The RIA Tipping Point: Corporate or Independent

Transcription

1 The RIA Tipping Point: Corporate or Independent For more information:

2 TABLE OF CONTENTS IMPACT POINTS... 4 INTRODUCTION... 6 METHODOLOGY... 6 COMPARING CORPORATE AND INDEPENDENT RIA SEGMENTS... 7 PRACTICE OVERVIEW... 7 PRACTICE COMPOSITION REASONS FOR CHOOSING AN RIA SETUP ECONOMIC PROPOSITION COMPLIANCE RESPONSIBILITY CHOOSING THE RIGHT RIA SETUP THE CORPORATE RIA SETUP FOR MAXIMIZING THE PRACTICE'S ECONOMIC PROPOSITION FOR OPTIMIZING TECHNOLOGY SUPPORT FOR MINIMIZING THE OPERATIONS BURDEN FOR MINIMIZING RISKS DUE TO REGULATIONS THE INDEPENDENT RIA SETUP FOR MAINTAINING FULL INDEPENDENCE AS A FINANCIAL ADVISOR EITHER SETUP FOR MAXIMIZING THE TIME AVAILABLE FOR CLIENT ACQUISITION AND PROSPECTING SUMMARY OF DECISION POINTS CONCLUSION RELATED RESEARCH NFP ADVISOR SERVICES GROUP WHITE PAPERS AITE GROUP RESEARCH ABOUT AITE GROUP LIST OF FIGURES FIGURE 1: DOMINANT REVENUE TYPE BY RIA SEGMENT... 7 FIGURE 2: PRACTICE OWNERSHIP... 8 FIGURE 3: BOOK SIZE... 9 FIGURE 4: PRODUCTION/REVENUE FIGURE 5: NUMBER OF PRACTICE MEMBERS FIGURE 6: ADVISOR S PREFERRED SETUP

3 FIGURE 7: REVENUE RETAINED BY FINANCIAL ADVISOR FIGURE 8: FINANCIAL ADVISOR ANNUAL INCOME AT SMALL PRACTICES FIGURE 9: ANNUAL INCOME OF FINANCIAL ADVISORS AT LARGE PRACTICES FIGURE 10: COMPLIANCE RESPONSIBILITY FIGURE 11: NUMBER OF COMPLIANCE SUPERVISORS AT PRACTICE FIGURE 12: TIME SPENT ON COMPLIANCE-RELATED TASKS FIGURE 13: CONFIDENCE LEVELS WITH CURRENT COMPLIANCE EFFORT AND DESIRED IMPROVEMENT FIGURE 14: RECENT REGULATORY AUDITS FIGURE 15: DESIRED COMPLIANCE SETUP FIGURE 16: IAR SETUP PERCEPTIONS FIGURE 17: INDEPENDENT RIA SETUP PERCEPTIONS LIST OF TABLES TABLE A: PRACTICE CHARACTERISTICS BY BOOK SIZE TABLE B: DECISION POINTS OVERVIEW

4 IMPACT POINTS Among corporate registered investment advisers (RIAs), hybrid advisors (those primarily compensated through a mix of commissions and fees) outnumber fee-only advisors by a 3:1 ratio. Among independent RIAs, nearly 60 percent are fee-only advisors. While independent RIA practices tend to have larger books of business (measured by client assets) and higher revenue production than corporate RIA practices, financial advisors leveraging corporate RIA platforms have higher personal annual incomes. Across all independent and corporate RIAs, approximately half of all practices generate less than $300,000 in revenue. Independence as a financial advisor is an "extremely important" or "very important reason for around 60 percent of financial advisors when choosing an RIA setup. Advisors are looking to maintain control over decisions affecting their practice, have more freedom with regard to their operating model and product mix, and be able to run their own business. Maintaining FINRA licenses and the ability to manage compliance risks are the top two reasons advisors leverage a corporate RIA structure. Keeping operational control within the practice is the next most important factor influencing advisors to choose the independent RIA model, second to maintaining independence. In terms of economic proposition, $100 million in client assets appears to be the mark at which lack of scale for an independent RIA has a negative impact on income. Below this asset mark, corporate and independent RIAs provide their equity-owning advisors proportionally a very similar income. However, independent RIAs with a book of business ranging from $100 million to $200 million require, on average, a 27 percent larger practice in terms of client assets to match the income of advisors at corporate RIAs. For RIAs with more than $200 million in client assets, whether economic scale tips positively for the independent RIA depends on its expense structure. A surprisingly high level of confidence exists across the board regarding compliance responsibility at corporate and independent RIA practices, and the desired compliance setup is remarkably similar within each practice type. All advisors would prefer to increase their time allocated to compliance-related tasks by percent to ensure full compliance. -affiliated advisors see maintaining advisor independence as the only area in which the independent RIA model is better positioned than the corporate 4

