The RIA world according to Cerulli

This report was originally published by the Investment Management Consultants Association as the 2011 1Q Research Quarterly. See: www.IMCA.org for more articles and information about the organization.

The concept of wealth management is ambiguous at best. A variety of firms, including advisors, asset managers, and even technology vendors, proclaim to be in the wealth management business. Although a wide range of advisors hold themselves out as wealth managers, their skills and service models can vary widely. Cerulli Associates attempts to quantify and measure various practice types through its practice-type analysis.

Cerulli Associates’ practice-type definitions matrix precisely differentiates among the various advisory options in the financial services marketplace (see table 1). Practice types essentially vary by the amount of advice offered that is not directly related to investment management. For more information about the RIA word, See: Six things to know about how and where RIAs are growing

Money managers.

At one end of the spectrum, money managers tend to believe they have built a better investment-management mousetrap and want to be valued solely based on their investment results; they eschew dispensing advice. The most successful money managers may end up as niche asset managers rather than continuing to operate as retail financial advisors. Cerulli Associates has seen the percentage of advisors in this segment decreasing for several years and expects this trend to continue.

table 1

Investment planners.

Investment planners fill the next step up on the advice ladder. Like money managers, investment planners focus mostly on producing portfolio returns for clients, but they also try to work within an investor’s larger financial context on an as-needed basis. Investment planners are likely to use modular planning tools, but they rarely if ever engage in comprehensive financial planning. An example of an investment planner is an advisor who sets up a college savings plan by calculating the amounts that need to be saved monthly and suggests an investment lineup, but he doesn’t consider financial aid or more-advanced planning strategies.

Financial planners.

Next on the advice continuum are financial planners, marking the beginning of regularly delivered comprehensive financial advice. Financial planners generally feel comfortable giving comprehensive advice (and often prefer to offer this level of service to all clients), but the majority of their clients do not receive written comprehensive financial plans. Anecdotal accounts indicate that these advisors often combine their accumulated experience and knowledge of a client’s situation to provide much of the value that would be delivered through comprehensive engagement but in a more timely fashion.

Wealth managers.

The final spot in the advice continuum is occupied by wealth managers, who generally provide the services of financial planners with additional offerings focused on the needs of high-net-worth individuals and families. Wealth managers often work in team-based practices that provide in-house resources for specialized services such as advanced estate planning and wealth preservation. As firms and advisors continue to pursue high-net-worth investors, wealth managers are competitively positioned and continue to expand by adding items such as philanthropic giving oversight and concierge services to differentiate their practices.

More than 80% of IMCA wealth manager respondents said they focus their practices on clients with more than $1 million in net worth; 20% said they focus on clients with more than $10 million in net worth. Working with wealthy investors presents a unique set of challenges. First, by virtue of their wealth, these investors’ situations are simply more complex. Second, wealthier investors are more likely to maintain multiple advisory relationships and compare the results they receive from each. Finally, because of the multiple relationships they maintain, the satisfaction of wealthy investors is mostly driven by investment performance.

These dynamics are reflected in wealth managers’ practices in multiple ways. Wealth managers typically operate in team-based practices, which allow advisors to specialize in the various components of the advisory profession (e.g., financial planning, portfolio management, etc.). This kind of specialization allows an advisor to go in-depth on a chosen topic and provide the more-sophisticated advice needed by wealthy consumers. Likewise, although Cerulli Associates defines practice types based on the comprehensiveness of advice, we note that wealth managers’ practices also run more complex, customized portfolios for clients. The complexity of these portfolios is partly due to the clients’ wealth: They can afford products with high minimums, such as separate accounts or alternatives. This complexity is due partly to these investors’ attention to investment performance.

These types of services also are a response to competition. Multiple providers have been aggressively staffing up and expanding their high-net-worth arms. As noted earlier, wealthier investors typically maintain multiple advisory relationships, which diversify advice and even custodians. Multiple advisors may sense that other relationships exist but are unaware of the details. Cerulli Associates believes, however, that these investors have an “alpha” advisor who is aware of the relationships and acts as the client’s financial hub. Advisors who can effectively develop the wealth management holistic business model are better positioned to take on this hub position.

table 2

Teams are most common in practices focused on serving higher wealth tiers. From a practice-type perspective, more than 70% of financial planners and more than 85% of wealth managers operate team-based practices, compared with 65% of IMCA respondents overall.

Key Implications: Meeting the comprehensive needs of wealthier clients generally requires the level of specialization available within a team structure. Wealthier clients have been conditioned to expect comprehensive service solutions from their financial professionals, and they will not hesitate to look elsewhere if a firm cannot support them in their preferred fashion. Advisors who hope to increase their appeal to wealthier clients must thoroughly consider creating a team-based practice to align clients’ service expectations with resources within the firm. A team-based structure generally allows senior advisors to spend more time on client-facing activities, which usually provides the greatest revenue opportunities for the practice.

