The market crash of 2008-2009 has fundamentally changed the competitive environment of the financial services industry in many ways as demonstrated by the relentless pressure on advisory fees and operating margins. This downward trend has been felt across the entire industry as the average advisory fee for new accounts opened in 2013 (1.02 percent) was 16 percent lower than just two years prior according to the PriceMetrix Insights “The State of Retail Wealth Management, 4th Annual Report.”  Over 62 percent of broker/dealers surveyed expect fee compression to be their greatest challenge in the coming three-to-five year period. 

In the face of this challenge to increase revenue and expand operating margins, an advisory firm must:

Traditionally, firms have needed to expand staff in order to handle more business and/or offer additional services to grow revenue. However, in today’s environment, firms can scale their businesses’ profitably and expand revenue by taking advantage of outsourcing options and technology solutions. The new market environment requires firms to both increase scalability and expand revenue in order to thrive. We believe that firms that can accomplish these two goals will be well-positioned to cushion the impact of fee compression.

Scalability

In today’s world, scalability is achieved by successfully managing two related key drivers: (a) the tradeoffs of insourcing versus outsourcing and (b) process automation. 

The availability of outsourcing alternatives provides advisory firms with unprecedented flexibility. Most firms will internalize functions that are “client critical” and closest to the core value proposition of the firm itself. This allows the firm to use its own personnel to control the quality of the client experience. Non-critical functions can be outsourced to trusted partners. A typical advisory firm might approach this question by filling in a chart similar to the one below.

Today’s advisory firms want access to a variety of outsourcing solutions as well as integrated access to other providers as part of a comprehensive service and technology ecosystem. Key outsourcing solutions include financial planning and customer relationship management (CRM) while fully-integrated solutions would include custody and account aggregation.

 

For those functions retained in-house, scalability can be enhanced through a combination of business process automation and integration. By using technology for tasks like creating investment policy statements, portfolio construction, accessing asset managers and investment products or portfolio stress testing, firms can increase processing capacity without a commensurate increase in headcount or expenses. 

While these tools can help advisors perform internalized functions more efficiently, additional productivity gains are achieved through workflow integration and automation. Intuitively this makes sense as technology can increase the efficiency with which a specific task is completed, but substantial additional benefit is achieved by eliminating the need to complete redundant tasks altogether.

Once technology has been deployed to streamline various business processes, the majority of quantifiable productivity gains in business process automation arise from the breadth and depth of integration.  

To create a growth company in today’s technology-driven marketplace, we believe that advisory firms need to be networked and flexible. They need to choose what to focus on, and find partners to do the rest. Even the largest of firms will rely on only a handful of key strategic partnerships that enable business model flexibility and empower scalability and growth. 

Revenue Expansion

In addition to the relentless pursuit of lower operating costs and improved scalability, advisors also need to expand the services provided to clients—in some cases to protect existing revenue and in others to expand the revenue generated on client assets. 

The primary products of choice for advisors building fee-based businesses have traditionally been mutual funds and separately managed accounts (SMA) portfolios. 

Most importantly, greater use of SMA portfolios enables advisors to expand the scope of advisory services provided to clients. The two most notable services are (a) environmental, social, and governance (ESG) screens for clients with particular needs and/or preferences, and (b) tax management.

ESG screens are generally referred to as account “restrictions”, which most advisors provide as a means of helping to differentiate their service and personalizing their advice. Advisors don’t generally charge a higher fee on accounts with restrictions, but do view the service as a way of protecting their existing fee structure. 

However, that is not the case with tax management. The paradigm shift to model-based trading enables advisors to exercise greater control over the tax implications of portfolio trading through expanded use of SMA portfolios. Tax management provides an excellent opportunity for advisors to increase revenue on client assets and enhance their value proposition to clients.

 

Advisors should look beyond traditional loss harvesting (which seeks to reduce the negative impact of taxes after gains have already been realized in an actively-managed portfolio) and instead work proactively with the client at the beginning of each year to determine a strategy for gains and losses to realize over the course of that year.

For most advisory firms, an integrated platform will offer savings in time and expense over a series of single point solutions cobbled together. To deliver the most value to clients, advisors will want to find an integrated solution which can run the gamut of tax management functions such as limiting the realized gains and losses to those that deliver the greatest value from a tax management standpoint while minimizing performance deviation from the investment manager’s model, incorporating gains and losses generated outside of the portfolio and linking multiple accounts together. The result is an unparalleled ability for clients and their advisors to proactively manage tax liability while still realizing much of the returns generated by their selected portfolio managers.

Active tax management is an excellent example of a premium service that reinforces and expands the value proposition of the advisor, generating additional revenue in the process. Most notably, it does so without additional expense and/or overhead while the client experiences a higher level of personalized portfolio management. Active tax management can play a critical role in an advisor’s efforts to enhance the value of his/her advisory service and in defending or expanding revenue generated on client assets.

Flexibility and Service

Building a successful advisory business requires a flexible operating model capable of rapid evolution. Most importantly it requires an organizational ability to take advantage of the technology and outsourcing solutions available in the highly-networked financial services industry. 

It is our opinion that firms that manage their service delivery model on an active, ongoing basis will not only be well-positioned to respond to the impact of fee compression, but will also thrive in a market environment that demands flexibility and continuous improvement in scalability.

Richard Dion is executive vice president and head of strategic partnerships with Envestnet Inc. Dion is a 30-year veteran of the financial services industry; having been successful in start-up endeavors as well as corporate executive roles in sales, product development and corporate strategy.

Craig Iskowitz is chief executive officer and zen master of Ezra Group LLC. Iskowitz is a technology and business strategy consultant providing innovative solutions to the wealth management industry.