5 RIA model to achieve goals germane to their practice operations. On all other aspects, they indicate that corporate RIAs are better positioned. Advisors affiliated with independent RIAs see maintaining advisor independence as their top advantage, followed by being a better economic proposition and maximizing time with clients. On the other hand, independent RIA-affiliated advisors see the corporate RIA model as more suited for minimizing compliance risk as well as for optimizing the technology and operational aspects of their business. Among corporate and independent RIA-affiliated advisors, there is ambiguity regarding what "independence" means and how it impacts practices. Both corporate and independent RIA structures are viable for advisors, but all business considerations, including expenses, business structure, personal preference, appetite for risk and revenue opportunity, should be carefully weighed to determine the RIA tipping point for each individual advisor. 5

6 INTRODUCTION One of the major challenges for RIAs in the United States is to find the best setup to operate the advisory business that they would like to create and run. A key decision in this context is choosing between starting or joining an independent RIA firm or leveraging the corporate RIA of a broker/dealer. Many financial advisors lack a clear view of the benefits and disadvantages of each model. Published by NFP Advisor Services Group and produced by Aite Group, this white paper provides insight into the independent RIA and corporate RIA models, describes the advisors who choose each of these setups, as well as their motivations to choose one over the other, and reveals their feedback on their choice. The goal is to provide financial advisors with a better understanding of which setup might be better for their advisory business. METHODOLOGY The analysis in this report leverages an online January 2013 Aite Group survey of 221 financial advisors. The data from practice owners has a six-point margin of error at the 95 percent confidence level. The case studies are based on detailed interviews with financial advisors operating within a corporate RIA or independent RIA structure. 6

7 COMPARING CORPORATE AND INDEPENDENT RIA SEGMENTS PRACTICE OVERVIEW Investment advisor representatives (IARs) affiliated with a corporate RIA overwhelmingly indicate that a mix of fees and commissions (referred to as "hybrid" throughout this paper) constitutes their primary form of compensation. Seventy-five percent of those advisors rely on fees and commissions as opposed to 25 percent who earn their compensation primarily through fees only. Conversely, a majority of advisors affiliated with an independent RIA are primarily compensated through fees only, with roughly 60 percent of advisors indicating fees are their primary form of compensation (Figure 1). Figure 1: Dominant Revenue Type by RIA Segment Q. What is your compensation primarily based on? (N=221) 75% 59% 41% 25% (IAR) (n=146) (n=75) Fees from assets under management and/or advice services Fees and commissions For purposes of comparison throughout this paper, advisor respondents are segmented into two main categories: those affiliated with a corporate RIA and those affiliated with an independent RIA. Within each category, respondents were further segmented into two subcategories by their primary form of compensation (fee-only and a mix of fees and commissions). Figure 2 summarizes the roles played by advisors in the aforementioned segments. Within each segment, a majority of advisor respondents indicate that they have significant or complete ownership of the practice. 7

8 Figure 2: Practice Ownership Q. What is your role in your practice? (N=203) 74% 67% 58% 71% 26% 33% 42% 29% (fees and commissions) (n=103) (fee only) (n=33) (fees and commissions) (n=26) Financial advisor owning all or part of the practice Financial advisor without significant ownership of practice (fee only) (n=41) A comparison of the distribution of client assets by practice size reveals that within corporate RIAs and independent RIAs, fee-only practices have a larger average practice size than hybrid practices within the same segment, respectively. Forty-four percent of fee-only corporate and independent RIA practices have at least $100 million in client assets (Figure 3), with the mean book size of independent RIAs being a third higher than the mean book size of corporate RIA practices. 8

