8 ways that the RIA business is achieving scale at breakneck speed

Brooke’s Note: There seems to be general agreement [Sallie Krawcheck aside] that RIAs are taking ground daily from Wall Street’s version of the financial advisor — the wirehouse broker. It shows up in Cerulli studies and Schwab, TD and Fidelity quarterly results and everywhere else. There is less agreement about whether RIAs can consolidate their gains by achieving the scale, organizational solidity and recognizable brands of the firms they are daily vanquishing.

Mark Hurley expressed pessimism in his recent report, saying that only 200 wealth management firms even have the potential to establish enterprise value. See: What to make of Mark Hurley’s latest prophesy that most RIA firms will go out with a whimper Last week RIABiz published a column by Bob Veres that expressed optimism that RIAs can and will achieve scale by following a script similar to law firms. See: Bob Veres’ vision: Scalable, multi-partner RIA firms will be profitable and powerful enough to beat the wirehouses

If I were to write a white paper, it would have a title similar to what Mr. Veres wrote, but I would express my confidence that RIAs are poised to grow into big firms based on a series of big events that are absolutely occurring right now. I drew most of my examples below from hot-off-the-RIABiz-press occurrences. It’s notable that many of the examples show where new scaling opportunities accrue primarily to the benefit of hybrid RIAs. This may speak to the greater power of this model going forward. It may also simply derive from the fact that brokers have been around long enough to have achieved scale. Hybrid RIAs are better positioned — short-term — to benefit. But virtually all hybrids tell me that they are assiduously working toward a fee business. Will they keep their Series 7 and deal with a second set of regulators once the revenues from commissions become insignificant?

Here are eight recent events that show the RIA industry’s potential to achieve scale.

1. Envestnet successfully completed its initial public offering last week – albeit at a reduced price from its original target. See: 10 reasons why the Envestnet IPO filing is for real The company is quite literally being built as a means of creating scale for RIAs. Yes, the company still makes a big business serving investment products to reps of IBDs. But Bill Crager, CEO of Envestnet is clear that tomorrow’s growth will come from RIAs, who seek scale in everything from outsourcing investments to performance reporting. There are already companies like Fortigent, PathMark and Adhesion that are also succeeding in creating supermarkets of outsourced services. In other words, these companies would scale up and RIAs could plug in to them and achieve a sort of instantaneous scale in the areas of business where they can’t do so themselves. Envestment may be the most ambitious of the scaled-up service providers.

“Envestnet is the one everyone has their eyes on,” says Dennis Gallant, principal and founder of Gallant Distribution Consulting.

2.) Another way that industries achieve scale – especially fragmented ones like the RIA business – is by use of franchises [think McDonald’s]. SEI Investments of Philadelphia tried without success to use this system. But perhaps the idea isn’t broken.

Elizabeth MacBride reported last week that Ameriprise has dusted off its franchise system – formerly used largely as a place for its successful employee-advisors to graduate to – and is now using it to attract breakaway wirehouse brokers. See: In a move that risks a backlash from within, Ameriprise opens the door wide for bigger wirehouse brokers Ameriprise has plenty of baggage that goes back to its days as an ugly stepchild of American Express. It seemed to get some questionable directives from the credit card’s New York headquarters. But Minneapolis-based Ameriprise may yet to prove to be a different kind of organization. Certainly H.A. McGill, formerly of Smith Barney, now describes it as the kind of place where you deal with reasonable Midwestern folks and get a sweet payout in the bargain. At the rate Ameriprise is bringing aboard new franchisees like McGill from wirehouses, it will soon have critical mass of breakaway brokers who are achieving scale in a different manner. Don’t discount this use of the franchise model as a viable means of achieving scale in an industry craving centralized resources and autonomous management.

3.) There is another big way that the advantages of scale are arriving on the doorstep of RIAs. Unthinkable a few years ago, some of the more gigantic corporations in the bank and brokerage realms are now eagerly conferring their scale upon RIAs. Here are some examples:

One giant that fits this category is Wells Fargo, which is technically a wirehouse because the old Prudential workforce — in addition to that of regional players like A.G. Edwards and Wheat First – is part of its big advisory staff. Perhaps it’s still a stretch to call Wells Fargo an RIA custodian, but its Finet program offers levels of independence that are pleasing to many a hybrid RIA and [seemingly] becoming more that way by the day. For more on Finet, see: Wells Fargo emerges as independent channel competitor.

Another giant bank and broker, Royal Bank of Canada, and its subsidiary, RBC Wealth Management, are putting wirehouse-like capabilities fully at the disposal of RIAs for the first time. RBC still has more potential than assets. But after swallowing JPMorgan’s RIA business in June and co-opting the capabilities used on behalf of the old Dain Rauscher brokerage force, it is getting a foothold. It has a core group of RIAs who agree that it is putting its giant scale to work on behalf of RIAs, so that they can compete with advisors of any size. A good example of this is John Duffy, CEO of Municipal Portfolio Managers, which manages about $750 million of assets from Atlanta. He left Lehman Bothers to manage bonds as an RIA – on behalf of institutions. He credits RBC with helping make him successful in his venture.

