Silver Linings

Well, it’s semi-official: We’re in the midst of what will undoubtedly be deemed a recession as soon as this economic downturn reaches the requisite two consecutive quarters (the preliminary GDP numbers released October 30 confirmed that we’ve already had one of those two quarters). Yet, rather than the dire consequences it bodes for other sectors of our economy, tough economic times typically offer myriad silver linings to independent advisors. As this is the last issue of 2008, it would seem an especially good time to list a few.

In addition to the virtual flood of new clients that many independent advisors usually get during down markets, if history is any predictor, here are some of the events we can potentially look forward to:

o Broker/Dealers will be divested. When times get tough, and revenues are running disconcertingly short of corporate projections, financial conglomerates that bought up independent B/Ds during the boom years start to rethink their commitment to this whole “independent advice thing.”

B/Ds that service independent advisors run on much thinner margins than wirehouses with captive brokers and proprietary and/or ridiculously loaded products. Given the nature of large corporations, this makes owning these B/Ds far harder to defend, especially when profits are falling even further. Moreover, because they are low-margin enterprises, independent B/Ds are usually not the core business of their parent firms. That makes “spinning them off” a pretty easy decision for a CEO–or new “turnaround” CEO–anxious to show the world (and Wall Street) that he/she is refocusing the firm on its real business.

o Smaller advisors will get jettisoned. At the broker/dealer level, falling revenues and profits often usher in a new round of home-office belt tightening. Since most B/Ds already have their belts fairly snug around their waspwaists, they just don’t have many options to make further cuts. So it’s not much of a reach to predict that sooner rather than later, they’ll focus their bean-counter gaze onto the least profitable segment of their advisor force. Under the weight of current economic pressures, all the reasons why they affiliated with these low-margin “smaller producers” in the first place–they’ll someday grow into big producers, a larger advisor force helps with recruiting, they share in the costs of services and technology, their collective assets give the B/D negotiating scale, etc.–seem to slip from management’s minds. The usual strategy involves raising minimum production levels, lowering payouts, and initiating direct charges for a menu of services that were formerly just part of the deal.

o New B/Ds will arise to serve these recently disowned advisors. Actually, the first thing that will happen is that top management of B/Ds that appear on the selling block will scramble to buy the firms themselves. (Being a B/D exec is a pretty cool gig, and if you can own part of your firm, too, it’s even better.) Predictably, current corporate owners will all decide to unload their firms at the same time, bringing B/D values down to almost nothing, and creating irresistible bargains for existing management or even groups of their affiliated advisors to take their firms independent once again. We’ll also see more than a few new firms spring up to serve the advisors who are now persona non grata at the larger B/Ds. We can expect that many of these firms will do quite well, eventually being acquired for high multiples when the economy turns around and the next wave of consolidation once again values those smaller advisors, who of course will be much larger by then.

o A new pecking order will emerge. Twenty-five years ago, AIG, ING, and Ameriprise were simply insurance firms; LPL was a virtually unknown, local firm in Boston; Raymond James was a regional wirehouse; and Schwab was a discount broker. But then came Black Monday, October 19, 1987, and all that changed. Who will emerge as the leading service providers for independent advisors for the next 25 years? If the past is any prologue, it probably won’t be the same firms that are on top today.

Outsourcing and practice Efficiency

Another trend that will get a shot in the arm from our current market woes–and which also has the potential to shake up the broker/dealer/custodian world–is outsourcing. I know, there’s nothing new about outsourcing. What is new is the renewed interest that independent advisors have in improving practice efficiencies by outsourcing many of the functions they do in-house: compliance, technology, trading and reconciling, and even portfolio management.

For years, Moss Adams, Angie Herbers, and other practice management gurus have been bemoaning the inefficiencies throughout the independent advisory industry. A consistent theme in the annual Moss Adams industry reports has been that an ideal 35% target expense ratio is all but a pipe dream for most advisory firms. The Moss Adams folks came to this conclusion because many financial advisors haven’t been trained in the finer points of business management, which of course, is all too true. But I’ve come to believe there’s a stronger reason behind operational laxity in advisory practices.

The short answer is that it just didn’t matter. Let me explain. Since this is kind of a year-end wrap up, indulge me in a short walk down memory lane. Independent advisors have a rather unique history. Unlike most “industries,” the independent advisory movement wasn’t spawned out of the desire to make more money. Rather, advisors left more lucrative jobs as stockbrokers or insurance agents to better serve their clients as independents. Quite a few of them actually made less money, certainly to start with.