9 Figure 3: Book Size Q. What is the approximate amount of client assets within your practice (i.e., the book of business)? (N=206) Mean (in millions) (fees and commissions) (n=103) 30% 32% 27% 9% $167 (fee only) (n=34) 24% 32% 35% 6% $335 (fees and commissions) (n=26) 38% 35% 19% $279 (fee only) (n=43) 40% 16% 26% 14% 5% $448 < $30 million $30 million to $99 million $100 million to $299 million $300 million to $1 billion > $1 billion The mean revenue production across the four segments is similar to the distribution of client assets by practice size in that within corporate and independent RIAs respectively, fee-only practices generate more revenue on average than do practices that rely on a mix of fees and commissions as their primary form of compensation. In all segments, percent of practices generate less than $300,000 in revenue (Figure 4). 9

10 Figure 4: Production/Revenue Q. How much revenue did your practice generate over the last 12 months? (N=206) (fees and commissions) (n=103) (fee only) (n=34) (fees and commissions) (n=26) (fee only) (n=43) 13% 9% 15% 9% 21% 14% 12% 8% 18% 8% 19% 21% 21% 19% 9% 23% 23% 24% 31% 21% 21% 28% 15% Mean (in thousands) $905 $1,249 $669 $1,283 < $100,000 $100,000 to $199,999 $200,000 to $299,999 $300,000 to $499,999 $500,000 to $1 million > $1 million 10

11 PRACTICE COMPOSITION Solo practices as defined in this paper include only one client-facing advisor. Of those, around 30 percent consist of only one person, the advisor, while the remaining solo practices are supported by additional team members (Figure 5). Advisor practices on corporate RIA platforms have an average of 4.9 team members, while independent RIA practices have an average of 5.5 people within their practice. Figure 5: Number of Practice Members Q. How many people, including you, employees and independent contractors, work at your practice? (N=206) Average (n=137) 25% 39% 23% 14% 4.9 (n=69) 29% 28% 25% 19% or 3 4 to 10 > 10 11

12 REASONS FOR CHOOSING AN RIA SETUP Advisors were asked to indicate the importance assigned to various factors that influenced the decision for their current affiliation or setup, whether with a corporate RIA or an independent RIA. Figure 6 displays the factors that are deemed "very important" or "extremely important" by advisors in influencing their decision. For advisors affiliated with a corporate RIA, there is no single reason that stands out with regard to the motivation to align with a corporate RIA; a whole range of reasons equally influenced that decision. However, the ability to maintain brokerage licenses and the ability to manage compliance risks are deemed "extremely important" or "very important" reasons for 60 percent of advisors on corporate RIA platforms. The rationale for advisors affiliated with an independent RIA to choose this setup is much clearer. Maintaining independence as an advisor is the only reason considered "extremely important" or "very important" by a majority of advisors in this category (63 percent). Keeping operations control within the practice is a distant second and is an important reason for choosing the independent RIA route for 40 percent of advisors in this category. It is interesting to note that independence as a financial advisor is an "extremely important" or "very important" reason not only for 63 percent of independent RIAs to choose this setup, but also for 57 percent of advisors on corporate RIA platforms. Clearly, both groups of advisors feel very strongly about being independent. In this context, advisors state that they are looking to maintain control over decisions affecting their practice, have more freedom with regard to their operating model and product mix, and be able to run their own business. The ability to maximize the economic proposition for the practice is another important motivation for both advisor groups when choosing an RIA setup. Fifty-seven percent of corporate RIA-affiliated advisors indicate that the ability to maximize the economic proposition for their practice was either a "very important" or "extremely important" factor in choosing their current setup, compared to 37 percent of independent RIA-affiliated advisors. 12

