3 ways volatility diminishes the value of your firm

After the U.S. stock market's red-hot returns last year, 2022 has gotten off to a rocky start. That’s why, when it comes to the value of your firm, having the right strategy and doing an exceptional job of implementing it, is the real differentiator between growth and decline.

Market corrections typically impact a firm’s value in three ways: a decline in profits, greater client attrition and something I call the “guru” effect.

Let’s start with the guru effect because it’s the least intuitive. The guru effect is the perception clients have that their adviser is a brilliant investment manager and market timer, and less so an overall financial, tax and estate planner.

But studies have shown that most guru advisers don’t achieve superior returns. In fact, they typically enjoy lower returns than an index or passive strategy. When the markets correct, lower returns result in a decline in assets under management and, as a result, lower fee revenue.

But when it comes to firm values during a declining market, guru asset management may be secondary.

The biggest negative impact that a guru adviser has on the value of a firm is that if they have health issues, or if they just want to cash out and retire, they’re not in the position to hand over their clients to another firm. After all, the client sees the investment acumen of the guru, rather than the advisory process and implementation, as the lone indispensable.  

From my experience of participating in 21 completed mergers and acquisitions in the past four years, the less that an adviser sees him or herself as a portfolio manager, and the more that an adviser regards him or herself as a financial planner, the more valuable the firm.

Firm valuations take another hit when the market tanks due to a decline in profits. Given that the value of most firms is based upon some factor of the profits derived from the total assets managed, a prolonged bear market can have a substantial impact on what a firm is worth.

To maintain the value of a firm during a down market, an adviser either needs to add a lot of new clients or drastically cut costs. But neither of these is easy when clients see the losses on their statements, and in response, seek more attention and guidance, which correspondingly results in an increase in employee workloads.

Last, during times of market turbulence, clients tend to search for greener pastures, and it’s normal to see a higher rate of attrition.

To combat this, it’s important to increase communication as well as education. The more a client feels you have their back, the more likely they are to stick around during the rough patches.

It’s anyone’s guess how the market will fare in 2022. But if you're thinking about merging, selling or retiring in the next five years, you’ll not only want to closely monitor the impact the above factors have on your firm’s value, but depending on how clients view your firm, you may need a change of direction.

[More: Your clients will show you the way]

Scott Hanson is co-founder of Allworth Financial, formerly Hanson McClain Advisors, a fee-based RIA with $13 billion in AUM.