Another company that declared its intent to avail its scale to RIAs for the first time this Spring was BNY Mellon. Yes, the New York-based giant already owned Pershing LLC, which is already one of the top RIA custodians. But it also had a unit of BNY Wealth Management that it quietly used to service its existing wealth management clients – usually mutual funds that did some private client business on the side. That company hired a former Schwab executive, Peter Berg, and told him to build open up the subsidiary’s services to outside RIAs too take advantage of its considerable scale. See: BNY Mellon’s new RIA custody unit will collaborate [and compete] with Pershing Advisor Solutions

4.) RIAs have always been sort of provincial: small firms of independent-minded people whose allegiances to different software providers and to client service stood in the way of efficiency. Now custodians are finding a way to overcome that provincialism by creating seamless platforms across different software providers. The situation is comparable to manufacturing standards that helped that industry develop: Everyone decided on the same size of a screw so they could work together.

Last week RIABiz reported that TD Ameritrade is developing a new means of bringing together disparate technologies and harmonizing them with Veo, the company’s basic dashboard for RIAs. All of the top asset custodians are reinventing their technological frameworks on a grand scale. See: Schwab unveils a plan to create a grand ecosystem of top technology vendors to RIAs Schwab has Intelligent Integration; Fidelity has WealthCentral; and Pershing is building out NetX360 with a soon-to-be-launched grander ecosystem of complementing technologies. For RIAs to make a series of applications work together and with their custodian is an act of infrastructure scaling that few dare to embark upon. That these custodians are engaged in an earnest arms race on this front is – presumably – encouraging.

5.) Independent broker-dealers are also working to build scale on behalf of large RIAs. Two good examples of that are Cetera and First Allied. Following up its poaching of Barnaby Grist from Schwab, Cetera recently nabbed Susan Theder from Pershing to head up marketing for its various IBD divisions. This adds to its big investment in Advent Software – also recently reported in RIABiz. Theder will market Cetera’s ability to make big hybrid RIAs even bigger [i.e. scaling up] by offering a series of tech and management services. First Allied is also following that script to some extent in its hiring of Matthew McGinness — a former LPL and Cerulli employee with great expertise in practice management. The implicit message of Matt’s presence: if you’re a big hybrid RIA who comes to First Allied, you’ll have a seasoned expert who is a phone call away as you make a complex set of scaling decisions.

6.) Kevin Tanner, an RIA with $240 million of assets under management, illustrates how individual advisors are capable of scaling up. He will soon have $2 billion if events continue to unfold the way they have been for him, he says.* He spent several years developing a scaleable investing process at his company, Saratoga Research & Investment Management. He buys large cap stocks in a highly defensive manner that has earned him top-notch returns. See: Suddenly noticed by big investors, Kevin Tanner’s small RIA is bracing for billions of AUM Now he’s scaling it up with two missing ingredients – a team of analysts and operations personnel [including his old operations officer at Smith Barney] and deft marketing to deep investing pockets – institutions. He did this by taking steps to get his track record posted on an institutional list and now his track record is propelling him to new heights.

7). The RIA business is suddenly crawling with venture capitalists. Envestnet has the venture capital backing of GRP Partners of Los Angeles and Foundation Capital of Menlo Park, Calif. Other companies backed by venture capitalists include: HighTower Advisors, Focus Financial, United Capital, The Mutual Fund Store, Cetera and KaChing [stay tuned for our article later this week!] By the way, I know it’s fashionable to say that companies like Focus Financial and HighTower are ‘rollups’ that don’t confer scale on RIAs. The RIAs who join these aggregators surely would not agree in many cases. Three Bridge Wealth Advisors partnered with HighTower a couple of weeks ago. Its principal, Brett Sharkey, suggested that building scale was the primary motivation of joining forces. My interviews with the principals of Delphi Private advisors, who joined Focus Financial through its Focus Connections program, echoed the same view.

What do VCs see in RIAs? Based on my conversations with venture capitalists backing a series of RIA-related businesses, I’d say they don’t have any more understanding of the nitty-gritty of the industry than most people entering its multi-layered, nuanced world for the first time. But that’s the point. The ones I talk to believe that the broad strokes of RIA success are so apparent that they aren’t necessarily worried about the details. They see a high margin, high growth business of RIAs that seems to be successfully cannibalizing the high margin business of wirehouses.

8.) Recently I visited the premises of an RIA practice with a few hundred million of AUM. Was the firm scaling up successfully? By some definitions, it was not. It was merely growing rapidly without any milestone changes in technology, organization and processes. On the other hand, this company is in the process of moving assets from ad hoc custodial arrangements with a series of wirehouses to Fidelity’s WealthCentral. The partners also traded in Blackberries for iPhones and they bought better filing cabinets to comply with Massachusetts’ new privacy laws.

These advisors have made modifications in how they screen potential clients and they are more wary of investors who tell them that they have a big appetite for risk. In my mind, this all adds up to a scaling of infrastructure, processes and technology. These advisors watch industry advisory publications – and immediate competitors in their region — like a hawk. If they perceive that they are losing a step, they’ll take further action.