RIA Valuation Insights

A weekly update on issues important to the Investment Management industry

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RIA Valuation Insights


Practice Management

An Ontological Approach to Investment Management

Review of “Winning at Active Management” by William W. Priest et al.

“Winning at Active Management” by Bill Priest is an important book for managing a successful investment management practice. Emphasizing the importance of corporate culture, Priest argues against traditional command-and-control structures, highlighting that knowledge-based businesses like investment management thrive on intellectual contributions from all levels of the organization. The book provides a fresh perspective on the role of culture in mergers and acquisitions within the investment management sector, preaching that cultural compatibility is crucial for the success of such transactions.

Margins and Compensation

How EBITDA Margins Affect Revenue Multiples

Whenever someone asks us what their RIA is worth as a multiple of revenue, we respond by asking about their firm’s EBITDA margin. This week’s blog post explores how RIAs can enhance their value by focusing on EBITDA margin, revealing the pivotal role of profitability in investor attractiveness. It also provides strategic insights for balancing growth and profitability.

Practice Management Wealth Management

Employee Alignment Is Essential in Wealth Management

Employee alignment is crucial in asset and wealth management due to the industry’s reliance on human capital. Creating alignment between employees and shareholders is essential for the growth and success of these firms, particularly for firms with non-employee ownership. Effective compensation models and incentive programs can align interests, supporting the long-term growth and success of the enterprise.

Practice Management

Capital Budgeting for Team Building

Tools for Long-Term Greedy Practice Management

The recent cancellation of Apple’s decade-long “Apple Car” project underscores the opportunities that capital budgeting offers for strategic decision making. Capital budgeting is a modeling exercise that has applications in the RIA community as well, where resource allocation decisions are more likely to involve human capital as opposed to equipment. This week, we explore the concept of returns to labor versus returns to capital in investment management, illustrating how long-term strategic thinking about human capital can lead to significant returns using the same tools integral to decision making at industrial concerns.

Current Events

Will RIAs Be Subject to Anti-Money Laundering Rules?

The Financial Crimes Enforcement Network (FinCEN) is proposing a rule that would require investment advisors to comply with Bank Secrecy Act requirements, including implementing anti-money laundering controls and filing suspicious activity reports. Unlike previous attempts, this proposal does not hold investment advisors accountable for identifying their clients, but FinCEN is considering a separate proposal with the SEC for future customer ID requirements. With an increased push from regulators and illicit actors’ growing utilization of RIA intermediaries for AML purposes, the investment advisory sector may soon face stricter regulations, particularly regarding customer identification.

Transactions

Reconciling Real-World RIA Transactions with Fair Market Value

When RIA owners think about their firm’s value, they frequently think in terms of the dollar value they believe they could sell the business for in an arm’s-length transaction. However, the nuances of real-world transaction terms in the investment management industry can often obscure what’s being paid for the business on a cash-equivalent basis. The details of transaction pricing—things like contingent consideration structures and thresholds— rarely make it into the trade press or RIA rumor mill, adding to the confusion. In this blog post, we explore various transaction structures employed in the industry and their relationship to fair market value.

Transactions

RIA M&A: What Can Possibly Go Wrong?

A Very Incomplete List of What Not to Do in Transactions

In the RIA community, nothing gets people’s blood flowing like a transaction. Big mergers are fantastic, but even deals involving a few hundred million of AUM are widely reported. For all the hype, making M&A successful requires minding Ps and Qs, and is as much, if not more, about attention to detail and being realistic as it is about sweeping vision and uplifting pronouncements.

Industry Trends Wealth Management

Will Finfluencers Replace Financial Advisors?

The CFA Institute Research & Policy Center’s recent report reveals the significant influence of financial influencers (finfluencers) on the investment decisions of Gen-Z, underscoring the urgent need for the wealth management industry to adapt to the digital age. Highlighting a concerning gap, the report notes that a substantial portion of finfluencer content lacks necessary disclosures, potentially leading young investors to make decisions based on biased information.

