Back in 1984, futurist Alvin Toffler was a keynote speaker at the IAFP (forerunner of the FPA) national convention in Anaheim, Calif. At that time, the IAFP owned Financial Planning magazine, where I had been recently hired as a senior editor. For reasons I don’t think I ever knew, I was assigned the privilege of keeping Toffler (author of the seminal book “Future Shock,” and subsequently, “The Third Wave,” “Power Shift” and “Revolutionary Wealth”) company backstage for an hour or so before he was scheduled to speak.
He was a brilliant and charming man, and it was one of the most fascinating hours I’ve ever spent, but I’ve always remembered what he told me about being a futurist: “Nobody can see the future,” he said. “But it’s important to realize that we all live in the past. For some of us, it can be days or months, and as we get older, it often becomes years or even decades. A futurist’s job is to understand what’s going on as close to the present as possible, which gives him or her insights that most people don’t have.”
I was recently reminded of Alvin Toffler’s thoughts about the present as I was reading through Mark Hurley’s new white paper, “The Brave New World of Wealth Management.” It’s Hurley’s third white paper on the future of the independent advisory industry. The first paper was written in 1999 when he was CEO of Undiscovered Managers Funds; the second came out in 2005 after UMF was acquired by JP Morgan. Now he’s released a new future-looking study as CEO of Fiduciary Network, a private banking enterprise he founded in 2007 that provides liquidity to transition independent advisory firms to their junior partners.
That makes this paper truly different: A former Goldman Sachs investment banker, Hurley’s first two papers were written as appraisals of the independent advisory industry from an outside investment professional’s perspective. He provided some interesting and valuable insights, but his conclusions and predictions were often skewed by a lack of understanding of the dynamics of the independent advisory business. After five years of evaluating hundreds of independent firms—and investing in 12 of the largest firms—Hurley has moved way up the learning curve, becoming one of the preeminent experts on the workings of the advisory business. While his perspective is still a bit skewed toward firms with more than $1 billion in client AUM, the insights in “The Brave New World” on the challenges facing the advisory industry today and the keys to successful selling and buying of advisory firms should be required reading for all independent advisors.
As you might expect, Hurley’s 84-page tome contains far too many useful nuggets for me to even summarize them all here. (Note to Mark: This probably would have worked better as two or even three separate white papers.) The analysis of the current independent advisory industry is both revealing and sets the stage for the present situation: Currently, there are roughly 19,000 independent fee-only firms. Hurley divides them into three groups: 200 “evolving businesses” that are “sustainable in the long run and have meaningful enterprise value,” which seems to mean more than $1 billion in client AUM; nearly 18,000 firms called “books of business” (which appear to have under $2 million or so in annual revenue) and that he describes as “jobs rather than businesses”; and 1,000 to 1,200 “tweeners” that have “greater scale and profitability than ‘books of businesses’ [but have not] evolved beyond a founder-centric model.”
Helpful as this breakdown is, Hurley’s bias toward larger firms (which is clearly evident even in these brief descriptions) is understandable given that Fiduciary Network is only interested in financing firms near the top of this pyramid. Still, that perspective does lead to some skewing of his assessment of the independent industry. For instance, in the same section, the paper states that the 200 evolving businesses represent the “majority” of the industry’s $5 trillion in client assets under management. Simple arithmetic reveals that half of those assets spread over 200 firms would average $12.5 billion in AUM each. Yet, the paper states elsewhere that “today, more than 100 firms manage more than $1 billion of client assets,” suggesting the aggregate of the top 200 firms is quite a bit lower than $2.5 trillion.
The section on the traits of successful buyers and sellers of advisory firms, on the other hand, is excellent, and is a must-read for advisors who are even thinking about transitioning their firm or acquiring one. Hurley provides 10 tasks for each side of a transaction, which clearly have been composed by someone with both substantial expertise and considerable hands-on experience with these transactions. For sellers these include: “Do not go to market until they are mentally prepared to sell their businesses”; “Recognize that buyers invariably underpay for rapid assumption of risk and overpay for certainty”; and “Accept that they are selling their firm to, and not merging with, the buyer.” For buyers: “Understand that all potential acquisitions are very-low-probability events”; “Recognize that success in transactions is ultimately based more on psychology than finance”; and “Focus on ensuring a continuity of client experience.”
With all that said, the best part of “The Brave New World” is the discussion of why the present is truly different for independent advisors and how that will affect the industry in the future: “An unprecedented bull market, a sudden spike in demand for independent financial advice, and limited competition for clients allowed even average wealth management firms to enjoy two decades of financial success,” he wrote. “However, the macro factors are about to change—in a fundamental way. [...] The tailwinds enjoyed during the industry’s infancy aren’t simply gone; wealth management firms are now flying into stiff headwinds.”
Hurley cites seven current macro factors that he believes “will reshape the industry over the next decade.” Some seem better-founded than others, while a few, such as increasing operating costs, greater regulatory scrutiny and higher risks of litigation, are pretty common knowledge. Taken together, it’s a comprehensive list of the things advisory firm owners should be at least thinking about today. Here are three of the most interesting:
Advisors’ client bases are aging and shifting to consumption. Yes, this is a well-known problem, but Hurley’s detailed analysis of its effects when combined with lower returns on lowerrisk assets and the end of the 20-year bull market on advisory firms is the best I’ve seen: “The combination of higher average gross capital consumption and lower nominal rates of return on [lower -risk] investments results in clients consuming much more of their capital over time on a net basis. Consequently, their assets gradually decline over time. [At the same time] wealth managers are effectively capped in the number of new clients that they can service at once. Thus, [many firms] will not be able to accept a sufficient number of new clients to offset the aging of its client base.”
Fewer millionaire households. “The supply of millionaire households (the core prospective clients of wealth managers) declined sharply with the 2008-2009 financial correction and, to date, has not recovered to pre-correction levels.” This seems to be a more questionable concern. Hurley cites that in 2007, we reached an all-time high of 9.2 million households with $1 million or more in investable assets. In 2008, that figure dropped to 6.7 million. Today, it’s up to 8.6 million. That’s off by 6.5% from the high, but it’s also a 28.3% recovery from the ‘08 low. To my mind, that’s a pretty positive trend. What’s more, back in 1999 there were only 7.1 million millionaires—so we’re up 21.1% from Hurley’s golden age of independent advice. Seems to me, by this metric anyway, that things are looking up, not down, for independents.
Founders are getting old. Mark’s belief that the smaller “books of business” firms are too small to be acquisition targets for the largest firms is undoubtedly right. Yet, he seems to have overlooked two other factors. First, they aren’t too small to be acquisition targets for other smaller firms or for those firms in the “tweener” category who also want to grow. What’s more, the term “book of business firm” is itself a misnomer. In the old days, when commissions were the sole source of revenue, it would have been accurate, but with today’s RIAs that are AUM fee-only, those assets do have value to other firms and to their junior advisors. While time is running out for baby boom advisors to create succession plans to transfer their ownership before they retire, we are currently witnessing an entire industry positioning itself for succession or for sale.
Simply put, “The Brave New World of Wealth Management” is Mark Hurley’s best research paper, by far. It’s far more authoritative than his past efforts, and consequently, his analysis of the present state of the industry is much more useful for independent advisors, regardless of firm size. While his bias toward the largest of firms is understandable, it’s also unfortunate: The paper would be even more useful for many more advisors were Hurley to turn his insights and knowledge toward furthering the industry’s evolution into business models that enable smaller firms to grow into larger firms.