Financial services firms have operated independently for decades. Looking back, we see this entrepreneurial mindset emerging in the 1980s, when the industry developed two variations on existing business models: registered investment advisors (RIA) and independent contractor broker-dealer (IBD) reps. These new structures featured practitioners who were also owner-operators, instead of working as employees of other firms.
Now, many years later, these models continue to evolve. We see new dynamics emerging as firms transform from practice to business, and from single-owner to multi-owner/multi-employee advisory firms. Interestingly, the success the independent advisory world has experienced now strains the notion of independence. More mouths to feed, more constituencies to please and more competition for strategic direction from multiple points of view tend to complicate and disturb the way firms operate. While ownership may feel independent, principals have lost the ability to make business decisions without the influence of others.
RIAs remain the purest form of independence. They are free of broker-dealer oversight and overrides on their compensation, whereas the IBD model is subject to supervision by the broker-dealers with whom they affiliate and must share an override on revenue production. These different business approaches include different regulatory structures: the Securities and Exchange Commission versus FINRA. The RIA model comprises professional buyers, whereas the IBD model is composed mostly of professional sellers; in the former, advisors get paid directly by the clients and act as fiduciaries or client advocates on all accounts. Broker-dealer reps get paid on a grid for the products they sell, including fee-based programs, and for the most part operate under a suitability standard (though a recent ruling by the Department of Labor will change that condition for retirement accounts).
These distinct identities have morphed in the past decade as many IBD reps have either formed their own RIAs or become investment advisor representatives (IAR) of their broker-dealer’s corporate RIA. (Those who are registered reps and have their own RIA are known as hybrid advisors, while those who operate under the supervision of their broker-dealer’s corporate RIA are known as dually registered).
This background helps in understanding the transformation of the retail financial advice business and the current catalysts for growth. Not only have we seen a big shift from brokerage to advisory, from transactional to fee revenue or suitability to fiduciary, but also from single books of business managed by solo practitioners to larger, professionally managed practices, many operating in multiple locations.
Perhaps the biggest leap in the evolution of the independent advisory business has been the shift from small to medium-sized firms. Consider this: The U.S. Small Business Administration (SBA) regards Financial Investment Firms (NAIS Code 523) such as securities brokerage, portfolio management, investment advice or trust and fiduciary firms as small businesses when their annual revenue is below $38.5 million. An advisory firm with $1 billion of assets charging an average of 80 bps would be generating under $10 million of annual revenue, so to exceed the small business threshold, an advisory firm would need to be managing somewhere between $3 billion to $4 billion of assets. While few fit into that mid-sized category today, it won’t be long before we see a meaningful cluster of such firms as more and more merge, acquire or grow organically to a new level of critical mass.
Just a decade ago, it was a big deal for an independent advisory firm to achieve $1 billion of assets under management (AUM). According to Evolution Revolution, produced by the Investment Advisor’s Association (IAA) in March 2015, more than half of all SEC-registered advisors have AUM between $100 million and $1 billion. Today, nearly 650 RIA firms manage more than $1 billion of assets, according to Cerulli Associates. Even more significant, according to the 2015 InvestmentNews Study on Compensation & Staffing, sponsored by Pershing Advisor Solutions, there are now more non-owner advisors within advisory firms than there are owners. Few indicators mark the emergence of a real business more accurately than this dynamic.
Many firms experience growth in the same way that we experience the expanding waistline of middle-age, adding a pound for every year we are on the planet. It’s insidious, it’s persistent and it’s maddening. Principals in larger advisory firms look around at their holiday parties and wonder how the guest list got so big. Managers must simultaneously juggle the challenges inherent in being a small practice with the added complexity of a larger business.