Despite the challenges posed by finfluencers, the report suggests they offer a unique opportunity for RIAs to engage with the next generation of investors, advocating for strategic partnerships complemented by rigorous compliance and transparency measures. Read the details in this week’s post.

Current Events Industry Trends Transactions

Quality of Earnings Analysis for RIAs

The M&A space in the RIA sector has seen a marked increase in transaction activity over the past ten years, along with advancements in its supporting infrastructure. Professionalization of the buyer market has led to a more detailed examination of target companies’ earnings. Mercer Capital’s whitepaper highlights the importance of Quality of Earnings (QofE) analysis in presenting a more accurate picture of a company’s earnings and cash flows for both potential buyers and sellers.

Current Events Industry Trends

Navigating the Shifting Tides

Trends Shaping the RIA Industry in 2023 and Beyond

In 2023, the RIA industry witnessed growth and rebounded from the previous year’s slump, despite earlier concerns about inflation and high interest rates. This growth occurred alongside a shift in the financial landscape, where public firms in wealth management underperformed compared to the broader market and alternative asset managers. Additionally, RIAs have found the importance of data use, with many advisors using data to enhance portfolio decisions, operational efficiencies, and client relationships.

Industry Trends

The Remarkable Resilience of RIA M&A Activity

Despite challenging macroeconomic conditions in 2023, RIA M&A activity demonstrated resilience, with Fidelity’s November 2023 report showing a 3% increase in deals compared to 2022. The total transacted AUM saw a notable 25% increase, with an average AUM per transaction rising by 21%. Factors contributing to this growth included consolidation forces in the industry, confidence in the macroeconomic environment, and significant investments by firms such as Mercer Advisors and CAPTRUST, as well as partnerships with private equity firms.

Industry Trends

RIAs Finish 2023 with a Q4 Rally

Investor Interest Moves to Alts and Big-Name Managers

In Q4 2023, most publicly traded asset and wealth management firms saw share prices rise, with alternative asset managers seeing 21% growth, outperforming the S&P 500. Despite market growth, there was a decline in year-over-year revenue for most RIA sectors, attributable to fee compression. This report also highlights that larger RIAs (with AUM over $100 billion) generally outperformed the S&P 500, while smaller RIAs (with AUM under $10 billion) underperformed.

Industry Trends Insights

‘Twas the Blog before Christmas….

The 2023 Mercer Capital RIA Holiday Poem

It has become a tradition for the RIA team at Mercer Capital to end the blog year with a “unique” annual summary of industry events, riffing off Clement Clark Moore’s classic “A Visit from St. Nicholas.”  We hope all of you in the investment management community are enjoying the holiday season and looking forward to the many opportunities of the new year.  We look forward to hearing from you in 2024.  For now, please enjoy the finest only holiday poem written about money management.

Practice Management Transactions

7 Considerations for Your RIA’s Buy-Sell Agreement

Working on your RIA’s buy-sell agreement may seem like a distraction, but the distraction is minor compared to the disputes that can occur if your agreement isn’t structured appropriately.  Crafting an agreement that functions well is a relatively easy step to promote the long-term continuity of ownership of your firm, which ultimately provides the best economic opportunity for you and your partners, employees, and clients.  If you haven’t looked at your RIA’s buy-sell agreement in a while, we recommend dusting it off and reading our seven considerations for your RIA’s buy-sell agreement.

Margins and Compensation Transactions

Assessing an RIA’s Quality of Earnings

Don’t Pay a Premium for a Project

Quality of earnings projects look at aspects of profitability that go well beyond audited financials. They include detailed analysis of revenue and expenses, and derive a measure of normalized earnings more meaningful than simple reported results, even if the presentation of those results is accurate.

Current Events

Munger Games: Charlie Munger’s Legacy

And His Common Sense Approach to Business and Investing

As a tribute to the late Charlie Munger, we reflect on his legacy and wisdom. His distinctive perspective on cryptocurrency, diversification, and financial projections offers a unique approach to managing investments, contrasting with conventional practices. We provide our thoughts on his lasting Munger-isms.

