The Next Five Years
Expect to see large-scale financial advisory firms with several billion in assets under management dotting the landscapes of most major metropolitan markets in the nation by 2012. That's the conclusion of a recent study conducted by Moss Adams LLC and sponsored by Pershing Advisor Solutions.
The wealth management business also is starting to create a lot of wealth for wealth managers. Officials at Moss Adams reveal that at least 1,000, and perhaps as many as 2,000, principals of advisory firms earn annual seven-figure incomes.
And the big numbers are likely to get bigger. Moss Adams estimates that about 70 to 80 of the 8,000 to 10,000 RIA firms offering financial planning today already manage more than $1 billion in assets. "Average firms today will be small if they don't grow over the next five years," says John Iachello, managing director of Pershing Advisor Solutions. "Small firms today have as much business as they can handle, even with no marketing. The big firms, with a tiny bit of marketing, are growing at very fast rates; it almost becomes a question of not overeating."
Philip Palaveev, a Moss Adams consultant, says that average assets per firm will grow from $385 million, a figure that is skewed by a handful of billion-dollar firms, to $1 billion per firm by 2012. Moreover, the top 100 firms should see their assets cross the $3 billion to $4 billion threshold.
"Five years from now there will be $4 billion to $5 billion firms in every major market in the country," Palaveev predicts. For the sake of comparison, the average wirehouse branch has about $1 billion in assets and is growing at a much slower rate.
What's driving this explosive boom? The current generation of retirees is the first to have more of their assets in defined contribution plans than defined benefit plans. "They don't care about beating the S&P 500," Iachello says. "They just care about paying their bills for the next 35 years."
At present, there is a much greater demand for skilled advisors than there is a supply of them. Moss Adams estimates that there are about 35,000 professionals working in about 10,000 RIA firms, many of which are solo shops. Over the next five years, the number of professionals should climb to about 52,000.
Attracting 17,000 people and holding onto them will be a challenge. "The price of talent will go up sharply," Palaveev says. "Firms will start throwing equity at them."
At some point, defining "yourself by client asset size isn't going to be enough," Iachello says. "RIA firms will have to specialize." He cites the example of a firm that specializes in servicing deaf clients as a harbinger of prototype firms to come.
None of the models developed by advisors so far are truly scalable, Palaveev and Iachello agree. Depending on the level of service a firm offers, one advisor can only serve 70 to 12 clients a year. Beyond that, they must keep adding professionals. However, larger firms can add more services, including attorneys and accountants, and raise their competitive value proposition.

Schwab Is Leading Choice For Custodian, Survey Finds
Well over half of the registered investment advisors who responded to a recent survey use Charles Schwab & Co., TD Ameritrade Inc. or Fidelity Brokerage Services LLC as the financial custodian for their clients' investments, according to a survey of 1,000 RIAs conducted by the Financial Information Group Inc. But almost all have used their preferred custodian for less than ten years, and many have used it for less than five.
Discovery-the Financial Information Group Inc., based in Shrewsbury, N.J., conducted the survey.
Charles Schwab & Co. is edging out TD Ameritrade among the advisors surveyed by 29% to 23%. In third place was Fidelity with 16.6%. Others in the top group are Pershing LLC, Fiserv ISS and Linsco/Private Ledger Financial Services. Only a little more than 8% of the advisors handle their clients' investments themselves, without utilizing a custodian.
Few advisors have a long history with their custodian of choice. Nearly 43% have less than five years' experience, and less than 12% have ten years or more of experience.
The largest group, 42%, say the service provided is the most important factor in selecting a custodian. The next largest group, nearly 15%, feel technological capabilities are most important, while 13% feel the range of securities and products offered is most important. Cost, marketing support and the ability to provide referrals were the next most crucial factors.

Are CDOs Sneaking Added Risk Into Your Clients' Portfolio?
When you care about your financial health, it's important to understand what's in your investments. One "ingredient" that warrants a closer look is the collateralized debt obligation, or CDO. Although CDOs carry the potential for impressive returns, they also involve substantial risk. And CDOs-or parts of them-can be hidden in funds that are in investors' portfolios, buried within the funds' holdings.
The CDO is a structured investment vehicle with assets comprised of a large, diversified pool of debts (predominantly mortgages, with a high proportion of subprime and Alt-A mortgages). The liabilities of a CDO are sold to investors with various levels of risk and return potential called "tranches" (from the French word for "slice.")
In exchange for the interest on these debts, investors take on the credit risk of the collateral and assume any loss if any of the debts in the pool default. In the case of CDOs based on cash flow, incoming payments are directed to various parts of the asset pool on the basis of their seniority, with the more highly rated obligations being paid first. Conversely, the lowest-rating tranches are the first to take on the losses.
CDO issuance has soared over the past few years, from $69 billion in 2000 to $476 billion in 2006. Over three quarters of CDOs are rated double- or triple-A. But these ratings can be misleading: CDOs can add highly speculative or even unratable debt to the highly rated tranches and boost the amount of collateral, thus theoretically diluting the risk.
Though undoubtedly risky, CDOs can work well for very knowledgeable and sophisticated investors, according to Jeff Tjornehoj, Senior Research Analyst at Lipper Inc. He notes that CDOs are most likely to appear in hedge funds that may be part of institutional portfolios, and points out that not all CDOs are created equal.
"Everyone knows that there is substantial risk in subprime loans," he says. "But the engineering behind these products can be very well thought out. In addition, a lot of stress-testing and modeling go into the ratings of these instruments, with careful examination of the timing of cash flows and the underlying risk of the securities involved."
Grant's analyst Dan Gertner is less confident in CDOs and feels that retail investors are not immune from the risk of exposure to CDOs within their mutual funds.
"We know for sure that asset-backed securities are included in some funds, and I am 99.9% certain that at least some fund managers are including long and short exposure to CDO tranches also," he says. "Fund managers can be attracted by a CDO tranche's high yield and misled by the triple-A ratings. ... An investor in subordinated CDO tranches can be collecting interest payments for years, thinking everything is going fine, only to suddenly lose their principal when losses are higher than expected."
To avoid unwanted exposure to CDOs in your own holdings, read all of your funds' documentation carefully and consult your advisor if you are still uncertain about the holdings of any investment in your portfolio.

Be Prepared For Disaster Recovery, IRS Advises
The 2007 hurricane season has started amid predictions that it will be an active one, and the IRS warns that a number of steps need to be taken by those who might be in the path of these summer storms. The same rules can apply to other types of natural disasters.
Digital technology now makes it easier to duplicate and safeguard records that used to be available only on paper. Tax returns, W-2s and financial records, including banking and investment statements, should be recorded on a USB drive, a CD or DVD that is then stored in a remote location or with a friend or relative who lives out of the storm's path, the IRS advises. Computer software is available for recordkeeping purposes that can help.
Digital photographs that are easily stored, transported or e-mailed, or videotapes, should be used to document the contents of each room of a home, especially any art works that are on display and jewelry or other valuables that are kept in the home. The IRS provides Publication 584, available through the IRS Web site, to help homeowners compile a room-by-room list of valuables. The evidence can be used to prove market value for casualty loss claims. The information should be stored at a remote location or with a friend or family member who lives elsewhere.
Employers should make sure their payroll service provider is bonded to protect them in case the service defaults. In addition, emergency plans should be updated periodically, advice that applies to family members as well as employers and employees.