The decade from 2012 to 2021 was an extraordinary time for wealth managers. A raging U.S. equity bull market was accompanied by historically low inflation. Typical diversified portfolios generated average annual inflation-adjusted returns that were nearly three times those of the previous decade.
As clients’ assets soared, so did the fees they paid. Given that owning a wealth manager is analogous to making operationally leveraged investments in the financial markets, advisory firms’ profitability tripled or even quadrupled, even if they added no net new clients.
Record low interest rates accompanied the bull market. Debt became plentiful and cheap. PE firms awash in uninvested capital saw the wealth management industry as an opportunity to put that capital to work, along with large amounts of leverage. More than 100 buyers emerged, and an industry-wide M&A feeding frenzy followed.
Nearly 1,600 transactions were consummated as competition drove prices to stratospheric levels. An industry accustomed to pricing metrics of eight to 12 times cash flow saw transactions completed at as much as 20 or even 30 times.
But whether acquirers paid too much did not matter. Asset appreciation papered over any mistakes. Buyers bet heavily on a rising tide and won big.
Meanwhile, many wealth managers went to sleep. They largely ceased marketing efforts and depended on either the prospects handed to them by custodians or erstwhile referrals from existing clients. Seventy percent of the industry’s growth came from asset appreciation.
Industry participants placed little emphasis on improving efficiency or recruiting new professionals. Although their fees climbed, many wealth managers provided less value to clients. By one estimate, nearly half are now de facto investment-only firms. But why worry about such things when one’s EBITDA is compounding at 15% to 20% annually from just turning the lights on?
Unfortunately, the party ended in March 2022 when the Federal Reserve began to aggressively combat inflation. Markets corrected and have yet to fully recover.
Today the industry remains fragmented and discombobulated. There are nearly 15,000 RIAs, and they have a median of $412 million in AUM. Their management and clients are now much older. A chronic shortage of qualified professionals will soon worsen as nearly 37% of the industry retires over the next decade. And cybercriminals meanwhile pose an existential threat to advisors and their clients’ wealth.
The easy money from M&A is now gone, and aggregators are paying for some of their earlier sins. Debt is much more expensive and far less available. Some are scrambling to recapitalize their balance sheets. More problematic is that many are not single businesses but rather confederations of small firms that have not recruited new clients for many years. It will be a mammoth task to transform them into integrated, growing companies.
Immense Opportunity Ahead
However, there’s good news—an immense opportunity is at hand.
Notwithstanding the hype about “boomers,” more than seven million more Americans are age 45 to 60 than 60 to 75 years old. Hundreds of thousands of them will need financial advisors over the next 10 to 15 years. More importantly, the current cost of acquiring new clients is a fraction of the value that their fees create for the wealth managers who serve them.
However, most of the industry is utterly unprepared to capitalize on this opportunity. Recruiting new clients is brutally hard, and most advisors rely on outdated operating models that discourage their best marketers and keep businesses from achieving scale. They have anemic brands and comfortable employees. Indeed, the industry’s largest firms allow its smallest ones to compete on equal terms with them for new clients.
Nevertheless, a group of extraordinarily successful participants will emerge from the industry’s current chaos. They will capture the vast preponderance of new clients and the tens of billions of dollars of enterprise value these clients create.
Ten traits will be common to these organizations:
1. They’ll have decisive owners with very long investment horizons.
The single greatest competitive advantage of any wealth management firm is having decisive owners with very long investment horizons, those who think in terms of decades rather than years. Successful firms will make substantial investments that won’t pay off for a very long time. They will also decide on and implement strategies today that will determine their outcomes in 10 to 15 years.
2. They’ll do whatever is necessary to capture as many new clients as quickly as possible.
The low acquisition cost for clients will not continue indefinitely. At some point in the not-too-distant future marketing costs will climb and wealth managers will also have to do much more for clients.
In the interim, advisors can build enterprise value. We estimate that adding a 45-year-old client with $2 million in assets who saves an additional $100,000 per year will produce fees of about $600,000 (in net present value terms) and have an acquisition cost of only $20,000 or less. But these economics won’t last.
The most successful firms understand they are in a limited time land grab. They also recognize that those firms that innovate and change the terms of competition will benefit most from this opportunity. Consequently, astute firms will do whatever is necessary to capture as many new clients as quickly as possible.
At the same time, they will not depend on outside parties, such as custodians, to generate prospects. Instead, they will create their own referral networks through other influential people.
3. They’ll re-engineer their operating models to better use their talent.
Advisors who want to capitalize on the organic growth opportunity will re-engineer their operating models. Instead of compensating their best marketers for the size of their books and discouraging them from getting new clients once they are full, the most successful firms will allow their talent to specialize: The most talented marketers will focus their time on recruiting new clients. “Closers” will spend their time persuading new clients to sign up. And everyone else will service clients.
Advisors shifting to this model will accelerate their organic growth rates four- to fivefold while taking advantage of their existing excess client servicing capacity, which virtually every wealth manager has.
But implementing these changes will be extremely challenging: Key employees currently control client relationships, and this is the source of their bargaining power with their employers. By unilaterally shifting to a specialization-by-function operating structure, which would institutionalize relationships, firm owners could strip the power from these key employees, perhaps triggering their departures (with clients) and risk blowing up a firm.
The challenge is to find new people who buy into the new system. If you can’t get people who embrace this new system, the business can’t be scaled.
To avoid the risk of key people leaving, the most successful firm owners will instead adopt a two-track approach. First, they will create a compensation system that lets marketers share in the value created by each new client they recruit. The most talented ones will be able to build immense personal wealth over time.
