular bull market with cyclical rallies and dips, while a smaller group (6%) predicted a genuine bull market. About a third (31%) forecast a directionless market, while one in eight foresaw a secular bear market.
Yet while survey respondents felt positive overall about the markets, they were worried about a number of economic issues. The budget deficit topped the list of their concerns, followed by Social Security and energy prices. Current hot topics like the trade deficit and the dollar’s decline were cited as reasons for caution among about one in 10 advisors.
Meanwhile, our survey respondents’ clients have dramatically moderated their expectations for returns after several years of volatile markets. Six in 10 advisors (62%) say that their clients have realistic expectations for market performance, while only a third (33%) believe that investor expectations are unrealistically high (see chart 1 below).
This adjustment in client expectations has contributed to a growing perception among investors that they will not have sufficient assets to last through retirement. For example, in one section of the survey, advisors reported that among their clients who had reduced their lifetime giving programs, 58% did so because they feared outliving their assets.
One way to profit from these two trends–lower performance expectations and concerns about long-term financial security–is to move the discussion toward higher-yielding alternative investments. Our survey shows that a plurality of advisors (43%) are spending more time educating clients about alternative assets, slightly ahead of the percentage (42%) that is spending the same amount of time on this topic.
Paying for Compliance
The emphasis on compliance in the financial services industry hit RIAs hard last year as legal and compliance-related expenses jumped nearly 153%, according to the Rydex AdvisorBenchmarking Study.
New compliance requirements have changed the way many advisors do business, piling on additional legal, accounting, and insurance burdens. Our survey showed that nearly two-thirds of the RIAs polled (62%) had already developed a written supervisory procedure, while more than half (55%) had hired a chief compliance officer. More than a third had developed a business continuity plan. A smaller, but still significant, percentage of advisors were taking additional, potentially costly steps, including increasing client communications, hiring a lawyer, or augmenting their liability insurance coverage (see chart 2 below).
Leading-edge advisors are working to meet new compliance requirements, but at a cost. Half the advisors surveyed said that developing a written supervisory policy had raised their costs of doing business. Other compliance factors cited as adding to the cost burden were increases in legal fees and insurance premiums, the development of educational materials, and the need to hire additional employees (see chart 3 below).
The dramatic rise in compliance expenses along with increases in staff compensation resulted in a drop in profit margins for RIAs for the fifth consecutive year, despite a 13% increase in net profits. Advisors did reduce the money they spent on advertising and marketing by more than two-thirds and focused on growing their businesses through their current client base. Focusing on their existing books of business paid off for advisors in 2003 as they saw revenues and AUM reach or exceed five-year highs, increasing 15.4% and 22.5%, respectively.
Yet despite the increased cost and administrative burdens, few advisors are ready to sell their businesses. Nearly three-quarters strongly objected to the idea that an increase in expenses would force them to exit the advisory business, while only about 5% agreed somewhat or strongly that higher costs might cause them to sell.
A Graying Client Base
One broad trend that is affecting the RIA marketplace is the graying of its client base, particularly as 77 million members of the baby boom generation reach and exceed retirement age.
This trend is still gathering steam. Our survey found that the largest group of investment advisors (37%) reported that retirees make up between 20% and 39% of their total client base. For many firms, however, the proportion is much higher. Slightly over one in five investment advisory firms (21%) said that retirees make up 60% to 80% of their overall client base, while an additional 27% say that retirees account for 40% to 59% of the total. Investment advisors are telling us that retirees are already an important client base and–given the overall aging of the population, longer life-spans, and greater affluence among the elderly–will most likely become even more dominant in the years to come. Forward-looking firms are looking for ways to meet this market segment’s unique needs.
Health savings accounts (HSAs) represent one potential area of growth. These are relatively new tax-sheltered savings accounts, signed into law by President Bush in December 2003, whose assets can be used only for medical expenses. They are paired with high-deductible health insurance policies so that routine health-care costs are paid out of the HSA, while larger expenses are covered by insurance.