Let the Fiduciary Movement Move You to Profitability

May 11, 2017


Each week after it is published, I go back to read the current Practically Speaking post. I am usually checking to see how it flows on the page or if I just missed something. Well last week, I think I missed a big one. The Shorts series was designed for articles and concepts that are not big enough for a full column, but too long for a tweet. As I re-read the post, I think there is a lot more to the WSJ articles I referenced. The articles demonstrated why independent advisory firms are poised to grow income and build value, but need to be focused on differentiation.

The articles mentioned that some larger firms were seeing substantial increases in fee-based AUM, which is exactly what we would expect for a lot of firms today. The fiduciary movement is driving advisors, in the spirit of putting their clients first, toward more fee-based business. And as more advisors move in that direction, it makes sense that the business metrics are going to see some significant changes, as well.

Doing the math

Think about the revenue and valuation shift:

  • Older accounts with products earning 25 bps trails that are converted to fee based now could be earning up to 100 bps (providing you are adding more value and advice). For example, a $25M book of old “A” shares earning $62,500 could be converted to $250,000 in revenue.
  • Newer fee-based accounts can have higher lifetime revenue. Of course, it depends on how long you and the client work together, but I’ve read that most advisors have a 90-95% retention rate. Think about a 10, 15, 20-year (or longer) relationship with a client. The revenue difference between a transaction fee and a small trail vs. a fee-based advisory fee is huge.
  • As we all know, advisory businesses are bought/sold/transitioned based on revenue – and recurring fee revenue is king. It has been a while since I looked, but the rule of thumb has been that businesses are sold between 2 and 2.5 times trailing revenue and much less on transactional business. It makes sense that the move to fee based could dramatically change the valuation as the recurring revenue increases.

So the positives are there for the fiduciary movement and independent advisors and wire houses are all moving that direction. Businesses will be more “recession proof,” as they will not be relying on transactions in down markets. Sounds like a big win, right? Maybe….

In the short term, I think you will see all the positives of the fee and fiduciary movement. Advice is and will be the focus, while products are more commoditized. I think early on, you will see valuations remain relatively in the same ballpark (that is, until everyone is doing it). I wonder, however, if most businesses start to look similar, will those valuations start to level off or possibly go down?

Who is buying?

Take a look at our industry today:

  • The average age of the advisor is increasing every day. Some reports suggest the average age of an advisory business owner is just over 60.
  • The fiduciary movement, while a positive for larger existing businesses, makes it very hard for someone newer to the business to gain critical mass. Those advisors typically get started by focusing on small accounts and using transactional products. If they can’t build mass, you may/will see an exodus from the industry.
  • While there are some great schools cranking out new CFPs, there is a severe shortage of young advisors getting into the business.
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So what does that mean?

Think about a scenario that looks like this: More businesses will start to look similar – think “financial planning for families,” which will be primarily fee based. The business metrics will start to look similar from firm to firm, so the multiples for fee and transaction could begin to level, as there is no more a premium for additional fee-based assets. Add that to more aging advisors looking to step down (or slow down) with fewer younger advisors who are in (or getting in) the business, and it means more sellers than buyers. Who knows if that will happen, but it is kind of scary.

Avoid the sea of sameness

Think of yourself as an advisory business buyer a few years from now. You would probably look for a firm that:

  • Has a good revenue stream (but there will be plenty of those out there)
  • Has significant growth potential, either from existing wallet share or new clients
  • Can set itself apart from the competitors – one that has truly figured out its clients and focuses on building programs and services around them
  • Serves a niche
  • Can command a premium, because what they do can’t be replicated by competitor or computer

The fiduciary movement can be better for your business, but what you do with it will affect your value and revenue. So what kind of firm are you building today, one that will command a premium or one that looks like everyone else?

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John Anderson

John Anderson

John Anderson is the creator and lead author of Practically Speaking blog and Managing Director of Practice Management Solutions for the SEI Advisor Network.

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