It’s no secret that 2015 was a tough year for independent financial advisory firms. The Russell 3000 posted a 34% gain in 2013, a 20-year high, and another 13% increase the following year, but it managed a meager 0.5% uptick last year. The effect of this slowdown on the advisory business was significant.
According to FA Insight’s 2016 “Growth By Design” study of 325 advisory firms, median annual AUM growth fell from 10.6% to 4.7%, while client growth slowed from 7.1% to 6%, dragging down year-to-year revenue increases from 14.2% to 7.3%. While these figures may still seem healthy to advisors who have seen worse years in recent times, they translated to some troubling numbers: annual average overhead expenses per client rose 31% to $2,800, driving down profit per client by 11% to $1,378, and reducing average operating profit margins by 6%. Despite the fact that the average firm still showed positive margin growth, the overall slowdown resulted in a 14.6% reduction in owner’s income: from 55 cents per dollar of revenue to 48 cents.
That’s not to say 2015 was a total bummer. We can learn a lot more about the advisory business during tough times than we can during banner years. FA Insight’s biennial analysis of what constitutes “Standout firms” — those in the top 25% of their peers in four size categories — offers some real insight into what independent firms can do to become more successful.
Before we get to the good stuff, let’s be clear about whom FA Insight is talking about here, for the value of any survey largely depends upon who was surveyed. In this case, of those 325 firms, 75% were independent RIAs with no BD affiliation, while another 11% were RIAs with a BD affiliation “for conducting limited commission-based business.” The remaining 14% were affiliated with independent BDs (10%), bank and trust companies (3%) or national full service brokerages (1%). Altogether, 96.5% of the participants are compensated by fees of one kind or another: AUM, hourly, flat retainers or project.
What Is a Standout Firm?
As for firm size, the participants break down this way: 17% had between $100,000 and $500,000 in annual revenue; 33% had between $500,000 and $1.5 million; 28% had between $1.5 million and $4 million; and 22% had over $4 million. As they do every two years, FA Insight ranks all the participants in these categories by revenue growth and owner income per revenue dollar, and combines those rankings to designate the top 25% of firms in each of those categories as “Standout” firms.
The differences between Standout firms and the rest in each of these revenue levels can be significant. For instance, revenue growth of the top quartile of the firms at each revenue level averaged 20.3%, 14.1%, 14.7% and 11.7% respectively, compared to only 11.7%, 5.6%, 3.7% and 4.9% for the remaining three-quarters in each level. As for income per revenue dollar, the top firm owners in each category took home $0.75, $0.64, $0.60 and $0.56 of every revenue dollar, compared to just $0.50, $0.46, $0.41 and $0.36 for non-Standout firms.
The FA Insight data also includes a striking anomaly. The growth of advisory businesses typically slows down as they get larger. In 2015, revenues of the smallest firms (called “Operators”) grew 15%, while those of the largest firms (“Innovators”) grew by just 6%. This is true of virtually all businesses (and is why small-cap stocks typically outperform large-cap stocks, albeit with higher risk).
However, as noted above, the Standouts among the largest firms grew 20.3% in 2015, while the Standout firms in the three smaller categories grew at just 14.1%, 14.7% and 11.7%, respectively. While those are all healthy growth rates during a year when stock market growth slowed, at least in the independent advisory business, size does have substantial advantages.
To find out how these Standout firms do so much better, FA Insight principals Dan Inveen and Eliza De Pardo asked the question: What do these Standout firms do that makes them, well, stand out? As I mentioned, this is a particularly important question in years like last year, when all boats weren’t rising on a bull market tide.
Here’s what FA Insight tells us about how Standout firms got that way.
A focus on “sustainable” growth. A recurring theme in FA Insight studies, this study differentiates between “sustainable” growth and “growth at risk.”