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Is Your Wealth Management Business Ready for Stormy Seas

Mike Langford
Jan 28, 2019

This article is the second in a series of “Get Ready to Pounce” themed posts by Truelytics. The goal for this series is to help wealth management firms, broker-dealers, and individual advisors prepare to take advantage of market changes that are likely to occur in 2019 and 2020.

One of the commonly overlooked benefits that a wealth management firm or individual advisor provides to a client is the ability to limit losses during volatile markets. As the oft cited Dalbar “Quantitative Analysis of Investor Behavior” study reveals, self-directed investors underperform the markets and professional wealth managers because they tend to make emotionally driven mistakes. The steady hand of a dispassionate financial advisor at the wheel of a client’s portfolio can help them avoid unnecessarily large or poorly timed losses.

We like to think of Truelytics as the steady hand at the wheel for your wealth management business or individual advisory practice. In the same way that you use financial planning tools and sound portfolio management platforms to help your clients achieve their goals while avoiding costly pitfalls along the way, Truelytics removes emotion from the process and provides you with objective business intelligence to help you maximize your valuation while minimizing risks.

What are the Biggest Risks Facing Wealth Management Firms During Times of Market Turbulence?

As I outlined in the first post in the “Get Ready to Pounce” series, it seems pretty likely that we are going to have a period of increased volatility in the near future. Many economists are predicting a recession in the next few years and we have already seen the markets pull back in 2018. Add in the rapid pace of new fintech innovations posing disruptive threats to the wealth management industry and you have a recipe for some serious risk to your business.

So where should you focus your attention now? It seems like there could be a million and one things to worry about. That’s where Truelytics comes in.

Once you have your business details loaded into Truelytics your eValuation report will highlight the areas that pose the greatest risks to your business while also highlighting your firm’s strengths. Most important, these risks and strengths are evaluated in comparison to your peers.  

As we think about getting you ready to pounce on the opportunities that are likely to present themselves in the next couple of years I thought it would be a good idea explore a few risks that you may need to shore up for the potential stormy seas on the horizon..

BONUS: These risks will also affect your competitors and acquisition targets. Keep them in mind as you evaluate your strategic moves in the next few years.

Client Concentration Risk

It’s funny how the old 80/20 rule seems to apply to so many things in life. For many wealth management shops and advisors it is not uncommon for 80% of their revenue to be driven by 20% of their clients. This makes sense if you think about how advisors grow their businesses over time.

In the first five years or so of an advisor’s career he or she is taking on any client they can to survive or they are handed a small book of business of lower-value clients from a senior advisor. As the years go on and the advisor matures, he or she learns how to win bigger client relationships and a few of the early ones grow substantially. But… as Grant Hicks mentioned in episode 9 of the Valuations podcast advisors often hit a wall where they no longer have the capacity to serve more clients. So, their client mix becomes relatively fixed and top heavy.

This can be true of larger firms as well. Elite RIA firms managing $750 million or more in client assets are still prone to a few ultra high net worth clients at he top and even independent broker-dealers can find themselves relying too heavily on a few top producers.

Truelytics tracks a couple of indicators that are helpful to evaluate your client concentration risk:

  1. % of AUM in Top 5 Relationships - An “A” grade indicates that you have little to worry about and a “C” grade would indicate your business is much more concentrated than your peers. If you manage 100 clients your ideal concentration in your top 5 relationships would be 5%. If it were 20% you might be in a very precarious position if one of these clients leaves.

  2. % of AUM with Next Generation Relationship - Having relationships with the heirs of your older clients is one of the best ways to ensure that assets aren’t lost when there is a major life event such as death or elder incapacitation. These relationships also create a bond that tends to make clients more sticky because your firm is the family’s chosen firm. However, if there is one family member that is voicing concern about performance or service you could be at risk of losing multiple clients at once, not just the cranky one.

It’s important to remember, clients typically change firms in times of stress. If the markets are causing performance to suffer and they aren’t feeling the love from you and your team they might be willing to listen to a pitch from another advisor. This is true for your competitors as well.

Get Ready to Pounce: When the market is down, you can get a lot more meetings with prospects that are with other wealth management firms.

Team Stability Risk

Like clients, employees and senior team members tend to get a little restless during times of heightened uncertainty. Down markets often lead to smaller bonus checks and limit a firm’s ability give employees raises. At the same time the job can seem like more of a grind during periods of increased volatility because employees are dealing with clients who are also restless.

Looking at the Business Stability Scorecard in your eValuation report you will notice a few indicators of the strength of your team.

  1. Has A Current Succession Plan - Having a succession plan in place is not just some abstract “here’s what happens 20 years from now” or “in case of emergency this happens” type of document. A succession plan provides leadership, employees, and clients with a sense of long-term calm. Sure, the markets may be down or the ride is a little bumpy at the moment but you have a plan as a team that goes well beyond the current environment. Without a succession plan in place, your senior team and other employees a right to wonder about their future. And some, will explore their options.

  2. Has a Stock Ownership Plan - There is a big difference between being a well-compensated employee and having an ownership stake in the firm. Owners can take a long-term view of the business and have a reason to invest their energy in innovation even when times are tough. Non-owners are only as loyal and innovative as their paycheck affords them to be.

  3. Has Employee Non-Compete Agreements - While not all states enforce non-competes and many people argue they are ineffective, there is merit to having some form of a non-solicit agreement or pre-negotiated separation agreement in place. Think of it as a pre-nup for employees.

    • If your top advisor decides he is going to leave this year what happens to his clients?

    • Will you be compensated for the lost revenue?

    • What about your other clients?

    • Is he able to solicit their business without recourse?

The goal isn’t to put handcuffs on people and try to keep them forever. What you want to avoid is having your best people suddenly becoming flight risks as soon as the seas get a little choppy. With a little preparation you can put some mechanisms in place to keep key folks happy.

There are many other KPIs to explore in your eValuation report but the ones listed above are the ones I recommend exploring if you haven’t already because losing clients or key team members can have a massive impact to your business for years to come. Shoring up these areas will help you ride out the storm and position you well to pounce while other firms are treading water.  

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