13 Figure 6: Advisor s Preferred Setup IARs considered the following when deciding on their RIA setup. (N=92) s considered the following when deciding on their RIA setup. (N=69) Ability to maintain security licenses (FINRA) 30% 29% Maintain independence as a financial advisor 33% 30% Ability to manage compliancerelated risks 26% 34% Operations control resides within the practice 20% 20% Maintain independence as a financial advisor 24% 33% Maximize economic proposition for the practice 17% 20% Maximize economic proposition for the practice 21% 36% Ability to maximize efficiency with operations-related tasks 16% 22% Ability to maximize efficiency with operations-related tasks 17% 36% Compliance control resides within the practice 13% 22% Ability to collect commission trails 22% 26% Ability to manage compliancerelated risks 12% 23% Extremely important Very important Extremely important Very important ECONOMIC PROPOSITION As shown in Figure 6, maximizing the economic proposition is an "extremely important" or "very important" aspect for a large share of advisors in their corporate-versus-independent RIA decision-making process. In the broker/dealer world, the payout a financial advisor receives from gross revenue is a key measure of the economic proposition. In an independent model, however, while there might be a payout grid in place (e.g., in the case of an independent broker/dealer), this share of revenue is not necessarily what a financial advisor takes home. Some portion of the costs involved in running the independent practice has to be covered by the advisor directly. A prime example is the platform fee that independent broker/dealer firms frequently charge their financial advisors. Comparing the share of revenue retained by the financial advisor in both corporate and independent RIA practices reveals a wide spread of rates. The majority of advisors in each segment receive more than half of their revenue production in the form of gross income. Advisors at corporate RIAs retain an average of 68 percent of their production compared to an average of 57 percent for advisors with independent RIAs (Figure 7). 13

14 Figure 7: Revenue Retained by Financial Advisor Q. What percentage of gross revenue is retained by the producing advisor? (N=111) Mean (n=58) 5% 33% 19% 26% 17% 68% (n=53) 21% 25% 28% 8% 19% 57% <= 24% 25% to 49% 50% to 69% 70% to 79% 80% to 84% To take a closer look at the actual annual income levels, Aite Group split the advisors in independent and corporate RIA platforms into two groups: small practices with client assets of less than $100 million and larger practices with assets of more than $100 million and less than $1 billion. Table A shows the characteristics of the four resulting groups. 14

15 Table A: Practice Characteristics by Book Size Independent RIA with book size of <$100 million (n=39) with book size of <$100 million (n=64) with book size of > $100 million and < $1 billion (n=22) % of RIA category 64% 78% 36% 22% Corporate RIA with book size of >$100 million and < $1 billion (n=18) Ratio fee-only vs. feeand-commission practices Ratio solo vs. team practices Average practice head count Mean practice size (book of business) % of financial advisor owning all or part of the practice 62% / 38% 22% / 78% 77% / 23% 28% / 72% 72% / 28% 75% / 25% 21% / 79% 44% / 56% $28 million $38 million $324 million $214 million 60% 75% 32% 67% The characteristics of these four groups align with the observation detailed in the early part of this paper. While across all independent RIAs two-thirds to three-fourths are fee-only practices (Figure 1), for larger independent practices it is more than three-fourths. The hybrid model dominates the corporate RIA space, with around three-fourths of practices in this category conducting fee and commission business. As would be expected, three out of four advisors with a book of less than $100 million are solo practices, while the majority of advisors at large practices work in teams. The team-practice approach is particularly dominant at large independent RIAs. Across both size categories, independent RIAs have a higher head count than practices leveraging corporate RIA platforms. While that head count is around one person more in the small-practice category, it is closer to two additional people when comparing large practices. In terms of practice size, independent RIAs are, on average, smaller than their corporate RIA peers on the lower end but 50 percent larger on average when comparing practices with a size of $100 million to $1 billion. To get to the core of the economic proposition for financial advisors, one has to look at their annual income, which takes into account any costs that advisors have to cover themselves. To 15

