by Cynthia Harrington

The dire predictions of a shakeout in the advisory business are coming true.

Competition for clients is squeezing revenue and the cost of delivering additional client services is eating at profits. Registered investment advisors face the decision to get big, get specialized or face the prospect of generating much less income.

The vision of what was to come was published in a pair of landmark studies in 1999 and 2000. “The Future of the Financial Advisory Business: Parts I and II” concluded that the profession would become a business and players would have to adapt in order to grow. Firms that wanted to stay small had two choices: dominate a niche and be profitable, or make less money.

The market reversal proved the truth of the prediction. While the market soared, fees paid as a percent of assets floated all boats higher. Then the market tanked. Since advisory businesses have high fixed and low marginal costs, there isn’t much flexibility to be able to adapt to the change. “Independent advisors garner compensation both from owning the firm and from working at the firm,” said Mark Hurley, chairman and chief executive of Dallas-based Undiscovered Managers LLC - the company that sponsored the advisory business research.

“In some firms, the owner’s compensation has gone negative and some are even worse. The advisor is getting paid less to work for their own firm than they might get working as an employee for a larger company,” Hurley said.

To address the problem, advisors are adding services, looking for ways to cut expenses, merging or being acquired and looking for ways to differentiate themselves in an increasingly crowded marketplace. “We have to do things faster, cheaper, better,” said Mark Balasa, CPA, CFP, with Balasa Dinverno Foltz & Hoffman, of Schaumburg, Ill.

Balasa added more customized asset management services, like tax-advantaged separate accounts, and is looking into using hedge funds. His firm merged to create the current entity in June 2001. The merger brought access to legal services. “In addition to creating the financial plan and the estate plan, we now complete the process by having lawyers connected with the firm who can draw up the papers for our clients,” Balasa said.

To balance off the costs of additional services, Balasa looked for ways to cut expenses. A new piece of software allows the firm to automate the quarterly client reporting process. “That’s a huge effort each quarter to generate, print, collate and mail the reports,” said Balasa. “We cut our effort down by about 60 percent with the new method.”

Client demand is one factor forcing the changes. But competition from the big brokers and bigger advisory firms is really turning up the heat. “Where we used to compete for clients against the local insurance agent, and someone’s brother-in-law handling investments, now we’re up against Merrill Lynch and Ernst & Young,” said Balasa.

The bigger companies offer wider services sometimes at lower costs. They offer the security of safety with size. “The consumer sees continuity and succession with the bigger company,” said Deena B. Katz, CFP, a principal of Evensky, Brown & Katz, in Coral Gables, Fla. “They worry about how long the smaller advisor will be around to serve their accounts.”

The bigger firms also finally caught on to the marketing edge of the independent advisor. Independents used to be able to easily differentiate the services. They’d explain how being fee-based meant that they worked solely for the client, offered comprehensive financial plans and customized asset management services. “Now the broker from Merrill claims the same thing,” Katz said.

Consumers can’t readily see the differences. The fee is charged as a percentage of assets, their relationship is built around a financial plan and they receive personalized attention from a company representative. “Of course, the broker is being paid from wrap fees on products and is just sending off the client’s informational questionnaire to headquarters for the financial plan,” said Katz. “But the consumer isn’t sensitive to how services are really delivered.”

Independents must find a way to communicate the differences. Balasa focuses on keeping the relationship between the client and the firm both integrated and “sticky.” Said Balasa, “Creating client value is part of the process.”

While competition from bigger firms is rampant, the rising barrier to entry cuts off start-ups. The capital costs for hardware and software are significantly higher than in the past. Finding a home for assets is harder with trustees requiring at least $2 million to use their services. And newer planners face a vastly more daunting task in having an edge in the crowded marketplace.

But, the direst of predictions is yet to be realized. Marketing has been a no-to-low-cost item. That is about to change. “What is most insidious is the low-hanging fruit is snapped up and the additional competition makes marketing to the available prospects even more difficult,” said Balasa. “And the referral sources of Charles Schwab and TD Waterhouse are now charging 15 percent, which reduces the profitability of those clients.”

The demand for payment for referrals is a symptom of the fact that the supply of advisors and the demand for their services is coming into a balance. Hurley predicted that when those two lines cross, marketing costs could reach 50 percent of revenues overnight. He points to several smaller markets with exactly that experience.

In these tight markets, when the existing firms wanted to grow, the cost of acquiring new accounts in the limited supply ballooned as a percent of revenues. “When the supply and demand lines cross, the affect is not linear. You have a step function,” said Hurley. “In a couple of years we could see this happen in most markets.”

The changes will keep the merger and acquisition market hot for the foreseeable future. Some will merge to get bigger, like Balasa & Hoffman’s combination with Dinverno & Foltz to form Balasa Dinverno Foltz & Hoffman in June 2001. Others will buy to expand into new markets, a strategy recently used by Harris Bank with the purchase of Sullivan, Bruyette, Speros & Blayney Inc., which bought them a presence in Washington, D.C.

Whatever the choice, advisors can’t sit still any longer. The future of the advisory business is here, today.

Register or login for access to this item and much more

All Accounting Today content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access