Many are seeking volume discounts from vendors to pass on to advisors.

With client assets shrinking and profit margins narrowing, it was no doubt tough for registered investment advisors last year-with no clear signals of an improvement in 2003. But there may be at least one thing advisors can take comfort in: Their services are in demand-maybe now more than ever.

"In some ways things are getting better for independent retail RIAs," says Matthew McGinness, an analyst with Cerulli Associates. "Most advisors indicate that they are actually still getting a lot of new clients through referrals."

Advisors don't find themselves hard-pressed to find clients because, with the market decline, investors are more likely to seek professional help, he says. "One thing that the last two years of stagnant equity markets has done is cause a lot of investors who thought they could do it themselves to seek relations with investment advisors," McGinness says. "What the bear market did is it moved many advisors from the validator to delegator column."

That trend, in fact, is having a profound impact on advisors and the way they do business-and what they want from their custodians, some observers say. Thomas Bradley, president of TD Waterhouse Institutional, says although advisors are generally seeing healthy client growth, asset growth is lagging. "What is happening here is advisors are looking for help in some way, shape or form to help control their costs," Bradley says.

One of the things TD Waterhouse has planned for 2003 to address those needs is the integration of Advent software with TD Waterhouse's platform, he says. Bradley says this will "significantly reduce costs" for advisors. Other plans for this year include a turnkey separate accounts platform and the integration of Financial Engines tools into the TD Waterhouse platform, he says.

Another impact of the margin squeeze has been that fee-based advisors have had to pay more attention to the marketing end of their business, says Mark Goldberg, president of Royal Alliance, which plans to expand its services for advisors.

"There were many many advisors who were unprepared for the reality of the last three years and needed to make adjustments," Goldberg says. "Many of them, aside from cost cutting, took in new clients for the first time in years. They're marketing."

Officials are seeing the same thing at Schwab Institutional. "This is a referral business, and the RIAs that are really not feeling anywhere near as pinched are those who are working their referral networks," says Joshua Rymer, senior vice president at Schwab Institutional.

Schwab, he says, hopes to feed that activity by increasing the number of advisors receiving referrals through the Schwab Advisor Network.

The San Francisco-based firm also sees technology as a key for advisors to cut costs, and plans to introduce a newer, more streamlined, version of its Centerpiece portfolio management software in 2003, Rymer says. Another Schwab initiative this year is to contract business management consulting services on behalf of advisors, he says. "The vision is to gather a network of independent contractors who might offer similar products at similar pricing," he says.

As the largest firm in the custodial services arena, Schwab has seen many smaller rivals attempt to lure their advisory clients away. However, advisor anger over the moves by Schwab's retail arm to offer their own advisory services seems to have subsided. During a town hall-style meeting at the Schwab Impact conference last October, advisors questioned Schwab executives about a variety of mundane housekeeping details, like the number of 529 plans and variable annuities available. But there was virtually no carping expressed about Schwab's retail moves.

Efficient business practices are becoming increasingly vital in the advisory business, observers say. Fidelity Institutional Brokerage Group (FIBG) recently commissioned a guidebook by Moss Adams outlining how advisors can improve their bottom lines (see related article on page 69). "We think our clients are being challenged in ways they haven't been challenged before," says Jay Lanigan, executive vice president in charge of RIA services at FIBG. "Advisors have to spend more time with clients in trying times. But RIAs are still incredibly well-positioned to enjoy impressive growth in the next decade."

Fidelity continues to flesh out its Practice Advantage program, offering advisors who use its custodial services discounts on everything ranging from compliance consulting service to technology support to periodical subscription discounts from AOL TimeWarner. The profitability guidebook makes some far-reaching suggestions to advisors about how to align a firm's practice management and human capital tactics with their business strategy, Lanigan explains.

Several studies, for example, have found that the average advisory business saw an increase in revenues last year-but only through the sheer force of bringing in new clients. The downside of the tactic is that servicing more clients raised operating costs. As a result, profit margins were on average down in 2002.

