The Importance of Specialization in Investment Management

A Review of Philip Palaveev’s The Ensemble Practice

Practice Management

In an industry characterized by constant pressure to adapt to market conditions and offer highly specialized client service, many financial advisors still spend a significant portion of their time acquiring new clients rather than collaborating with other professionals. According to Philip Palaveev in his recent book The Ensemble Practice, the majority of financial advisory practices still function as “solos,” or one individual against the entire market. This practice is inherently problematic in its lack of sustainability and the problems it poses for an owner who desires to leave a legacy post-retirement.

Palaveev argues that, like prehistoric hunters and gathers, solo firms face constrained resources and limited growth due to the amount of time owners must spend on business development. Just as the discovery of agriculture allowed for specialization and the sharing of knowledge and resources, a team-based approach to asset management allows employees to focus on the cultivation of relationships with clients and other professionals. The result, again according to Palaveev, is a lasting organization with more predictable revenue streams.

The book defines this organization as an “ensemble,” or a team of financial advisory professionals that relies on the team rather than an individual to service and manage client relationships. The advice to shift away from reliance on the owner as a key man is very similar to the recommendations we heard in Success and Succession, but Palaveev offers insight into how and why to develop an ensemble practice even before succession planning becomes a priority.

According to the book, an ensemble practice offers a number of tangible advantages. Ensembles are proven to grow faster, attract larger client relationships, achieve higher levels of profitability, and create more substantial long term value for their principals. However, they do require owners to relinquish some control, and not just in terms of influence on the business. A principal in an ensemble practice must ultimately accept a less flexible lifestyle due to his participation in an ambitious team of people. In addition, the process of actually achieving ensemble status is difficult, especially for firms with an ingrained individualistic sales culture. All considered, an ensemble practice offers a number of additional benefits that are promoted throughout the remainder of the book.

  • Leverage and Growth. One of the first steps in the evolution towards ensemble status is the addition of less experienced professionals who can help increase profitability through leverage. According to Palaveev, hiring professionals with less experience and training them is the “most reliable path to building a valuable firm.” Though a new hire will require a significant amount of investment, his inexperience will allow the senior advisor to continue to fashion the culture of the firm. This associate increases the income generating capacity of the senior advisor while incurring less expense for the firm per labor hour as compared to a more experienced individual. In addition, the associate can be mentored by the owner and allow for the future growth of the practice. A young, inexperienced professional helps incorporate enthusiasm and energy with the wisdom and relationship of the owner. However, Palaveev warns against a culture in which tenure leads to guaranteed promotion. He argues that 100% “home grown” firms are susceptible to inefficiencies and the possibility of missing out on new ideas and perspectives.
  • Legacy. Eventually, the new associates hired will form the next generation of senior advisors and allow for the possibility of internal succession. In accordance with the advice offered in Success and Succession, Palaveev suggests that internal succession is more reliable and offers the owner more control over the terms of his exit. In contrast, external transactions involve years of hard transition work and the prospect of seeing a stranger take over the practice. Emphasis is again placed on starting the transition process early, because although in a growing firm staying invested will maximize the value to the majority owner, it will leave him with a highly valuable but highly illiquid “chunk of stock.”

In conclusion, this book provides valuable insight into how to successfully navigate the transition to an ensemble practice and highlights both the short term and long term benefits of this transition. It shares many themes with Success and Succession and helps solidify the importance of reducing key man risk early in the life of a practice. We would note that, in our experience, it requires a certain scale to implement the ensemble strategy, and it’s a bit of a chicken-and-egg issue as to whether you build a large enough practice first using a more traditional, individualistic sales culture and then try to redirect the culture toward specialization, or invest in specialization up front and hope the clients will come in to justify the overhead. One strategy has certain risks for the top-line, the other clearly affects the margin. In either event, Palaveev seems to capture the importance of specialization – which is significant in any profession – and provides a roadmap to implementation in a traditional investment management firm.

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