Margins and Compensation Practice Management

Evaluating Your Firm’s Margin

An RIA’s margin is a simple, easily observable figure that condenses a range of underlying considerations about a firm that are more difficult to measure.  As much as a single metric can, margins reflect the health of a firm—indicating whether a firm has the right people in the right roles, whether it’s charging enough for services, whether it has enough (but not too much) overhead, and much more.  But when assessing your firm’s margins, it’s important to consider the context of the firm’s ownership and compensation structure and also the tradeoffs associated with margins that are too high or too low.

Practice Management

Speed, Velocity, and Momentum

The Best Measure of RIA Success

Market performance gives you speed.  Employee performance gives you velocity.  Practice management gives you momentum.  If you want to be successful, focus on building momentum.

Asset Management Industry Trends Margins and Compensation Mutual Funds

Can Active Management Survive a Bear Market?

The recent analysis by Bloomberg highlights the potential for a bear market to intensify the challenges faced by active money managers, including fee pressures, asset outflows, and growing competition from passive investing strategies. Despite headwinds and the rising popularity of passive products, the resilience of some active management firms suggests a future where the industry might see less competition and more opportunity for alpha. Despite higher market caps than in 2008, asset management firms face a contraction in earnings multiples, suggesting a complex outlook that balances risks with the potential for restructuring and consolidation within the sector.

Industry Trends Transactions

Consolidation in the RIA Industry?

A Look at Record-Pace RIA Acquisition

In the midst of robust M&A activity, the RIA industry defies typical consolidation trends, continuing to grow with new firm creation outstripping the pace of acquisitions. This expansion has been propelled by a shift from the broker-dealer model to a fiduciary model, alongside the allure of building valuable, saleable enterprises.

Alternative Assets Asset Management Industry Trends

Alt Managers Race Ahead

A Resurgent Year for Investment Management Firms

In the recent financial landscape, alternative asset managers have significantly outpaced other categories, particularly in the RIA sector, demonstrating resilience and impressive gains amidst market volatility. While traditional asset managers have seen some pressure, larger entities, especially those in private equity, experienced notable growth and stability, largely due to their robust structures and strategic partnerships. The current trends underscore the importance of understanding nuanced market shifts, what these developments mean for various asset managers, and investment approaches in an evolving economic climate.

Current Events Industry Trends Transactions

RIA M&A Update

Although inflation has begun to subside and the stock market has rallied after a turbulent start to 2023, elevated interest rates and macroeconomic uncertainty have contributed to a slight decline in deal volume so far in 2023. Despite the slight decline in deal volume, total transacted AUM increased. In this week’s post we discuss some of the contributing factors of this, and what it means for your RIA.

Industry Trends

Q3 2023: Alts Take the Lead as Other RIAs Lose Traction

Market Uncertainty and Fee Compression Trends Lead Investors to Take an Alternative Approach to RIA Investing

In Q3 2023, while most publicly traded asset and wealth management firms experienced share price decreases in tandem with the broader market, alternative asset managers stood out with about 10% growth. This deviation can be attributed to factors like market volatility since 2020, which has boosted demand for stocks of alternative asset managers due to their more predictable revenue streams. Furthermore, the shifting market conditions highlighted potential implications for individual RIAs.

Transactions

A Shortcut for Tax Savings

Charitable Giving Prior to a Business Sale Yields Big Results

This post unravels how donating a portion of your RIA ownership before a sale can furnish you with a charitable tax deduction and minimize capital gains exposure. With practical examples, the role of Donor Advised Funds, and timely gift planning to bolster the value of your contribution, ensure maximum benefit for both you and your chosen charity, without the cumbersome tax burden.

Investment Management

Mercer Capital provides RIAs, trust companies, and investment consultants with corporate valuation, litigation support, transaction advisory, and related services