Todd Investment Advisors and Fort Washington Investment Advisors

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PRACTICE MANAGEMENT PRACTICE MANAGEMENT 104 INVESTMENT ADVISOR / April 2005 www.investmentadvisor.com The latest re s e a rch shows that RIAs are enjoying a re s u rgence in the markets and their practices. Challenges remain, however, for those who want to sustain gro w t h April 2005 / INVESTMENT ADVISOR 10 5 T HE REGISTERED INVESTMENT ADVISOR marketplace has rebounded in re c e n t
years, with advisors building assets under management and revenues re t u rn-
ing to pre-dot-com-crash levels. Yet
new and evolving challenges face RIAs as
they work toward increasing their busi-
nesses’ pro f i t a b i l i t y. Those challenges
include an uncertain market and econom-
ic environment, rising costs for compli-
ance, an aging customer base that needs
h e a l t h c a re and re t i rement rollover pro d-
ucts, and a more competitive climate. Rydex AdvisorBenchmarking re c e n t l y s u rveyed more than 1,000 RIAs on invest-
ment and practice management issues. Our
results, gathered by phone and online sur-
veys, highlight critical trends that will aff e c t
RIA pro f i t a b i l i t y, client retention, and busi-
ness success over the next several years.
We’ll explore some of the issues that lead-
ing-edge investment advisors are curre n t l y
dealing with, and propose strategies for
t u rning these challenges into opport u n i t i e s . Market conditions have improved for advisors, with strong stock perf o rmance in
2004 and an overall re c o v e ry in assets
under management. Our re s e a rch found
that the three-year decline in median assets
managed by RIAs reversed itself in 2003,
m o re than making up for losses since 1999
and outpacing gains in the S&P 500 Index. Advisors themselves are moderately opti- mistic about the market outlook but re m a i n
c o n c e rned about the long-term implications
of a rising federal budget deficit and a fund-
ing shortfall for Social Security. Asked to
f o recast the U.S. equities markets over the
next three years, half (50%) of the advisors
polled expected a long-term secular bull
market with cyclical rallies and dips, while a
smaller group (6%) predicted a genuine bull
market. About a third (31%) forecast a
d i rectionless market, while one in eight fore-
saw a secular bear market. Yet while survey respondents felt posi- tive overall about the markets, they were
w o rried about a number of economic
issues. The budget deficit topped the list of
their concerns, followed by Social Security
and energy prices. Current hot topics like
the trade deficit and the dollar’s decline
were cited as reasons for caution among
about one in 10 advisors. Meanwhile, our survey re s p o n d e n t s ’ clients have dramatically moderated their
expectations for re t u rns after several years
of volatile markets. Six in 10 advisors
(62%) say that their clients have re a l i s t i c
expectations for market perf o rmance, while
only a third (33%) believe that investor
expectations are unrealistically high ( s e e
c h a rt 1 on following page). This adjustment in client expectations has contributed to a growing perception
among investors that they will not have
sufficient assets to last through retirement.
For example, in one section of the survey,
advisors reported that among their clients
who had reduced their life-
time giving programs, 58%
did so because they feare d
outliving their assets. One way to profit fro m these two trends—lower per-
f o rmance expectations and
c o n c e rns about long-term
financial security—is to move
the discussion toward higher-
yielding alternative invest-
ments. Our survey shows that a plurality
of advisors (43%) are spending more time
educating clients about alternative assets,
slightly ahead of the percentage (42%) that
is spending the same amount of time on
this topic. Paying for Compliance The emphasis on compliance in the financial services industry hit RIAs hard
last year as legal and compliance-related
expenses jumped nearly 153%, according
to the Rydex AdvisorBenchmarking Study. New compliance re q u i rements have changed the way many advisors do business,
piling on additional legal, accounting, and
insurance burdens. Our survey showed that
nearly two-thirds of the RIAs polled (62%)
had already developed a written superv i s o ry
p ro c e d u re, while more than half (55%) had
h i red a chief compliance off i c e r. More than a
t h i rd had developed a business continuity
plan. A smaller, but still significant, perc e n t-
age of advisors were taking additional,
potentially costly steps, including incre a s i n g
client communications, hiring a lawyer, or
augmenting their liability insurance coverage
(see chart 2 on following page). Leading-edge advisors are working to meet new compliance requirements, but at
a cost. Half the advisors surveyed said that
developing a written supervisory policy
had raised their costs of doing business.
