Which type of AUM is worth more to a buyer?

Assets farmed out to money managers are generally more valuable than purely discretionary assets under management

Sunday 11.18.12 by Guest Columnist Jack Waymire

If you are a fee-only or fee-based financial advisor, your key to success is building a critical mass of assets under management. Based on your ability to control assets, you will enjoy an enviable lifestyle during your working years and you will sell your business for two to four times revenue when you retire (Source: IFA Marketplace). That’s eight to 16 times higher than commission businesses that frequently sell for 0.25% of revenue.

The question is, what types of assets maximize your AUM business valuation?

We know assets are a measuring stick, but the number that really matters is the recurring revenue that you generate from the assets. For example, two advisors control $100 million each, but one generates $750,000 of fees and the other $1.5 million of fees. The explanation of the range may be as simple as different fee schedules or it may be the types of services that are provided by the advisors. See: Two advisors debate the financial viability of serving as a fiduciary to small accounts amid DOL’s new rules.

This article focuses on four types of assets that may be included in the AUM calculation.

Most AUM descriptions include the following conditions:

• The services are delivered by RIAs and investment advisor representatives.
• The assets produce continuous fees.
• The investor receives ongoing advice and services for the fees.

The roles of the professionals do not matter. They could be money managers, financial advisors or financial consultants. What matters is meeting the three conditions.

1. Managed assets

The distinguishing characteristics for this type of asset are money managers who are decision-makers and invest client assets in the securities markets. They do not invest in other money managers — financial advisors do that. For example, separately managed accounts, mutual funds, hedge funds, and ETFs are money managers because they invest in the securities markets. See: Fidelity launches major division in Denver with an 'ETF quarterback’ calling the shots.

These assets meet the three AUM requirements.

2. Advisory Assets (discretionary)

There are two types of advisory assets based on the professionals’ willingness to make investment decisions for investors — there are discretionary and non-discretionary advisors.

Discretionary advisors provide information, recommendations and make decisions for clients — just like the money managers. The advisors’ decision-making is based on a Limited Trading Authority that is part of their service agreements. This Authority permits them to make buy/sell decisions for clients without their approval in advance. For example, they make the decision to sell Fund A and buy Fund B. Investors may not find out about the decision until they receive their next monthly statement or quarterly performance report. See: Should I dump my securities licenses?.

These assets meet the three AUM requirements.

3. Advisor assets (non-discretionary)

Non-discretionary advisors provide the same services as the discretionary advisors, but there is no limited trading authority. In this case, advisors make recommendations to clients, but nothing happens until clients make the final decisions. The professional is acting as a true advisor or consultant and does not make any decisions on behalf of clients. See: Three RIA adventures that led to dramatic asset growth.

These assets meet the three AUM requirements.

4. Broker-dealer assets

Broker-dealers and their sales reps would like to include assets that are invested in financial products in their AUM. Four times revenue is a lot better than 0.25%. However, most of their assets do not qualify when we apply the AUM conditions. There are a couple of gray areas that meet some of the conditions. See: A hungry NYC-based firm takes aim at a bigger future by signing on with Dynasty Financial Partners.

First, there are assets that produce level loads (continuous compensation) for the sales representatives. This may meet the definition for continuous fees, but the rep may not be providing any continuous advice or services. Regardless, these are B-D assets and not RIA assets.

The second type is assets that reside in variable annuity contracts. The contracts may have 30 or more investment alternatives and advisors charge a fee (IAR, continuous compensation) to help investors select the right options and monitor their results (continuous services). The regulators are not fond of this sales practice, they call it double dipping, but the assets fit all three of the AUM conditions. See: Not without criticism, TD Ameritrade opens an 'insurance agency’ for RIAs that want to provide annuities.

The first type of asset does not meet the AUM conditions. The second type of asset may meet the conditions, but regulators frown on the combined methods of compensation, unless the products are no-load.

Which assets have the highest valuations?

Assets that have high retention rates should have the highest AUM valuation rates. For example, non-discretionary advisory assets have high retention rates because advisors have lower levels of accountability. Remember, the advisors provide advice, but the investors make the final decisions. For this reason, these assets should have higher valuations.

Based on accountability, discretionary advisory assets should have the second highest valuation. In this case advisors are decision-makers, but they use the services of money managers. When performance expectations are not being met, advisors are in a position to fire underperforming managers and retain client relationships. See: Do 401(k) assets require all fiduciary care all the time?.

Managed assets are the most vulnerable because the managers have the highest degree of accountability for performance. Managers can lose a lot of clients if they underperform in back-to-back years. Therefore, managed assets would have the lowest valuations because they have the lowest retention rates.

Jack Waymire spent 28 years in the financial services industry. For 21 years he was the president of an RIA that provided investment services to more than 50,000 investors. He is the author of “Who’s Watching Your Money?” and the founder of two major financial websites.One, www.InvestorWatchdog.com provides free tools and data to investors who use the services of financial advisors, and Paladin Registry is a compendium of pre-screened, five-star-rated, independent RIAs and IARs. Jack is a columnist for Worth magazine and a contributor to major financial websites, and is frequently quoted by the media.

Jack Waymire