FA Insight's Growth by Design study shows how standout firms got that way. (Illustrator: Agent Illustrateur/© theispot.com)

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.”

“Despite a slower pace of industry expansion in 2015, most firms (62%) continue to report that they have experienced significant recent growth. However, fewer firms are growing sustainably,” wrote the authors. “Firms need to be aware that not all growth is positive. Only 26% of firms cited significant recent growth and achieved these results without experiencing negative impacts, which can include overworked staff, outgrowing technology and an increase in overhead expenses.” The study includes an entire chapter on sustainable growth.

Quality of client service. According to FA Insight, the majority of Standout firms at every level except the smallest firms cite “the quality of their client experience as primarily responsible for recent firm growth,” the authors wrote. “The importance of the client experience cannot be understated. Successful firms adhere to a well-defined value proposition that speaks to the firm’s target clients and articulates specific valued outcomes that will be delivered. The quality of the client experience determines the extent to which the firm is able to deliver on its value promise. Upholding this promise is vital for client retention as well as future business development.”

Operational efficiency. “Operational efficiency may be the single most important business area that distinguishes the Standout firms,” wrote the authors. “At every development stage, the typical Standout firm devoted a much lower percentage of its revenues to overhead expenses.” The study cites designating a firm operations manager, formally structuring workflow processes, coordinating tasks between team members, and automation through the increased use of technology as the biggest drivers of efficient operations.

A quality strategic plan. “The vast majority of firms participating in the study (82%) report having a strategic plan in place, with Standout firms demonstrating a greater tendency for planning,” wrote the authors. “Simply having a plan, however, doesn’t guarantee success.”

The study cites three factors that greatly increase the effectiveness of a strategic plan: making sure that all team members clearly understand the plan; tying a strategic plan to the individual performance objectives of staff members; and including details about how a plan’s objectives will be met.

A target market. The study tells us that “Standout firms are generally more inclined to serve a target market.” At every firm size but the smallest firms, a higher percentage of the Standouts have a target market compared to the other 75% of firms.

However, while many firms target clients with specific levels of assets, the authors tell us that assets alone do not make a good target market: “Assets may be a helpful starting point for determining a target,” they wrote. “However, they are not particularly telling in determining client needs. Two clients with the same level of wealth can easily have very disparate needs. The most successful firms use a combination of financial and demographic criteria when determining their target or niche market.”

Marketing through centers of influence or external professionals. Across the board, FA Insight found that Standout firms have attracted a larger share of their existing clients from COIs and professionals than the other 75% of firms: ranging from 31% of clients for the smallest firms, to 36% of clients for the largest. Concluded the authors: “The difference suggests that many Standouts are marketing more proactively to cultivate these relationships and garner referral recommendations.”

Finally, Inveen and De Pardo offer a bit of mystery in Figure 14 of their study (see chart above). Their FA Insight data shows that Standout firms have a significantly higher percentage of owners under the age of 45 years. The authors suggest that in the smaller firms, younger advisors have the advantage of more advanced non-legacy technology, and that the larger firms are proactively recruiting new advisors at a younger age.

Perhaps like most of the study’s other findings, it’s an indication that the independent advisory industry is reaching a new stage in its evolution.