In our last article, we covered revenue, time management and investment trends among registered investment advisors. In this piece, we address two critical components of effective practice management: business development and client communication. Success in these areas helped the advisory industry fare relatively well during the recent recession, compared to overall equity markets.
Median firm assets fell much less than equity markets, and then not only regained their upward trend, but hit a new high only a year later (see Figure 1). We believe there are many reasons for this relative AUM stability and quick turnaround, including effective diversification, a sharp market rally, and strong new business development, among others. And this commendable performance under tough circumstances bodes well for the industry overall.
There are, however, some concerning trends that must be addressed if the industry is to capitalize on the many opportunities now emerging. The key is for firms to focus on the challenges of business management, business development and client relationship building.
Industry margins have been under stress for nearly a decade now. They have been shrinking steadily since 1999. Figure 2 clearly shows that the 2001–2002 recession challenged advisory firms’ profitability, and that while margins and profits jumped a bit in the mid-2000s with the asset bubble in equities, they have since resumed their decline. History is showing us that asset growth on its own can no longer be relied upon to make up for the industry’s inherent inefficiencies—especially during severe market dislocations.
While top performing firms posted 40% higher AUM growth in 2009, their outperformance on expenses, revenue and margins was even higher. These firms grew revenue more than three times faster than other firms, and actually decreased expenses at the same time. At other firms, expenses were going up, while new assets were not translating into as much revenue growth. As a result, top performers were able to operate at nearly twice the margins of other firms.
Top firms are able to turn new assets into revenues and profits at a much higher rate than other firms. The data indicates that these firms are bringing in higher quality new business, while also keeping costs restrained. For example, nearly a quarter of advisors do not focus on specific types of clients at all. And of those that do, many focus narrowly on assets. The overall industry response for “wealth range” as the defining factor of an idea client increased from 49% of firms in 2008 to 63% of firms in 2009.
But top firms are much more likely to look at a variety of factors, from age, to lifecycle situation, to specialized investment needs (see Figure 4, above). We believe that their more comprehensive approach helps them bring in clients that are well matched to their offering—including product and service mix, as well as pricing.
In addition to targeted new business development, top firms excel in the most important driver of new business: referrals. They far outpace other firms in both active and passive referrals (see Figure 5), with active referrals becoming the most important source of new business for advisory firms (see Figure 6). Since 2007 active referrals, as a source of new clients, have quadrupled, while passive referrals have been cut by three-fourths.
What we can learn from top firms is that sustainable success requires a disciplined and systematic approach to business development, focused on active referrals; and that strong client relationships are required to ensure strong lead flow.