Other compliance factors cited as adding
to the cost burden were increases in legal
fees and insurance premiums, the develop-
ment of educational materials, and the
need to hire additional employees (see
chart 3 on page 107). The dramatic rise in compliance expenses along with increases in staff
compensation resulted in a drop in pro f i t
m a rgins for RIAs for the fifth consecutive y e a r, despite a 13% increase in
net profits. Advisors did
reduce the money they spent
on advertising and marketing
by more than two-thirds and
focused on growing their busi-
nesses through their curre n t
client base. Focusing on their
existing books of business
paid off for advisors in 2003
as they saw revenues and AUM reach or exceed five-year highs,
increasing 15.4% and 22.5%, respectively. Yet despite the increased cost and administrative burdens, few advisors are
ready to sell their businesses. Nearly three-
quarters strongly objected to the idea that
an increase in expenses would force them
to exit the advisory business, while only
about 5% agreed somewhat or strongly
that higher costs might cause them to sell. A Graying Client Base One broad trend that is affecting the RIA marketplace is the graying of its client
base, particularly as 77 million members of
the baby boom generation reach and
exceed retirement age. This trend is still gathering steam Our s u rvey found that the largest group of
investment advisors (37%) re p o rted that
re t i rees make up between 20% and 39% of
their total client base. For many firms, how-
e v e r, the pro p o rtion is much higher. Slightly
over one in five investment advisory firm s
(21%) said that re t i rees make up 60% to
80% of their overall client base, while an
additional 27% say that re t i rees account for
40% to 59% of the total. Investment advi- M aya Iva n ova sors are telling us that re t i rees are alre a d y
an important client base and—given the
overall aging of the population, longer life-
spans, and greater affluence among the
elderly—will most likely become even more
dominant in the years to come. Forw a rd -
looking firms are looking for ways to meet
this market segment’s unique needs. Health savings accounts (HSAs) repre- sent one potential area of growth. These
are relatively new tax-sheltered savings
accounts, signed into law by President
Bush in December 2003, whose assets can
be used only for medical expenses. They
a re paired with high-deductible health
insurance policies so that routine health-
care costs are paid out of the HSA, while
larger expenses are covered by insurance. HSAs address one of re t i ree clients’ main concerns, i.e, how to prevent medical
expenses from eroding their long-term
financial security. In fact, our study
showed that more than 87% of retiree
clients were either somewhat or very con-
c e rned about the impact of healthcare
costs on their re t i rement savings or
income. This is a very real issue for many
individuals, as higher costs and regulatory
changes push many employers to eliminate
retiree health coverage or force retirees to
pick up a larger percentage of its cost. A
study by employee benefits consultant
Hewitt Associates released in June 2004
found that retirees whose medical costs
w e re not subsidized by their form e r
employers may spend up to 20% of their
preretirement income on healthcare costs. Still, despite the fact that retired clients are worried about the effect of healthcare
costs, most investment advisors have yet to
focus on HSAs as a potential solution. Our
survey showed that less than one-third of
investment advisor firms re p o rted dis-
cussing HSAs at all, and less than two per-
cent considered healthcare expenses an
important topic of discussion. Advisors
who did not discuss HSAs with clients said
they felt that these vehicles were not right
for most of their clients (42%) or that
HSAs were too new (11%). The fact that very few firms are selling HSAs will make these vehicles all the more
effective as a business-building tool for
those who develop expertise in this area. With the emergence of older individuals as an even more important client base,
investment advisors have other opportuni-
ties, particularly in the areas of estate and retirement planning. Our survey showed
that just 14% of RIAs focused to a large
d e g ree on estate planning, indicating
another market opportunity. Lifetime giving programs are one key ele- ment in many estate plans, since they allow
a ffluent individuals to transfer, estate- and
gift-tax free, up to $11,000 per year per
b e n e f i c i a ry (married couples can transfer
$11,000 each). Over long periods, lifetime
gifting can substantially reduce the taxable
estate while providing psychological bene-
fits to the donors. Our surv e y, however,
showed that use of gifting programs was
declining slightly, with approximately 20%
of clients reducing their gifts to friends and
relatives; 17% were increasing gifts. This subtle trend has been driven by a number of factors, according to the advi-
sors we surveyed. The most important,
according to 58% of respondents, was
clients’ fear of outliving their wealth, per-
haps due to several years of subpar invest- ment results and concerns about higher
medical costs. Other reasons for reducing
gifts to family included clients’ desire to
personally enjoy the assets they had accu-
mulated (16%), and the attitude that they
were not obliged to transfer wealth to
other generations (12%). Our survey shows, nonetheless, that gifting programs remain an important ele-