Though some current key employees will likely reject changes, a successful firm can create parallel operating systems that effectively grandfather certain key individuals into past compensation structures.
4. Successful firms will reset their cultures.
Equally important to re-engineering an operating model is resetting a culture. Organizations with high rates of organic growth are obsessed with new client recruitment. They are high-stress workplaces that hold every employee accountable for the firm’s growth.
Unfortunately, most advisory firms today are low-stress, relaxed places to work that, years ago, effectively stopped recruiting new clients aggressively. Even firms that previously had high rates of organic growth lost their focus over the last decade as many were acquired and their founders—who drove their marketing efforts—retired.
The most successful firms will quickly reset their organizations’ cultures. But doing so will be no easy task and will likely lead to many departures.
5. They also will do whatever is necessary to quickly acquire the necessary talent to grow.
Even with more efficient operating models and reset cultures, successful firms will require additional talent. They will need to replace large numbers of retiring professionals and add others. They will do whatever is necessary to quickly get them.
Since the industry has no pool of available trained professionals for hire, advisory firms will instead poach their competitors’ best people. That might turn their management into pariahs at industry events (where they will be treated like lepers at a nudist colony). But that’s irrelevant given the talent scarcity and the organic growth opportunity at hand.
The first rule in the jungle is to not be eaten. So successful advisories will create financial incentives ahead of time to keep their best people, long before any other organization tries to recruit them. (And it’s a fool’s errand to rely on restrictive covenants to keep people.)
6. Successful firms will develop cost-effective, powerful brands.
Thriving wealth management firms will develop cost-effective, powerful brands. These brands have up until now been largely irrelevant, which is why they can’t drive large volumes of prospects to firms’ doors. Certainly, Schwab’s and Fidelity’s brands do this. However, those companies spend hundreds of millions of dollars annually on marketing, outstripping what even the largest aggregators can currently afford.
Certainly, some larger advisories will try to go toe-to-toe with Schwab and Fidelity, ignoring the costs. But the most astute firms will instead build potent, cost-effective brands that communicate their expertise in diagnosing and solving the problems of a specific target audience. The most successful bigger firms, meanwhile, will rely on a collection of sub-brands wrapped in a larger national one.
7. They will embrace rather than just endure the many changes forced on them by cyber threats.
The Securities and Exchange Commission’s new cybersecurity regulations are going to transform the way businesses operate—and not for the better. The firms that thrive will recognize the immense threat cybercriminals pose to their clients’ wealth and well-being and make the necessary investments to upgrade defenses. The firms that can demonstrate these defenses (and make their cyber investments part of their marketing) will do better than less-prepared peers.
Successful firms will also have to explain the risks posed by the vulnerable third parties they work with. They’ll be obligated to disclose to current and future clients that custodian and brokerage agreements obligate the clients to bear most of the risk of cybertheft from their accounts. But rather than just inform and likely scare the living daylights out of people, successful managers will instead help them manage the risks.
8. Successful firms will be aggressive in expanding their value propositions.
If you want to succeed, you’ll tell prospects (and the clients of competing advisors) to look more closely at the AUM fees they’re paying and what they’re getting for those fees—and then to demand more value for their money. Your proposition is that you can do more for clients for the same money, distinguishing your offering and capturing greater market share.
Savvy smaller organizations will respond by developing specialties for the problems facing narrow groups of specific clients in their geographic regions. Rather than just helping clients manage their wealth, they’ll want to play a much larger role in helping them create and build it.
9. Successful firms will be much more sophisticated and discriminating buyers and sellers.
The most successful industry participants will be discriminating and sophisticated when it comes to buying and selling firms. Acquirers will focus on only those opportunities fitting their overall strategy, deals that create more value than just the amount paid at closing.
Buyers should build relationships with prospective sellers long before they come to market. They should also understand the perspectives and objectives of each of the seller’s employees and be well positioned to address everyone’s concerns.
Sophisticated sellers will likewise invest a great deal of time identifying and learning about prospective buyers. They will study the incentives of each buyer’s backers, research the acquirer’s prior acquisitions, and determine how the buyer interacts with the seller’s affiliates.
More importantly, astute sellers will prepare their firms for a transaction long before they come to market. They will try to pre-emptively address potential buyer concerns.
These sellers will also demand much greater value from their bankers. In many prior transactions, bankers were paid immense amounts of money to be glorified auctioneers. The sellers will demand that their potential bankers educate and prepare them for a potential transaction.
10. The managers at successful firms will have the necessary skills, temperament and expertise to execute.
Lastly, only those organizations whose managers boast the necessary skills, temperament and expertise to execute—in what will be a very different future operating environment—will join the ranks of the most successful. Their owners will quickly determine whether current managers—regardless of how successful they were in the past—have the skills and abilities to lead the businesses in the future.
Successful firms will be led by business operators—individuals who are passionate about the day-to-day details of running a wealth manager—with personalities that are a cross between Mary Poppins and Attila the Hun. They’ll need the patience to renegotiate agreements with many key employees, and the decisiveness to know who should be let go. They will have to build brands and sub-brands. And they must be effective recruiters, who at the same time can effectively manage their firms’ owners.
Unfortunately, many successful firms were largely built through acquisitions, led by individuals with great vision who took a great deal of risk. However, not all of these people will be successful at building future enterprise value over many years.
Mark Hurley is the CEO of Digital Privacy & Protection. This article is excerpted from the new white paper, “Welcome to the Jungle—The Next Phase of the Evolution of the Wealth Management Industry,” which can be downloaded for free from www.dpripro.com.