Table 3

A practice’s headcount often correlates with the depth of advice provided to clients. Wealth managers average 5.2 personnel per practice, compared to 4.0 in financial planning practices and 3.8 at investment planner practices (see table 3). We see an outlier here, however: IMCA money manager practices average 10 personnel. This, however, is largely attributable to several practices that each manage more than $1 billion on behalf of 300 or more clients, so these firms actually are practicing with an economy of scale.

Key Implications: Assets under management (AUM), size of client base, and other factors affect the scale of a practice headcount, but average client wealth and the services required to support those clients are the major determinant of how many personnel are needed to support each client. Firms must anticipate increasing labor costs in order to build a foothold among wealthier investors.

Table 4

More than 90% of wealth management practices manage in excess of $100 million on behalf of clients. Overall, 58% of IMCA respondents manage in excess of $100 million.

Key Implications: Wealth managers are most likely to cater to the needs of wealthier investors and therefore build larger books of business than advisors in other channels with similar numbers of clients. The larger AUM of wealth management practices assures that product and service providers will cater to them for the foreseeable future. With increased attention from providers, wealth managers are well-positioned to receive the best in products and negotiated pricing.

table05.jpg

Commission revenues account for 27% of IMCA member respondents’ compensation. This figure is highest among money managers, where commissions account for 41% of revenue, and lowest among wealth managers, where commissions make up just 21% of revenue.
IMCA member respondents across practice types plan increased use of fee pricing. Wealth managers plan on increasing fees from 79% of compensation in 2010 to 84 % of compensation by 2012. Though money managers now earn the lowest percentage of revenues from fees (56%), as a group they are optimistic about their ability to transition to fee-based relationships: They anticipate earning nearly 80% of their revenues through fees by 2012.

Key Implications: After years of attention, the debate over fees versus commissions is poised to come to a head in 2011 with consideration of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which would govern all retail financial advisors with a fiduciary requirement. The current fee-pricing model presents a chicken-and-egg scenario. Although fee-based clients technically receive a higher fiduciary standard of care (as opposed to the less strict suitability standard associated with commissions), advisors and clients both are drawn to the holistic, goals-based relationship promoted by fee pricing. As such, the appeal of fee pricing is tied closely to addressing wealthier clients. On one hand, a wealthier client has deeper needs and, thus, can benefit from a deeper advisory relationship. On the other hand, however, Cerulli Associates’ research has shown that less-wealthy clients prefer to pay-as-they-go (commissions) and wealthier investors are more willing to pay an ongoing fee for oversight. Wealthier investors already are comfortable paying for advice in other parts of their lives (e.g., attorneys, accountants) and see value in engaging professionals. However, it remains unclear whether the universal fiduciary standard of the Dodd-Frank bill would force all financial advisors to solely price on a fee basis.

Table 6

As would be expected, the depth of advice offered correlates with the wealth of an advisor’s core market. More than 80% of IMCA wealth managers report they focus on clients with more than $1 million in net worth. IMCA wealth managers are most likely to be addressing high-net-worth clients, defined by Cerulli Associates as those with more than $10 million in net worth.

Key Implications: A conundrum exists at the high end of the market in terms of client service models. As table 6 shows, wealth managers are the most likely to be targeting both affluent ($1 million to $10 million net-worth) and high-net-worth (more than $10 million net-worth) clients. However, money managers and investment planners are having some success in this market. Wealthier investors typically maintain more advisory relationships than less-wealthy investors. Just as an advisor would diversify a client portfolio, clients are diversifying sources of advice and, post-bear market, even custodians. Proponents of an issue-based advice model argue that it can address the most pressing of a client’s needs with a fraction of the effort of a holistic model; a modular advice model can fit better with other advisory relationships, including nonfinancial professionals such as attorneys and accountants. Cerulli Associates believes many of these wealthy clients with multiple relationships, however, have an “alpha” advisor who is aware of all a client’s relationships, whereas secondary advisors might not know of each other. The alpha advisors likely operate holistically, positioning themselves as an end-to-end solution for clients.

Table 7

IMCA respondents almost universally provide asset allocation and retirement income and accumulation planning among their services. IMCA wealth manager respondents all provide asset allocation and estate planning. Investment manager due diligence and retirement income planning are the next most common services provided by wealth managers.

Key Implications: Closer examination helps define the distinction between financial planning and wealth management as holistic advisory models. Financial planner service sets are likely to address needs of the middle-market client ($250,000 to $1 million in net worth), many of whom are just achieving financial stability and seeking professional financial advice for the first time. Financial planners also are likely to offer insurance, education funding, cash management, and elder care planning, which address immediate needs and risk management for households with tenuous balance sheets. Wealth managers, however, gear their services to a wealthier investor and are more likely to include charitable giving, trust services, tax planning, and business planning. These services are needed by households that have addressed day-to-day cash flow needs and are focused on long-term wealth maximization and transfer.

