The skinny on RIAs

Predictions indicate growth in the registered investment adviser channel, but many small RIA firms are starting to feel the squeeze from rising costs and stiffer competition. RIAs are expected to hold 14.4% of the market share of total assets by the end of 2014, up from 12.9% last year, according to Cerulli Associates Inc., but increasing margin pressure could favor bigger players in the channel. The most outspoken pessimist, as far as small firms go, is Mark Hurley, chief executive of Fiduciary Network LLC, which provides financing to wealth management firms by taking minority stakes. The vast majority of advisers will have to work harder for less money over the next decade, while 150 or so “extremely profitable, large [RIA] firms will manage the vast preponderance of assets,” he wrote in an April report. Some of these mega-firms will produce $75 million to $150 million in annual revenue, Mr. Hurley said. For the rest of the 19,000 advisory shops in the industry, life won't be so good. “Costs are going up 5% to 7% a year, [aging] clients are consuming more of their capital, which is not being offset by market forces, and it's just getting harder to get new clients,” Mr. Hurley said. Rob Francais, chief executive of Aspiriant LLC, agrees with much of Mr. Hurley's assessment. “It used to be that by being independent, objective and fee-based, you'd distinguish yourself, [but] we're not differentiated by that anymore,” said Mr. Francais, who wants to build his $7 billion firm into a national behemoth. “It's really, really challenging.” Achieving size and scale is the answer, at least according to firms that are in the business of making acquisitions, such as Aspiriant and United Capital Financial Partners Inc. United Capital chief executive Joe Duran thinks Mr. Hurley is underestimating how large the dominant RIA firms will become, noting that his firm already has surpassed $75 million in revenue. How much more, he declined to say. A consolidation trend is normal for a maturing industry such as this one, Mr. Duran said. “This has happened in accounting and law, where the mom-and-pop firms became large firms,” said Mr. Duran, whose company manages $8.5 billion and oversees another $16 billion for itself and its affiliates. “Big accounting firms and law firms now dominate,” he said. “The same will be true of wealth management.” Cerulli noted this trend in a report on the RIA industry last year. “While the rising tide is raising all boats, the largest firms by assets are expanding their market share, extending their offerings and building scale,” which allows for a reduction in costs through shared compliance, operations and staff, according to the report. Regulatory burdens, of course, have become enormous. “They're only going one way — they will continue to increase,” said Rudy Adolf, chief executive of Focus Financial Partners, whose partner firms oversee about $60 billion. In addition, software has gotten more expensive, with providers charging on a per-account or per-user basis rather than with a one-time fee, Mr. Duran said. The larger firms, though, are getting big enough to push back and dictate some vendor pricing. That puts smaller firms “at a massive disadvantage,” Mr. Duran said. Meanwhile, the ever-present issue of succession continues to haunt most small firms. “They're going to have a lot of trouble retaining and recruiting talent, because people want career paths,” Mr. Duran said. “It's hard to have a path in a personality-based business.” Additionally, the financial value of mature practices “has outpaced the ability of the second generation to buy in,” Mr. Francais said. But here again, scale provides a solution, he said. Aspiriant has 42 owners and an “institutionalized” succession program financed through a regional bank that provides partner loans just for the firm. So are small to midsize RIA firms destined to disappear? Even Mr. Hurley doesn't predict that. “But instead of making $200,000 a year, they'll be making $100,000,” he said. “The reality, is, you can run a practice in many ways, and it's perfectly OK to run it as a "lifestyle' business” that won't generate a huge payoff at retirement, Mr. Adolf said. Mike Durbin, president of Fidelity Institutional Wealth Services, agrees. “The lion's share [of RIAs] are not looking to sell in some big monetary event,” he said. Their practices are “capital-light and cash-flow-heavy, [and] they can make a great living doing that,” Mr. Durbin said.

EFFICIENCY IS KEY

Small firms don't have to find themselves on a slippery slope of compressed margins, said consultant Deborah Fox, founder of the Fox Financial Planning Network and owner of a small RIA. The problem is that the average advisory practice hasn't given enough attention to building efficient business practices — in particular, to developing a niche market with specialized expertise and the systems to support it. “Then you can charge higher fees because you have in-depth knowledge,” Ms. Fox said. Meanwhile, technology is producing efficiencies. And with 40% of industry assets at wirehouses, this is a market that independent RIAs of all stripes feel confident pursuing. Add in the fact that close to $30 trillion in assets will transition to the next generation over the coming decade or so, and advisers should have plenty of opportunity, Mr. Francais said. “Clients need help [and] there is greater demand for more transparency, comprehensive service and objectivity,” he said. “The consumer needs to have diversity in choice,” Ms. Fox said. “Smaller firms will always have a place in the profession because financial advice is always personal.”