ment of estate planning. In fact, nearly
two-thirds of our respondents said that
their clients had made no change in their
charitable giving plans. For those who are
v e ry concerned about outliving their
wealth, investment advisors may wish to
open a dialogue about certain estate plan-
ning trusts that allow clients to continue
enjoying the benefits of their assets during
their lifetimes, while reducing the estate
tax liability for their heirs. R e t i rement planning is another issue that naturally affects an aging client base, and
our survey results here showed another 106 INVESTMENT ADVISOR / April 2005 www.investmentadvisor.com CHART 1: ARE CLIENT MARKET E X P E C TATIONS REALISTIC? PERCENTAGE OF FIRMS 0% 10% 62.14% 33.17% 4.20% 0.46% 20% 30% 40% 50% 60% 70% CHART 2: HOW HAVE YOU RESPONDED TO COMPLIANCE REGS? 60% 50% 70% 40% 30% 20% 10% 0% Yes, market expecta- tions are realistic No, they are unrealistically high No, they are unrealistically low Don’t know their expectations April 2005 / INVESTMENT ADVISOR 107 a rea of opport u n i t y. Investment advisors
re p o rted that re g a rdless of whether a re t i re-
ment rollover was triggered by job change,
l a y o ff, or early re t i rement, only a very
small percentage of clients were re i n v e s t i n g
all or nearly all of their lump-sum distribu-
tions. For example, among job changers,
only 8.5% were rolling 80% or more of
their distributions into tax-deferred invest-
ment vehicles, a figure that dropped to
1.4% of early re t i rees, and less than 0.5%
of laid-off employees. This substantial leak-
age from re t i rement savings may be under-
standable from the perspective of a laid-off
or forcibly re t i red employee, but can have
only the most dire consequences for clients’
l o n g - t e rm financial security. Some investment advisors see a market o p p o rtunity in specializing in financial counseling for employees in transition. RIAs
can build a presence in this market by devel-
oping an expertise in rollover strategies, sev-
erance, budget and income planning, and
tax issues surrounding job change. Getting Closer to Clients In an increasingly competitive market, investment advisors succeed not just by
adding new products or services, but also
through a genuine commitment to under-
standing their clients. Advisors can benefit
from receiving regular feedback from their
clients by asking them a range of questions
to determine clients’ level of satisfaction
with the firm and its products and services.
Asking for comments on the fees charged
by the firm can be educational, too. A client survey or client advisory board can be an effective way to gather such infor-
mation. According to our surv e y, less than
half of the advisors polled (43%) conduct
s u rveys of their clients or have a client
b o a rd. Those who do, however, benefit
g reatly from the information gleaned. For
example, surveying allows advisors to
understand the level of satisfaction clients
have with the advisor and with the firm ’s
range of services, and helps advisors learn
which new products clients might find most
appealing. Most important, an effective sur-
vey helps advisors understand their clients’
needs and motivations (see Chart 4 at left
fpr questions advisors ask their clients). Advisors who use surveys seem t o u n d e r s t a n d t h e i m p o rt a n c e o f
t h i s t o o l . A c c o rding to the latest AdvisorBenchmarking study, the 62% of
advisors who have clients with “reason-
able expectations” use surveys to ask ques-
tions about current services and product
o fferings. Altern a t i v e l y, advisors with
clients who have “high expectations” are
more likely to ask their clients which new
services they would like to see offered. After several years of sluggish re t u rn s and pronounced volatility, market condi-
tions have improved, and RIA firms have
been able to rebuild assets to pre - 2 0 0 0
levels. Most RIAs we surveyed expect this
positive market and economic backdro p
to continue. Still, even if the investment
e n v i ronment remains favorable, signifi-
cant challenges remain in educating and
building ties with clients, managing
expenses, and operating investment advi-
sor businesses in a profitable manner.
Things may be better, but smart advisors will realize that they cannot rest on their
l a u rels if they want to continue their suc-
cess in the future . Maya Ivanova is a re s e a rch analyst
with Rydex AdvisorBenchmarking, and
can be reached at m i v a n o v a @ a d v i s o r-
b e n c h m a r k i n g . c o m . I n f o rmation re p o rt e d
in this article comes f ro m t h e Ry d e x
AdvisorBenchmarking survey of 1,023
RIAs, which was conducted between
M a rch 2003 and June 2004, as well as a
supplemental survey conducted in
November 2004. Rydex PracticeValue is a
f ree practice management pro g r a m
designed to help RIAs better manage and
g row their firms. This survey is part of the
Rydex Practice Value Research Study
Series, which began in 1999. CHART 3: WHY HAVE YOUR COMPLIANCE COSTS INCREASED? 60% 50% 40% 30% 20% 10% 0% CHART 4: WHAT DO YOU ASK CLIENTS IN SURV E Y S ? PERCENTAGE OF FIRMS 0% 5% 27.07% 23.25% 19.43% 8.92% 8.60% 5.73% 5.73% 1.27% 10% 15% 20% 25% 30% Other Market outlook Level of satisfaction with firm's fee structure Products would like to see offered Level of satisfaction with current products offered Services would like to see offered Level of satisfaction with current services offered Level of satisfaction with relationship with advisor/firm