Table 8

About half of IMCA wealth managers report having 50-150 clients. Approximately one-tenth of wealth managers reported having 500-1,000 clients, although these are likely to be massive advisory practices, among the industry’s very largest.

*Key Implications:*Once again, we see the debate between modular and comprehensive advice play out. The argument for a modular advice practice is scalability—if an advisor provides non-comprehensive, issue-focused advice in a client engagement, the advisor then, theoretically, works with more clients. One can see the appeal of this approach for less-wealthy clients. For example, a client with $400,000 in assets likely does not need an estate plan and the client’s needs can be addressed through relatively simple services such as retirement and education planning. Wealth managers, on the other hand, have traded the scalability of limited advice delivery for a comprehensive client relationship; hence wealth managers focus on fewer and wealthier clients. Also, advisors with a more comprehensive business model are more likely to act as the relationship hub for wealthy clients with multiple advisory relationships.

Table 9

IMCA wealth manager respondents said they allocate more client assets to separately managed accounts (30 ) than to mutual funds (14). In many instances these wealth managers have chosen to replace their allocations to mutual funds with the benefits of direct ownership associated with separate account offerings.

Key Implications: IMCA advisors use a product mix that is distinctly different from that used by retail advisors overall. Separately managed accounts traditionally have been used with wealthier investors, and IMCA advisors—particularly wealth managers—use these products more than retail advisors (21% of AUM versus 8% of AUM). Note that portfolio construction practices of wealth managers tend to differ from other advisors. Client wealth drives some of this difference, which is reflected in the separate account allocations shown in table 9. A client with $1 million in investable assets could afford to own 2–3 separate accounts and rely on mutual funds and exchange-traded funds to achieve full diversification, but a client with $10 million could afford to allocate to numerous separate accounts to achieve diversification. In addition, even within a single relationship, high-net-worth investors can have opposing goals. These wealthier investors are risk averse and want to protect their wealth but also wish to aggressively grow their wealth, and they have the resources to pursue aggressive, illiquid products such as alternatives. Addressing these opposing goals in a single portfolio is a tall order and requires thoughtful portfolio construction.

Table 10

Advisor practices that are focused on meeting business owners’ needs make up the largest niche, served by 14 % of IMCA advisor respondents. Retirees and pre-retirees are next-largest and account for a combined 24% niche segment.
Wealth manager respondents were more likely to report operating a niche practice: Only 32% reported serving a broad base of clients, compared to 55% of overall IMCA respondents. This difference is largely attributable to an outsized focus on business owners (29%) and corporate executives (12%).

Key Implications: Practices dedicated to a niche strategy can create a strong competitive position against generalist practices. In contrast to mastering a variety of skills applicable to a widely varied client base, niche advisors are able to provide superior individualized service to clientele with specific needs. For example, advisors serving business owners would need to address concentrated positions and provide business financing, succession planning, and cash management support. The propensity of top advisors to serve a specific client segment represents another step in the advisory industry toward specialization.

Table 11

Advisor respondents’ preferred method and frequency of client contact varies widely across practice types. Outgoing phone calls are the most frequently used communication; more than 85% of advisors report that they contact each client by phone at least quarterly.
In-person meetings typically are held on a semi-annual basis (42% among all advisors). Wealth managers are most likely to favor quarterly meetings (35%), compared to 26% of respondents overall.

Key Implications: The annual to semi-annual client meeting has become ubiquitous across the financial industry. While phone conversations frequently are used to communicate in between comprehensive planning sessions, Cerulli Associates’ research shows that clients’ preferred method of contact from their advisors is e-mail. E-mail allows advisors to thoughtfully package actionable information for clients that clients can digest on their own time. Client contact is especially important during periods of market duress. Advisors may not always have all answers, but easing clients’ fears and remaining in contact will maximize client retention.

Table 12

Wealth manager respondents reported that 36% of their clients come from referrals; this is in line with the average of 35 % across all IMCA members. Approximately one-fifth of wealth managers’ clients came from referrals from other professionals, slightly ahead of the IMCA average of 17%.

Key Implications: Wealth managers are more likely than other advisors to get clients via referrals, either from a client or other professional; 55% of their clients come from these sources. Wealth management practices often create strong public images that increase their local credibility, allowing other professionals to feel more comfortable sending referrals their way. In many cases, wealth managers strengthen these referral relationships by acknowledging the limitations of their own practices and referring clients whose needs outstrip the practice’s capabilities. However, advisors must realize that building a referral pipeline from an outside professional is not simple. Any professional will be wary of referring a client because a bad experience will reflect poorly on the referrer. As such, advisors must carefully cultivate these relationships.

Contact Bing Waldert at wwaldert@cerulli.com or Scott Smith at ssmith@cerulli.com.