The Enduring Advisory Firm. Mark C. Tibergien

client without reason to understand the jargon of this business, it may come as a surprise to you when you are recommended or sold something that doesn’t fit your goals, your risk profile, or your level of comprehension.

      This is not to imply that one segment of the business is less trustworthy than another. It would be as if a chiropractor held himself out as an osteopathic doctor. Chiropractors and osteopaths are both medical professionals who treat patients with a focus on the musculoskeletal system. But the two disciplines require different levels of certification.

      A chiropractor is a medical professional trained in chiropractic medicine, typically in a three to four year program. An osteopath, on the other hand, must be a licensed physician and is able to perform surgery and prescribe medicine.

      The parallel to financial services is that clients do not know if they are being served by someone who gets paid based on the products they sell them, or paid for the advice they give regardless of which financial solution they use. Furthermore, when a bad act is committed, the press usually uses the word “advisor” in the headline, which reinforces the idea that the entire business is suspect.

      In the end, advisors and brokers who are able to convey confidence and trust and who are transparent in how they conduct business will go a long way toward giving comfort to clients, prospects, and centers of influence. But the apprehension people have in dealing with financial services providers remains a headwind in the conduct of business.

Compliance Costs Are Rising

      Regardless of which business model financial professionals operate under, the cost of compliance continues to rise. For independent firms, this cost can represent 2 to 4 percent of all expenses. For the most part, it is a variable cost, meaning that it goes up and down based on the volume of business one is doing.

      Much of what has to be done in the advisory profession is prophylactic and not to remedy bad deeds, but the cost of surveillance and enforcing rules of behavior is meaningful. To be effective, it requires at least one individual whose sole job is to monitor activities and take remedial actions when something is amiss. It’s like having a traffic cop on every corner.

      Most advisors would say they are honest and ethical, so the cost of compliance seems especially burdensome. But the myriad rules in place to ensure both brokers and advisors are acting in the best interests of their clients require well-trained specialists to educate, inform, and direct partners and employees to stop, look, and listen before acting.

Consolidation Is Inevitable

      All of these forces of change contribute to the need for advisory firms to become bigger. “Bigger” is a relative term, of course, since for the most part, advisory firms are small businesses, even micro businesses.

      But complexity and costs require firms to be managed professionally. Adding layers of process and management to a business means that revenues also have to increase to cover those costs. The need to generate more requires the addition of people and thus begins a never-ending cycle of growth.

      Many firms have grown naturally by adding layers as needed, but others have found benefit in merging8 with like-minded firms to more efficiently consolidate certain costs, gain operating leverage, and establish a bigger market presence more quickly.

      Firms like Hightower moved quickly to create a semi-national Registered Investment Advisory firm focused on recruiting people out of wirehouse brokerage firms. Focus Financial was an early roll-up firm that has acquired numerous large advisory practices around the country though it has not tried to merge them into a singular brand or common client experience. Middle-wear providers such as Dynasty serve as a bridge between advisors and their providers, providing outsourced solutions to those not yet big enough or disciplined enough to create their own management infrastructure for this purpose. Numerous advisory firms throughout the United States and in other countries have merged, as the founders of one looks to retire but seeks to provide continuity to their employees and clients.

      While we do not predict the end of the solo-practitioner, it is clear that there will be a divergence in size and presence in different markets. It is not unfathomable to see some truly national advisory firms much like we see in the accounting profession with its Big 4 CPA firms. More likely, we will see the emergence of super regional advisory firms – what the accounting profession labels as “Group B” firms.

      These super regional advisory firms will be managed professionally with a branch manager system not unlike the brokerage industry. While there will be some that are scattered across the frontier, more likely the best-performing super regional firms will have a geographic concentration that provides for tighter management, tighter branding, and operational leverage.

      We expect there will also be smaller, local advisory firms that find value in banding together with other advisors to create some economies of scale and continuity of practice. Many of these will be formed by second- and third-generation advisors who do not have the same fear of working with others that many of the industry pioneers seemed to have.

      What the Assumptions Mean for You

      One thing is clear in any business: What got you here will not get you there. In our mind, this means that the assumptions about the advisory business over the past 100 years have changed dramatically.

      Think of what has transpired since the 1970s alone.

      In 1975, fixed commissions, which were the standard of practice for brokerage firms for decades, were eliminated. Discount brokers such as Schwab, Scottrade, and TD Ameritrade (Waterhouse) emerged as major players in the delivery of financial products. Many well-known brokerage firms subsequently went out of business.

      This was one of the catalysts for the creation of the independent broker/dealer movement, in which registered reps were switched from being employees to becoming independent contractors. Their average payout went from 35 percent to 82 percent, which changed the economics of many broker/dealers.

      Late in that decade and into the 1980s, the retail-oriented Registered Investment Advisor (RIA) emerged along with new support models, which we have come to know as “custodians.” These custodians, like Schwab, TD Ameritrade, Fidelity, and Pershing Advisor Solutions, replaced institutional brokers and providers by wrapping in technology, practice management support, and service teams as well as best execution capabilities. Today, the RIA segment represents almost $4 trillion9 in total assets, or roughly 20 percent of the U.S. retail market.

      In the 1990s, no-load mutual fund platforms emerged, in which advisors could get access to packaged products for no commission payments. This reduced the cost of access. So, too, did the emergence of index funds provided by the likes of Vanguard and Dimensional Fund Advisors.

      In the early part of this century, ETFs emerged as a threat to the mutual fund model because of its liquidity and low-cost appeal. Once again, traditional providers were undermined and the custodians saw their margins compressed as the revenue went from 12(b)1 fees provided by the mutual fund companies to their fund supermarkets to transactional revenue.