People Who Need People

At a time when advisory firms are experiencing unprecedented demand for professional advice, many do not have the physical capacity to capitalize on the opportunity. Nor do they have a human capital plan in place to ensure they can keep good talent once they’ve attracted them. As a result, advisory firms are spending more in total dollars on people-related costs in order to keep pace while they continue to search the landscape for people who can make an immediate impact on their businesses. While it takes time to realize a return on this investment in human capital, the good news is that apparently those firms who made a conscious decision to add capacity over the last few years are now bearing fruit from the seeds they have sown.

For this year’s just-completed Moss Adams Compensation & Staffing Study, sponsored by SEI Investments and JPMorgan Asset Management (www.mossadams.com/surveys/advisor/compstaffing.aspx), we looked at key trends over the past five years to try to understand how this retrenchment and investment is manifesting itself. There were some compelling indicators: Compensation expense as a percent of revenue is down slightly, but compensation as a percentage of total expense is taking a bigger piece of the pie.

Since our 2003 study, average firm revenue has grown at a compounded annual growth rate (CAGR) of 14.13%. Surpris-ingly, total expenses grew at only 13.27% CAGR. However, non-professional salaries (dedicated management and administrative, support, and technical staff) grew at a rate of 18.65%, and total benefit costs grew at a rate of 20.3%! Apparently, financial advisors are finding efficiencies in their organizations, which come through achieving critical mass in operations. But the one wild card is total employee cost.

Especially intriguing in looking at this data is that professional staff compensation grew at a rate below revenue growth, 12.41%. One conclusion we could draw from our experience in designing compensation plans for advisory firms is that the method of reward is shifting toward a fixed-based structure, veering away from variable components (see table, Five-Year Trend, at www.investmentadvisor.com).

One of the more compelling developments in this assessment is how advisory firms have effectively translated the cost of labor into an investment. By dividing operating profit by total compensation expense (both professional and non-professional staff), we are able to define a return on labor (ROL) metric that is worth noting. From 2003 to the present, the average advisory firm has improved its ROL from 28.4% to 33.9%. Such a small percentage increase may not seem significant, but in light of the greater size and greater investment in the business and its people that advisory firm owners are making, it is a very encouraging development.

Hire or Perish

The hiring trend appears to be continuing unabated. Fifty-four percent of respondents in our annual study completed a hire in 2006, hiring an average of 2.6 employees. For 2007, 58.1% of respondents expect to hire additional staff.

In another recent study, one commissioned by Pershing Advisor Solutions called Uncharted Waters: Navigating the Forces Shaping the Advisory Industry, we modeled a projection that shows a huge jump in the number of professional staff within RIAs alone over the next five years–as many as 9,000, for a total of 52,000 advisors! And this is just RIAs. We did not look at the expected growth in independent broker/dealer advisory practices for this study, but we presume it will also affect the talent shortage.

There are many elements driving this growth besides the obvious. Clearly, there are more clients experiencing liquidity events or who are retiring from employers with 401(k)-type retirement plan rollovers. But most who view this opportunity are focusing on asset growth rather than individual client growth. It is this point that has ramifications for the typical advisory practice.

Assuming you are not a transaction-based practice or just living off of trails but are providing some form of financial planning or wealth management services in addition, we find that the typical advisor can effectively manage somewhere between 60 and 150 active client relationships. The more sophisticated the type of client one is dealing with, the more complex their needs, the fewer relationships one can manage–that ratio may in fact slip down to 35 or 40 active client relationships in firms with more complex clients. A lead advisor can raise the number by surrounding himself with other professional staff who can play an active role in providing advice, but then the question becomes, “What skills set will their professional staff need to possess?”