That has put fee-based advisors to the test when it comes to the operational side of their businesses, says Ramy Shaalan, vice president of AdvisorBenchmarking.com, which specializes in RIA marketplace research.

In a survey of 163 advisors last year, AdvisorBenchmarking.com found that advisors increased their client bases by an average of 8.18% and their assets under management by 21.61% from a year earlier. This resulted in a 5.97% increase in revenues.

Yet the survey also found that profits declined by an average of 4.59%, primarily because operating expenses grew by 9.46%.

Similar findings were contained in the 2002 Financial Performance Study of Financial Advisory Practices recently released by the Financial Planning Association (FPA). That study found that while revenues increased 6.9% from 1999 to 2001, the average operating profit declined from $97,184 to $69,938, and that the squeeze on margins was chiefly a result of higher operating costs.

The study, conducted by Moss Adams LLP in Seattle, also found that advisors seemed to be providing more services for the same fees.

"Advisors are learning, the hard way, that one of the downsides to a fee-based model is declining revenues in a declining market," says Shaalan.

This is why, he adds, many fee-based advisors are starting to fold hourly and project-based fees into their offerings, instead of solely relying on asset-based fees.

Unlike in the 1990s, RIAs are finding that having an efficient business model is a necessity, Shaalan says. "Those who did not have a fundamentally sound business model in place-those who really rode the wave a few years ago-I think a lot of them are hurting now and may not remain afloat for long," he says."

How are RIAs adapting to these new business realities? One way is expansion through merger and acquisition, according to industry observers.

At FPtransitions, an online matchmaking service for buyers and sellers of advisory practices, the number of buyers interested in RIAs businesses has increased 33% this year, says David Grau, principal of the company.

While the number of sellers hasn't increased, those who are selling are seeing an increased number of offers and inquiries, he says. "If we list a fee-only RIA on our site, in a metropolitan area, it will pick up between 40 and 60 written buyer inquiries within a 30-day period," Grau says. That's compared to a typical response rate of 25 to 28, he adds.

Most of the buyers are other RIAs looking to expand or are looking to add an RIA component to their business. For example, Grau says, about 8% of buyer inquires are coming from CPAs. "Most are coming from other fee-only, or at minimum fee-based, firms who want to buy recurring revenues and assets under management," he says.

Because many RIAs seeking to sell their practices have experienced as much as a 20% to 25% deterioration in their assets under management, sellers are not seeing the heightened demand drive up prices, Grau says. The research suggests that those seeking to sell are the ones hardest hit by the bear market, but the evidence isn't conclusive. However, sellers are seeing down payment offers of 45% to 50% of the purchase price, up from the typical 25% to 40%, he says. "If anything, I see a general, almost overwhelming sense of optimism in the marketplace," Grau says.

While it's not mandatory that RIAs get bigger to survive in the current environment, it does make running the business easier, says McGinness of Cerulli Associates. Firms with more than $1 million in revenue have more flexibility and more of a financial cushion.

Fewer vendors, for example, are willing to service smaller advisor shops, he says. Clients are also seeking more services and demanding more time of advisors, further putting the squeeze on the small operators, McGinness says.

"We're not saying advisors can't make a good living staying small, because they certainly can," he says. "But it's becoming increasingly more costly to do so." The challenge, he says, is that advisors are looking to cut expenses at the same time that clients are asking their advisors for a broader array of wealth management services.

As a result, advisors are looking for firms that can provide services such as performance reporting, marketing support and financial planning in an efficient, cost-effective way, says Michael J. Di Girolamo, senior vice president and head of advisory services with Raymond James Financial.

"The ones we're talking to are looking to provide more comprehensive wealth management solutions and they're looking to outsource it," Di Girolamo says. "Margins are tighter and they don't want to add any more staff, and where they can decrease their costs, that money goes into their pockets."

AdvisorBenchmarking.com's Shaalan says successful advisors are responding by being more selective about spending and who they take on as a client. They're also rethinking fee structure, he adds. "Those who don't have minimum account requirements-we're seeing them imposing one," he says.