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Tough Markets Can Make Independent Firms Better

By Bob Clark, Bob Clark

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One of the benefits of getting older is that you start to get some historical perspective. When I started covering financial services in 1984, the economic environment was vastly different from the one we’ve come to consider normal: during the preceding 20 years, the top tax rate hit 90%, inflation reached double digits, interest rates peaked in the high teens, and the stock market, which hit a record DJIA of 995 in 1966, finally broke 1000 in 1973, then didn’t reach that high again until April 1981.

Now consider the “golden age” we’ve enjoyed during the past 20 years: inflation has been almost non-existent, interest rates hovered in the low single digits, taxes were low, and the stock market boomed, reaching 14,164 on October 9, 2007.

This environment has been perfect for independent advisors.

Determining client goals and risk tolerance, then allocating portfolios between asset classes (additional financial planning is optional), is a high-margin business in which the advisors in a firm typically take home 60% or more of their substantial revenues.

But what happens if the “Golden Age” is coming to an end? The Federal deficit that exploded under Bush and seems to be spiraling out of control under Obama has the potential to choke off our economic recovery for the foreseeable future. If that happens, creating volatile “trading range” markets with little or no overall gains, investment success will shift away from allocated buy-and-hold portfolios that take what the market gives, to stock picking, market timing, commodities, and dare I say, speculation.

Where will that leave the business of independent financial advice? It seems to me advisors will have two options. The first is to bring in-house the necessary economic and financial expertise to actively manage future-looking, high-turnover portfolios. But these folks are expensive: Putting them on staff, or even adding them as partners, will undermine the current favorable economics of independent firms.

The other option is to continue the trend to outsource investment management altogether. While the cost of this route can be considerable, many firms today find that the savings in overhead from not managing client portfolios or dealing with backoffice trading, confirming, reconciling, reporting, etc. more than offsets the additional expense.

What’s more, the advisor moves further into their clients’ corner, helping them to sort out potential managers, and distancing themselves from portfolio performance.

This option is better for the clients, better for advisors, and if it results in better portfolios even in challenging markets, may truly be a sliver lining.