Behind the Numbers

Financial advisors should read the myriad of industry studies and surveys that come out each year with a grain or two of salt.

At best, these are aggregations of responses and information usually from hundreds of advisory practices. While most reports attempt to explain what kinds of advisory firms participate in the research and usually segment the data by firm size, these are still broad categories. This means that any data gathered may or may not be useful for your business.

What’s more, there’s also the problem of the veracity of survey responses. I have on good authority from business consultants (who should know) that the filled-out survey forms they’ve seen rarely bear much resemblance to the businesses in question.

Most believe this is because the owners of some advisory firms tend to fill out the forms or respond to calls without checking the precise figures. And, of course, it’s human nature to want to make yourself and your firm look as good as possible.

With that said, we can still glean some useful information from certain studies by focusing on areas where the numbers have gotten “worse” (lending credence to their veracity) or on historical trends (for which we might assume the same fudge factor year after year).

Latest Industry Research

This brings me to the “2017 FA Insight Study of Advisory Firms: People and Pay” by Dan Inveen and Eliza De Pardo, both of whom were formerly with Moss Adams.

“In this year’s study,” write the FA Insight authors, “we explore how firms are continuing to evolve the advisory model. We explore how productivity, organizational design, the scarcity of talent, compensation structure and succession planning all contribute or detract from a firm’s ability to meet their strategic objectives.”

This year’s FA Insight study offers a few surprises on the upside, as well as one or two on the downside. In 2017, 388 firms participated, up from 325 last year. There is some turnover among respondents, but according to Inveen roughly 50% tend to repeat year after year.

The first step toward determining whether any of this study’s results are relevant to your firm is looking at profiles of the 388 firms. From an age standpoint, their median year of establishment is 2002.

Next are the business models they use. This year, 76% of the participants are “RIA only” with another 11% listed as “primarily RIA.” Of those with their own RIA, the advisors work with the following custodians: TD Ameritrade Institutional, 53%; Schwab, 21%; Fidelity, 10%; and Pershing, 4%. Of participating firms without their own RIA, the bulk work with indie broker-dealers. (FA Insight was acquired by TD Ameritrade Institutional in 2016, by the way.)

Good News, Bad News

The latest FA Insight study has more than a few bright spots. The brightest is the fact that Inveen and De Pardo felt the need to expand the categories of firm size from four to five. They added “pacesetters” (firms with $8 million and up in gross annual revenues) to the existing “operators” ($100,000 to $500,000), “cultivators ($500,000 to $1.5 million), “accelerators” ($1.5 million to $4 million) and “innovators” ($4 million to $8 million).

The fact that we now have enough advisory firms with $8 million or more in annual revenues to warrant their own category is a clear indication that the industry is well on its way to outgrowing its “small business” classification. Perhaps Fiduciary Network CEO Mark Hurley was right when he wrote over a decade ago that eventually the industry would consolidate into a dozen or so very large advisory firms with a smattering of small firms.

The study reveals that the average advisory firm’s number of clients increased 6.4% in 2016 from the year before; total AUM increased 12.5% (largely due to the markets, as there was a 9.84% gain in the S&P 500); and operating profit margins increased to 24.4% from 19.6%. While revenues were up, they improved only 6.7% — way below the healthy AUM increase.

“Firms have managed to keep expense growth to a level less than revenue growth, which has helped to enhance profitability,” Inveen explained in an interview. “This comes despite a trend over the [past] year toward increasing services and servicing a slightly less affluent client. For firms to continue this level of profitability, they would be well-served to focus on productivity, as featured in this year’s study. Pricing is another fruitful area for focus.”