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).

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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."

Talent Crunch

The study tells us that despite the industry's push over the past 10 years or so, succession planning is still a struggle. Nearly two-thirds of firms do not have an adequate plan, despite the growing and significant number of owners nearing retirement. Those who do plan for succession favor homegrown successors. In support of this trend, we are seeing the pace of adding new owners increasing, although not at a pace fast enough to alleviate concern," the report states.

The root of the succession-planning problem clearly is a dearth of qualified successors. As the study shows, an industrywide, decade-long talent shortage continues to plague the independent-advisory world.

Despite the above-mentioned increases in the number of clients, revenues and profit margins, only 19% of advisory firms surveyed "have a documented plan for their future staff structure." On average, the participants are looking to add the equivalent of just one full-time employee in 2017.

This is probably because 22% of firms say they are finding it difficult to hire administrative personnel, and some two-thirds (68%) of firms are having problems hiring "revenue generators." (While this may seem to be an odd term in an RIA setting, the authors define it as lead advisors, associate advisors and business-development specialists.)

The study also finds that today's advisory firms are getting quite creative in how they address this talent shortage. For example, some 60% of respondents report they are currently using some "outsourcing" to solve their staffing needs.

What's more, for jobs that are still better done within the business, firms are turning to new talent pools: 31% are targeting recent college graduates for revenue-generating roles. Did you get that? Not support roles, but client-facing, revenue-generating roles.

The study does tell us that lead-advisor compensation decreased: "Median lead-advisor compensation declined at an annual rate of about 7% over the last two years … to $168,050 in 2016," the authors explain.

"In contrast, for associate and support advisors as well as client service associates, compensation continued on a steady upward trend. Firms may be focusing on developing their support roles in order to release lead-advisor capacity," they add.

It's also possible that lower lead-advisor compensation simply reflects less experience: The study reveals that a typical lead advisor today has two years less experience than the average lead advisor had in 2015.

Profits First, Clients Second?

Perhaps even more surprising is the finding that 36% of advisory firms say they are looking to fill management roles with professionals from outside the advisory business. You could argue that the independent-advisory world could benefit from professional financial services management rather than the typical homegrown variety. But I can't help but think that more business-focused, profit-oriented managers will have a negative impact on the client-service orientation that historically has been the hallmark of independent financial advice.

Inveen and De Pardo do a nice job of capturing the challenges advisors face today, along with the various solutions that firm owners are employing to solve them. Some are impressively original: increased outsourcing, flextime and telecommuting.

Others, though, seem likely to cause more problems. Pushing younger professionals into key revenue-generating roles could set both the professionals and their firms up for failure. There's a reason that young professionals in medicine, law or accounting go through lengthy "apprenticeships"; it takes time and experience to learn professional skills.

Bringing profit-centric professionals into the business doesn't sound like a good fit either, particularly in a fiduciary-oriented climate. With AUM up and revenues down, it appears advisors still have some things to figure out. With the inevitable market downturn on the horizon, I fear they don't have a lot of time.

— Read 7 Steps to Attracting Your Clients' Kids on ThinkAdvisor.