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Hope and Change for the Independent Advisory Business

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I don’t usually do year-end retrospectives or looks into the future in these pages. That’s because good, sound practice management isn’t trendy. In fact, it’s just the opposite: Effective business strategies protect advisory firms from the ups and downs of trends that typically affect the financial services industry. When truly helpful trends in practice management occasionally do surface, we usually talk about them straight away. With that said, I have been following a few macro trends in our industry that, when combined, appear to hold the potential for reshaping the independent advisory world. While change is inevitable, many advisors find themselves unhappy about some of the recent changes in regulation and the business climate, which could finally bring the consolidation in independent advice that’s been predicted for decades.

We’re all aware that the baby boom generation of independent advisors began reaching retirement age during the past decade. It’s a demographic that, when combined with the emergence of fee-based asset management over the last 20 years, has created a new industry around transitioning those retiring advisors’ clients to new advisors. What many folks are not aware of, however, is the tremendous demand for—and resulting shortage of—qualified successor advisors this has created.

Those of us who work in the recruiting and human capital end of the business have been aware of this trend for some time, and it’s quickly reaching crisis levels. The shortage of young advisors, and heightened competition to recruit them as boomer advisors’ time for transitioning clients to them is running out, is creating three problems at many firms: overpayment, unrealistic expectations and high turnover rates.

Attracting superstar advisors to a firm with over-the-top compensation packages isn’t on the surface a bad thing. One of the double-edged swords in the independent advisory business is that many owner/advisors can afford to overpay a key employee or two. The problem is the expectation that paying top dollar creates in both the mind of the owner/advisor (the new star will quickly make a major contribution to the firm with little or no training), and in the mind of the star advisor (if this job isn’t satisfying, there’s a better one somewhere with even better pay).

Consequently, most of these blue-chip recruitments don’t work out, usually within two years or so. Primarily due to effective training programs, independent advisory businesses have historically been plagued with exceptionally high turnover rates among younger advisors, which has diminished both growth and profit margins at many firms. While the increased demand for successor advisors has magnified both of these problems, it’s also had the even more dire effect of setting back an owner/advisor’s transition plans for years, by starting the recruiting, training and client-transitioning processes all over again. Many owner/advisors are forced to delay their retirement or turn to an outside buyer to realize the value in the firm they’ve created.

At the same time, we’re also seeing dramatic increases in regulation and compliance-related issues for independent advisory firms. Both RIA and BD-affiliated firms are experiencing a flurry of new rules and increased oversight at virtually every level. This has been driven not only by Dodd-Frank and the increased focus on independent firms, but also in response to the explosion in the industry use of digital communications and social media. For independent firms, the economic threat of increased regulation has been well-documented. What’s often been overlooked, though, is the dampening effect that this avalanche of regulation is having on advisors who want to start their own firms—it’s very hard to start an independent advisory practice today. That’s why the majority of breakaway brokers we see these days are groups of the largest producers and why they need so much help from their new custodians to go independent.

One result of this de facto regulatory crackdown is the growing interest in existing advisory firms from institutions such as banks, so-called roll-up firms and already-large independent advisory firms. Higher firm values and the dwindling supply of potential successors are driving more near-retirement-age owner/advisors than ever to consider the option of simply selling their firms outright. That suggests to me that we may well be on the brink of an industry-wide consolidation on a scale that we’ve never seen before.

The effect of such a consolidation on independent advisors would be dramatic. In my experience, most independent advisors today became independent for two reasons: to have the freedom to serve their clients’ interests to the best of their abilities, and for the lifestyle and working environment of owning their own businesses. If most of the advisors that I know wanted to work for large institutions or in large firms, they would.

Instead, they made the choice not to, and it’s not hard to see why. There are jobs in which you can make more money, but for control of one’s working environment, harmony with one’s personal life, a more than comfortable living and the ability to help people in an area of their lives where they desperately need it, being an independent advisor is hard to beat. It’s hard to see them or the next generation of advisors happily working in large firms, with or without an institutional owner.

That brings us to the question of whether industry-wide consolidation into larger advisory firms is, in fact, inevitable. I don’t have a crystal ball here, but it seems to me that the ultimate effects of retiring baby boomers and increased regulation will depend on two factors: what solutions advisors themselves demand, and how the industry that supports independent advisors—custodians and broker-dealers—respond to that demand.

I suppose it’s possible that some of our industry custodians and BDs would actually prefer to work with larger advisory firms and consequently don’t view these trends as problematic. From an operations perspective, it’s probably more efficient to work with a smaller number of very large firms, rather than the currently very large number of smaller firms. Still, I can’t help but feel that this thinking will sooner or later be revealed as rather short sighted.

For one thing, from a larger business perspective, working with a small number of large firms greatly increases the risk exposure of losing even a few of those firms to the competition. Currently, we can see this effect on Wall Street wirehouses, which are reeling from the fallout of larger producers breaking away. Larger advisory firms have greater bargaining power, which translates into the ability to negotiate lower fees and higher payouts from their BDs or custodians. In fact, today, most larger firms have relationships with multiple institutions, effectively creating a bidding system for major business lines.

Whether these institutions will see things this way is anybody’s guess. I suspect independent advisors will increasingly demand help facing today’s challenges, backed up by the growing ease with which even small advisory firms can work with multiple custodians or BDs to get the best deals for their clients. To keep their advisor firms happy, these institutions will need to step up in the areas where advisors are facing the greatest challenges.

On the regulatory front, the support institutions need to use their technology to create efficient systems for advisors to meet their growing compliance responsibilities. Custodians don’t have to oversee advisors as BDs do, but they have to make it much easier for their advisors to comply. They need to use their bargaining muscle to negotiate lower fees from independent compliance firms in strategic partnerships.

To help retiring advisors transition their firms to the next generation of advisors, custodians are going to have to go beyond education about succession plans and start addressing the real problems. Succession planning is essentially an HR problem, and custodians are going to have to get more involved with financial planning colleges to connect talent with firms; with programs to help firms prepare their young advisors to become firm owners; and with programs to finance the internal succession of these increasingly valuable firms.

These changes in the independent advisory world can’t help but force the institutions that support it to adapt. The firms that help independent firms stay independent will end up with the majority of advisors—and assets under management—in the years to come.


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