Declining markets present a real risk to an advisors business: they destroy client wealth; they create real client distress; they produce an unending string of emotional client calls; they cause advisor revenues and profits to fall in the best case; and, if not handled properly, they result in client attrition and a permanent decline in advisor revenues and income. For the emerging advisor who is already time constrained, the challenges can be even greater.
Many RIA firms simply collapsed in 2008 and early 2009 due to the deep and prolonged market correction. The firms that survived and thrived during that difficult period were those who employed a more Risk-Managed approach to investing their clients’ assets. By reducing downside volatility, these advisors produced better returns and reduced the emotional distress of their clients. As a consequence, retention rates were higher, asset levels were less impacted and those advisors experienced a smaller decline in revenues and income.
But there is another important advantage to risk-managing assets: it provides a differentiated story for prospective clients. Most of us will agree that it is more challenging to onboard clients when the market is performing well. There is little impetus for clients to make a change when things are going well. Similarly, clients are often “frozen” and reluctant to make big changes when the markets are crashing. There is a place, however, when volatility is high and performance is under pressure when clients explore alternatives. I call this the sweet spot for growth. When those times come along and an advisor can demonstrate an ability to more effectively manage risk, then he will attract prospect interest and convert them to his firm. By contrast, more common passive strategies that take clients along on an emotional roller coaster will appear less attractive and less differentiated.
To illustrate the point, consider a typical emerging independent advisor who manages $30 million. Assuming an average price of 0.90%, that advisor should generate annual revenues of $270,000 and profits of $160,000 assuming a lean expense structure. A quick review of the 2008/2009 investment cycle in which the typical balanced fund fell by 26% in 2008 and recovered 24% in 2009 illustrates the damage that can be done to an advisors business by riding the market with a strategic asset allocation strategy managed in-house.
- Best Case. In the best case, the already time-constrained advisor found additional time in his long day to endure a long string of emotional client calls and managed to retain all of his clients despite achieving average and debilitating performance. Over the two year period, the advisor witnessed AUM nearly recover to $30 million and his income run-rate at the end of 2009 reach $150,000, or 7% below where it began due to the impact of inflation on expenses. Over the two year period while AUM was depressed, the advisor suffered a cumulative loss of income amounting to $40,000.
- Worse Case. In an only modestly worse case, the same advisor endures the same long string of emotional client calls but is less effective and loses two clients in 2008. After two years, AUM has not recovered and his income run-rate at year –end 2009 is only $130,000 or nearly 20% below his original $160,000 income. Moreover, during the two year period while AUM was depressed, he suffered a cumulative loss of income of nearly $60,000.
The only conclusion one can draw is that riding the market through such volatile periods is as painful for the advisor as it is for the client. It’s no wonder that advisors seem to be uniformly making at least modest tactical adjustments to their portfolios in this downturn. After two major market meltdowns with the aforementioned results, advisors are searching for a more risk-managed solution for the benefit of their clients and their own bottom lines. For comparative purposes, let’s now look at the results if the same advisor had chosen to outsource investment management to a risk-managed strategy like the one employed by Pinnacle Advisor Solutions. Pinnacle suffered a substantially lesser loss of 17% net of fees in 2008 and fully recovered that loss in 2009 with less volatility than its 60/40 benchmark.
- Base Case. In the worse case, the advisor must also endure a long day of emotional calls with clients but stress is considerably reduced and his effectiveness considerably improved for three reasons: first, investment returns are less volatile and better than benchmark supporting the value-add of the advisor in the eyes of the client and reducing client stress; second, the investment manager is providing the advisor with thorough and timely communications so he can be more effectively communicate with his clients; and, third, by offloading the investment function, the advisor has freed 20-50% of his time so he is less pressed for time when fielding client calls. As a result, this advisor retained all of his clients. Over the two year period, the advisor saw AUM more than fully recover and as a consequence, his income run-rate at year-end 2009 matched his initial $160,000 per annum income. While AUM was depressed during the two year period, the advisor absorbed a $25,000 cumulative income loss – substantially smaller than the $40,000-60,000 cumulative income loss in the previous example.
- Expected Case. Because the advisor has outsourced the investment management function to an effective risk-managed solution, the advisor has the performance, the support and the time to manage and retain concerned clients. But there is a bigger opportunity here. These unsettling periods are opportune for business development. Following the financial crisis in 2008, many do-it-yourself investors reconsidered and sought professional help. In addition, clients unhappy with the poor performance or poor communication of their advisors during the crisis sought a new advisor. These opportunities fueled growth for adept advisors. If we assume that this advisor added 2 clients in 2008 and 4 clients in 2009 (not a lot), we see that over the two years, AUM climbed 25% and his income run-rate at year-end 2009 had increased 36% from $160,000 to $220,000. And unlike any of the previous examples, the advisor suffered no cumulative losses at all.
Three more great reasons to consider a change in your approach: protect your clients’ bottom line, protect your firm’s bottom line and position your firm for the growth you deserve.
For a more in-depth discussion of this topic, please join us for our webinar on the subject in September. Dates and times will be posted on our website and delivered to our mailing list shortly. You should also feel free to contact Peter McGratty, VP Business Development at email@example.com or (201) 919-4838.