Piggybacking off of our post from last week, we discuss the various options one faces when leaving a wirehouse firm, including the various pros and cons to doing so. The advisory profession has evolved significantly over time, so we’re writing this post to keep you apprised of your options as you consider the big leap.
The industry has come a long way over the last couple of decades if you think about it. The client visits we go on today thankfully bear no resemblance to The Wolf of Wall Street or Boiler Room depictions of life as an “advisor” at a brokerage firm in the 80s and 90s.
While Hollywood undoubtedly dramatized this reality for entertainment purposes, these films reinforce the rationale for all the change that has taken place over the last twenty years. Ongoing technological and regulatory shifts suggest that the profession will continue to evolve.
All these iterations and alterations to the profession mean that advisors now have a variety of different platforms and businesses models to choose from. The three primary options include RIA aggregators and their network platforms, traditional wirehouse firms / broker-dealers, and independent RIAs.
Michael Kitces’s blog, Nerd’s Eye View, includes a recent guest post from Aaron Hattenbach, who worked as an advisor under all three of these models and provides valuable insight on which path makes the most sense.
The Evolution of RIAs
As a recent two-year participant in Merrill Lynch’s Practice Management Division (PMD), Hattenbach estimates the program’s failure rate to be 99% (other industry observers have estimated 95%; the wirehouse firms do not publish these statistics for obvious reasons). This sad reality is something an aspiring financial advisor should keep in mind when considering employment at one of the major wirehouse or brokerage firms.
It also explains why the industry has such a tough time recruiting millennials to the business. Those who do succeed tend to be aggressive networkers and champions of the wirehouse brand and the breadth of services it can offer clients.
Even if you are part of the 1% (or 5%) who make it through the program, the independent or aggregator RIA routes can be enticing. As noted last week, the sheer economics justifies the move to the independent route if you can transition most of the clients and manage overhead efficiently.
Independence also breeds creativity and customization as the wirehouse firms tend to be more bureaucratic while offering firm approved, templated solutions to clients on behalf of advisors across their entire network. Hattenbach noted that most of his advisor colleagues at Merrill placed more emphasis on “being compliant” than sharpening their craft, advising clients, or growing their book of business.
But independence isn’t the only option. Fortunately, there’s a compromise or go-between for total independence and the wirehouse route.
The Tenets of RIA Independence
The RIA aggregator model allows its advisors to maintain some degree of autonomy without having to manage an actual business. Aggregators will purchase books of business from advisors and offer an ongoing payout structure after the deal.
Aggregators like LPL Financial and Focus Financial have gained popularity in recent years as these businesses did not suffer the reputational (and financial) fallout of their wirehouse counterparts during the last financial crisis. Also, like their wirehouse competitors, RIA aggregators can use their massive scale to negotiate better terms for things like custody fees and trading costs than independent RIAs.
Still, a lot of advisors have left the RIA aggregator network, perhaps one of the reasons behind Focus’s delayed plans for an IPO. Perhaps once the advisors get a taste of freedom, they will want full independence and start their own RIA. Even after operating under an RIA aggregator, the transition to independence can be quite the leap, and Hattenrach advises that the following attributes are needed:
- Operating experience in the investment advisory channel
- Niche specialty that allows for differentiation from the competition to compensate for the lack of brand recognition
- A client base large enough to sustain itself or the financial flexibility and patience to grow it from scratch
- Entrepreneurial attitude and willingness to put in the many hours necessary to succeed
- The ability to effectively multi-task and prioritize
- An advisory study group or professional group of colleagues that can from your “unofficial advisory board”
Anecdotally, we’ve heard (and generally observed) that it often takes $500 million in client assets to create an independent RIA that is consistently profitable, depending upon fee structure, location, and headcount, among other things. This may be a bit conservative, but could be what it takes to breakeven in an environment dominated by passive investing, fee compression, evolving regulatory requirements, and rising compliance and compensation costs.
We’ve seen profitable RIAs at lower levels of AUM, but to build consistent profitability in the face of all the aforementioned industry headwinds and a potential market downturn, you’re probably going to need a few hundred million in client assets.
This is a lot to think about as each route has its own risks and rewards. If the solution were obvious, it’d be the only option. We see the independent and aggregator RIA model continuing to gain client assets and advisors from wirehouse firms, but think the Wall Steet firms and other broker-dealers are too heavily entrenched (and dedicated to fee income) to be totally wiped out anytime soon. Whatever the outcome, as asset management models continue to evolve the relative merits of independence and affiliation will too.