With last week’s release of the 2018 InvestmentNews Compensation & Staffing Study, trends in pay and performance expectations are making the rounds in the RIA community. Even though we are a valuation firm, we are often asked to weigh in on compensation matters, as officer pay and firm value are typically intertwined.
A few months ago, a client who reads our blog regularly sent me a photograph of his first car, a 1957 Chevy Handyman. The Handyman was a two-door version of Chevrolet’s station wagon series with less chrome and a powertrain oriented more to utility than the better known Chevy Nomad series. Because most Handymans were not well cared for (they were fleet vehicles that served manual laborers), examples like the one our client owned could be bought cheap. And because it was cheap, a teenager growing up on the West Coast, such as our client, had no qualms about using it to haul surfboards and damp surfers back and forth to the beach. Unfortunately, what can be bought cheap is often sold cheaper, and such was the fate of this particular Handyman. Today, a Handyman in prime condition is rare, and that which is rare, and sought after, appreciates.
Stories like this drive the collector car market, and you can watch the appreciation curve on certain models mature as the demand created by nostalgia for first cars or dream cars meets the supply of accumulated wealth that comes later in life. Muscle cars from the 1960s have shot up in value over the past ten years because collectors who were teenagers in the 1960s have reached the peak of their careers, put their kids through college, amortized their mortgage, and can finally afford to buy back part of their youth at an auto auction. Professionals who follow the collector car market consider the price trends to be fairly predictable based on demographics.
In the RIA community, regardless of firm size or type, there is a predictable relationship between staffing decisions (positions, expectations, compensation, etc.) and firm performance. It’s a well-worn phrase that the assets of professional service firms get on the elevator and go home each night, but that doesn’t tell the story of the value of the firm, which is not merely the assemblage of assets, but rather the organization, orientation, and utilization of those assets for a common purpose: serving client needs.
Staffing Your Model
We think compensation surveys offer interesting data, but that data needs to be filtered carefully to provide useful information. No two RIA business models are exactly alike, and staffing needs and compensation requirements of one model do not necessarily translate into another model. So while the averages of reported data are interesting, they have to be put into context to be meaningful.
Some RIA models, for example, are highly vertical, focused on supporting the talents of one or two individuals at the top of the firm. In such a situation, compensation might be expected to be very top-heavy, as most employees of the firm serve to leverage firm leadership. This is common for niche asset management firms. Firms with a more horizontal orientation (lots of rainmakers contributing to the revenue stream) are inherently more sustainable, with less dependence on any one individual and an easier system to bring junior talent along into senior positions. Wealth management firms tend to exhibit this horizontal organization – at least most of the time. Aggregate compensation expense and margin can vary in both vertical and horizontal structures. It’s more important to know the “why” of your compensation structure than the “what.”
Staffing for Margin
Margins can be tricky to interpret. Too low and the viability of the firm is threatened by market downturns. Too high and the firm is vulnerable to market forces bidding away talent or bidding down fees. Since the key variable in firm profitability is compensation, it’s a good idea to keep an eye on your margins relative to market and your aggregate compensation expense relative to market. Most firms aren’t “average,” so there’s no expectation that you would be either. But the average is a benchmark to measure against, and if you can articulate why your margins and compensation costs are different than market averages, you’ll have a better handle on managing those numbers through different economic environments.
Staffing for Growth
In one sense, investment management firms are simply collections of people – and those firms can’t grow any faster than the people who compose the firms. Brent Brodeski published a useful article in Financial Planning a few months ago talking about the tradeoff between current profitability and growth. The message, which is worth reiterating, is that growth isn’t free. A common myth in the RIA industry is that, at a given scale, an upward trending market provides a tailwind that carries firms along whether they intentionally focus on growth or not. The problem is that RIA staff do not live forever, and without investing in subsequent generations of leadership and subsequent generations of clients, every firm will quietly begin to wind-down regardless of the market.
Staffing for Sustainability
RIAs are business models that can, if managed thoughtfully, survive most any change in the business climate or market dynamic. Our oldest client firm dates to the 1940s, and during their 75-year history, they’ve experienced several changes in control ownership, client focus, and portfolio expertise. Adaptability is integral to sustainability. That said, having a staff that is motivated to adapt – not just be capable of it – helps provide for the firm’s needs as they change. A firm with 5% client turnover is a brand new firm every twenty years. Are you prepared to start over during the course of the next two decades? This is another place where benchmarking is useful as a reference rather than a rule. With many studies reporting that the average age of financial advisors now tops 50, does the average age of client-facing staff in your office suggest you are building the future firm or simply cashing in on what you built previously? This applies to your staff as a whole and to senior staff needs in particular. What would it cost to recruit a younger version of you today? Have you hired that person?
Staffing for Value
We often say that investment management is not a capital-intensive business, but the capital investment in a typical RIA is in human capital. Technology offers the promise of some relief, assuming regulatory requirements don’t consume those efficiencies over time. Most RIAs could operate at a higher margin than they report, but doing so would require understaffing – either in the number of employees or quality of employees – such that the clients of tomorrow aren’t being recruited, nor is the talent to service those clients being developed. Absent reinvestment in human capital, an RIA becomes a depreciating asset which, unlike collector cars, isn’t likely to evoke nostalgic interest years later.
The one that got away