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If the seeds of destruction are sewn in good times, then the seeds of success are sown in challenging ones. As advisory firms await a clear and sustained economic recovery, a unique opportunity exists to learn from the human capital challenges illuminated by the trials of the recent economic downturn. These lessons will serve firms well both now and in the future. Even in the best of times, there will be external economic pressures beyond the control of the firm owner that will invariably challenge firm growth and profitability.
In 2008 about three of every four dollars spent by advisory firms was related to compensating or developing people (see Chart 1: Investing in People). People can be an overwhelming cost component for firms, especially in the current business climate. Much more than simply a cost, however, human capital is an asset that must be constantly invested in, nurtured, and allowed to grow in order for firms to enjoy long-term success.
People are without question the engine that drives client satisfaction, client retention, business efficiency, and financial performance for advisory firms. While managing costs is important, costs can be controlled in ways that avoid compromising the skill and talent that sets a firm apart in a competitive marketplace.
Sponsored by TD Ameritrade Institutional and with Investment Advisor as its media partner, the inaugural 2009 FA Insight Study of Advisory Firms aims to guide business owners facing serious decisions about people and pay. Without unduly risking the firm’s chances of surviving through the economic downturn, how do advisory firm principals best position their firms in order to exploit new opportunities when the economy ultimately rebounds?
To help answer this question, FA Insight analyzed survey results submitted from 200 advisory firms. To be included in the study, firms were required to have been in business for at least 12 months and report minimum annual revenues of at least $75,000. In the comprehensive survey, firms generously shared their experiences and expectations concerning people and pay practices as well as firm performance. The survey, which was administered exclusively online, was fielded between May 1 and June 29, 2009. Participating firms invested 45-60 minutes of their time to complete the survey. They were required to provide a thorough financial statement, detailed information on up to 33 advisory firm job positions and the individuals that fill them, and answer 37 questions relating to the firm’s operational characteristics and human capital practices. The results yielded a trove of data for better understanding how success correlates with a firm’s capabilities to organize, motivate, retain, and develop people.
The Good, the Bad, and the Ugly
Borrowing from the epic 1960′s spaghetti Western film, financial advisory firm performance over the past year can only be characterized as equal parts good, bad, and ugly.
The bad came in the form of dramatically shrinking investment portfolios, a decline in profits, and a workload that climbed in the opposite direction as advisors struggled to calm clients’ frayed nerves, retool financial plans, and get clients back on track toward meeting financial goals. The ugly came in the form of scandal and misrepresentation, led by Bernie Madoff and a variety of mini-Madoffs. The publicity devoted to these negative events largely drowned out the good, which formed an overlooked but significant subplot to the drama of the past year.
We include among the positive developments the facts that client growth continues, the industry is maintaining and even adding to employment levels, and profit margins, at least through 2008, have remained healthy. Despite an 18% annual decline in AUM during 2008, the typical firm ended the year with the number of clients increasing 6% and gross revenues up 5% (Chart 2: A Slowdown in AUM). As a result, the typical or median firm earned a very respectable 2008 pre-tax operating profit margin of 18%.
Firms Remain Committed to People
We were encouraged to find in this year’s study results that so many participating firms are maintaining their commitment to their colleagues and employees. The typical participating firm expects to maintain the same level of five staff members in 2009 that the firm maintained in 2008 and 2007. Our data show that in 2009 just 8% of firms plan to let staff go as a result of weak financial performance. In fact, many of the best firms in our study, the ones we call Standouts, are taking advantage of a suddenly available talent pool and adding staff instead of cutting back. Due to these planned hires, participating advisory firms are anticipating an average 3.5% increase in staff for 2009.
With the exception of possible contractions in incentive compensation, firm owners are similarly steadfast with respect to pay. While most owners do not anticipate any 2009 adjustments to salaries as a result of economic conditions, of those that do plan to make a change, more say they are apt to be raising salaries than decreasing them (See Chart 3: Raising the Salary Bar).
Reasons for Concern
While the patient may no longer be in critical condition (assuming it ever was), the recovery process for advisory firms is far from complete. Reasons for concern remain as growth rates ratchet down while firms struggle to contain expenses. Especially if the current recession lingers on and a financial market recovery fails to hold, the profit margins firms enjoyed in 2008 will not be sustainable through 2009.
Client growth among participating firms in 2007 was an estimated 8%, with firms expecting 5% growth for 2009. Annual revenue growth, as a result of shrunken portfolios, is off more dramatically. Median firm revenue growth, dropping from 21% in 2007 to 5% in 2008, is expected by firms to dip to -2% in 2009.
While revenues are trending down, the opposite is true of firm workloads. As clients demand increased attention to restore their damaged portfolios and lost sense of confidence, it’s been a struggle to contain costs. In 2008 about 45% of revenue was related to overhead, defined as those expenses not directly associated with generating revenue. Normally this ratio should be in the range of 35% to 40%.
Advisory firms’ recent challenges with overhead expenses, particularly evident among the larger practices, are similar to trying to brake a runaway freight train. As revenues began to contract in 2008, overhead expenses could not be reigned in quickly enough. The fact that advisors still had the same or greater number of clients to serve, all of whom were requiring more attention, compounded the cost challenges for firms.
Standout Firms Really Stand Out
While no firm was able to completely escape unscathed from the effects of the economic downturn, a sub-set of firms in our study fared remarkably well, particularly with regard to their ability to keep overhead expenses under control.
In order to better understand what makes an advisory firm successful, Standout Firms were distinguished at each of four stages of development. We defined these firms according to two key criteria related to building firm value:
o The ability to generate income for owners
o The ability to grow (as measured by revenue)
The top third of firms ranking highest across both factors in each of the four stages of firm development were distinguished as Standouts. Both the owner income and growth criteria received equal weight.