Where’s Your Compensation Heading?

Most financial advisors expect to see a spike in revenue in 2011 but continuing market volatility and a growing unease over Washington have put a chill on any unfettered enthusiasm.

As “New Realities in Wealth Management: From Dusk Till Dawn,” a new report from Aite Group, frames it: “Overall, the path to recovery remains lengthy and littered.”

Compensation expert Alan Johnson, downgrading his Wall Street year-end projections following a turbulent second quarter, called the solid first quarter an “anomaly” and identified the absence of an economic recovery, the varying impact of regulation in the U.S. and abroad, and ongoing uncertainty in world markets as key drivers this year in financial services compensation.

“On average, compensation may be up a little bit,” said Johnson, who heads Johnson Associates in New York City. “But my forecast is not nearly as robust as it was early in the year.”

Notably, Johnson attached this footnote to his forecast, issued in mid-August: “Caveat: Assumes turbulent market conditions don’t lead to 2008 type meltdown.”

If there is any one distinctive characteristic about the current state of advisor compensation, it is that there are so many moving parts. The bottom line as Danny Sarch, president of Leitner Sarch Consultants in White Plains, N.Y., draws it: the potential for a cut in pay, particularly at the wirehouse level.

“Take Morgan Stanley Smith Barney, as an example. [CEO] James Gorman has been very public about wanting a 20 percent return on the wealth management side. But every time quarterly earnings come back, where is it? Eight or nine percent, far short of that,” notes Sarch. “It’s the big elephant in the room: What can we get away with as far as cutting advisor pay that won’t cost us much in terms of defections? As a rational person, when you’ve cut and stretched, at what point do you say ‘Okay, what else do we do?’ Advisor compensation has to be under scrutiny. I’d find it hard to believe they could go too many years without tinkering with the grids.”

Still, financial advisors are a generally cheerful lot as the Aite report suggests. “Financial advisors are always optimistic,” observes Sophie Schmitt, co-author of the survey. “In every study, you’ll see that they think higher growth is coming versus what they just experienced.” Consider: Most financial advisors surveyed by Aite in the first quarter of this year expect 2011 revenues to grow by 19 percent over levels a year earlier. (At press time, there were no data on growth expectations in more recent quarters.)

Schmitt said the optimism may be fueled in part by a “significant” change over the last two years in the way advisors are compensated. According to Aite’s research, the percentage of commission-only advisors dropped by 40 percent between late 2009 and early 2011. It’s no secret that many advisors and firms have long looked to the fee-based model as a more sustainable income source. “The subscription model allows you to spend more time deepening relationships. The more time you spend face to face, the more revenue you have,” she added. “You’re not out there hunting for that next client.”

When financial advisors were asked to select the business model they believed would grow the most as a percentage of their total book over the next few years, 60 percent cited fee-based assets. Notably, Schmitt said, those advisors who were most heavily invested in fee-based products experienced the highest growth in 2010.

The upward tick in fee-based business corresponds with a renewed push by the wirehouses to improve the composition of their advisors’ books of business. Through compensation-related measures, according to Schmitt, wirehouse advisors are being incentivized to focus on larger clients and reduce smaller accounts as a path toward increasing the revenue generated per advisor. As an example, she said, Bank of America Merrill Lynch is developing new pay incentives that include rewards for working in teams, having fewer but wealthier clients, and bulking up fee-based accounts. The firm already compensates advisors for referring small clients to its Merrill Edge platform, according to Aite.

At the moment, Sarch says, many advisors are in a holding pattern as they contemplate the shifting landscape that has come to define the compensation conversation.

“They are worried on this level: How can I continue to grow my business in an uncertain environment? The very best advisors, they are going to grow their business no matter what. I met a guy last week who’s up 22 percent from last year,” he said. “My point is I think the best guys are doing even better. My sense is the good guys are holding their own. This middle group feels lucky and glad to stay flat. Advisors at the bottom will lose market share because it’s a downward spiral for them in terms of how successful they can be relative to their peers. If the cuts come, the organizations are going to do what’s best for the firms. That may mean cutting their lower-end advisors and sprinkling fairy dust on everyone else.”