Not surprisingly, a prolonged period of very low nominal returns on low-risk assets would compound the issues raised by aging clients (who, over time, invest larger and larger portions of their portfolios in fixed income and lower-risk assets).
4. Operating costs accelerating at a rate higher than inflation in general.
While the three factors described above will negatively impact the rates at which wealth manager revenues grow, wealth managers also will face an expense issue over the next decade: operating costs—and compensation costs in particular—will continue to rise at a faster rate than general inflation.
Nearly every wealth manager that the Fiduciary Network has studied is currently experiencing average annual cost inflation of at least 5% to 7%, largely driven by higher labor costs for qualified professional employees. A shortage of even semi-qualified professional staff (versus the demand for them) is reflected in their salaries: Typical wealth manager non-owner compensation costs are rising about 7% to 10% annually. Other costs will rise as well. An increasingly adversarial regulatory environment will raise compliance costs, newly litigious clients and former employees will bring more legal fees well in excess of past ones, and more competition will require increased marketing and business development budgets.
5. Aging Founders
Overshadowing the four previous forces is the irreversible fact that most of the founders of wealth management firms are approaching that point in their lives when they need to consider doing their own financial planning. More than a few of these founders have built up lavish lifestyles, the maintenance of which requires significant annual expenditures. But for most, their single most valuable financial asset is the equity in their businesses. Consequently, the value they ultimately receive for that equity will be a key determinant of their ability to sustain their current lifestyle in retirement.
Impact of the forces on individual firms will vary based on their current business model.
The first four forces described above will affect the economics of every wealth manager. However, the types of effects and degree of impact will vary based on the organization’s current business model.
The evolving businesses, with younger client bases, institutionalized brands and marketing efforts, diversified ownership and mature governance structures, are in the best position to adapt to, and capitalize upon, the forces. Their challenge, however, is finding a way to maintain their historically high rates of profitability growth, a precondition to attracting and retaining the experienced and talented successor professionals who are essential to their business model. Unfortunately, doing so is going to be far more challenging over the next decade than in the past.
As relatively large organizations, evolving businesses must add increasingly larger volumes of new clients each year in order to maintain revenue growth rates at a time when the supply of prospects has stagnated. Moreover, even if their business development efforts are successful, servicing ever larger volumes of new clients requires substantially increasing their cost structures. The resources required to onboard a new client are 15 to 20 times greater than the resources required to service an established client—a feature of the wealth management model that effectively caps the number of new clients any firm can add at any one time. Thus, every large industry participant faces a “growth conundrum.”