16 compare apples with apples, Figure 8 compares the income of financial advisors who own all or part of their practice and does not include financial advisors without practice ownership. Among practices with client assets of less than $100 million, the annual income of financial advisors with practice ownership appears to be directly correlated with the practice's size. In other words, on average, corporate RIA practices are 41 percent larger than their independent RIA peers, with the average income of financial advisors being proportional to the practice's size (Figure 8). Comparing the two categories of financial advisors at large practices shows that their average annual incomes are very close to each other at around $270,000 (Figure 9). To earn this income in an independent RIA practice, a 27 percent larger book size is required than is needed at a corporate RIA practice. As was shown in prior research, 1 when independent RIA firms grow beyond $100 million in size, scale frequently becomes an issue. Many practices are run inefficiently, resulting in lower income for the financial advisor(s), and require a change in operating setup. It is not until a firm surpasses $200 million in client assets that the practice realizes economies of scale. Figure 8: Financial Advisor Annual Income at Small Practices Annual Income of s and IARs with a Book Size of < $100 Million (N=77) 41% 41% $152 $108 $27 $38 (n=29) Mean book size (in $ millions) (n=48) Mean annual income (in $ thousands) 1. See NFP white paper authored by Aite Group, RIA Technology Integration: The True Opportunity Cost of Inefficiency. July

17 Figure 9: Annual Income of Financial Advisors at Large Practices Annual Income of s and IARs with a Book Size of > $100 million and <= $1 Billion (N=22) 1% $305 27% $272 $270 $240 (n=10) Mean book size (in $ millions) (n=12) Mean annual income (in $ thousands) COMPLIANCE RESPONSIBILITY Responsibility for compliance requirements is handled quite differently between corporate and independent RIAs. Seventy-six percent of advisors leveraging a corporate RIA setup rely on their broker/dealer to assume compliance responsibility, and another 32 percent indicate that they have a dedicated chief compliance officer (CCO) within their practice (Figure 10). Independent RIAs are less likely than corporate RIAs to rely on their broker/dealer for compliance responsibility; 51 percent of independent RIAs indicate that they have a CCO within their practice. 17

18 Figure 10: Compliance Responsibility Q. Who is responsible for compliance matters as they relate to your practice? (N=161) 76% 32% 41% 51% 10% 6% (n=92) (n=69) Broker/dealer Chief compliance officer (CCO) within the practice Specialist compliance firm Other Under the auspices of the Securities and Exchange Commission s (SEC s) Investment Advisers Act of 1940, RIAs are required to have written policies and procedures in place that reasonably guard against potential violations of securities laws. The policies focus on disclosures and investor protection with regard to portfolio management processes, trading practices and softdollar usage, supervised personnel proprietary trading, safeguarding client assets and privacy information, client asset valuation and reporting, and business continuity planning. Rule 206(4)- 7 also requires all RIAs to designate a CCO tasked with developing, enforcing and maintaining responsibility for their firm's compliance procedures. As shown in Figure 11, the majority of corporate RIA practices do not have a compliance supervisor at their practice. Conversely, approximately one-third of independent RIA practices do not have a compliance supervisor at their practice. The absence of a compliance supervisor at 61 percent of corporate RIA practices is not surprising in light of the standard compliance oversight model in which the role of CCO is situated within the larger corporate RIA, which operates in tandem with the sponsoring brokerage firm. Indeed, 60 percent of advisors in corporate RIAs cite managing compliance-related risks as "very important" or "extremely important" in influencing their decision to operate under a corporate RIA structure (Figure 6). The importance can be attributed to advisors wanting to take advantage of the compliance supervision provided by their sponsoring firm and therefore not needing dedicated personnel within their practice. On the surface, it might seem that the approximately one-third of independent RIA practices lacking a compliance supervisor are in violation of Rule 206(4)-7, which requires independent 18

19 RIAs to designate a CCO. The independent RIAs without a compliance supervisor in-house, however, are hybrid firms that also maintain FINRA brokerage registrations. The sample of independent RIAs surveyed indicates that approximately one-third earn their compensation primarily through a mix of fees and commissions, which is indicative of dual registration (Figure 1). In the case of hybrid firms maintaining dual registration, their sponsoring broker/dealer firm is tasked with providing compliance supervision over both brokerage and advisory activities, regardless of whether advisors own their own independent RIA or are affiliated with their sponsoring firm's corporate RIA. The supervision of advisory activities falls within the broker/dealer's responsibility to maintain oversight over outside activities. The degree of supervision may vary, as hybrid independent RIAs can choose to have their broker/dealer assume full compliance responsibility or they can elect to have their own CCO in-house. In essence, hybrid independent RIAs are only obligated to have a CCO in-house if they elect (and if the broker/dealer permits them) not to have their associated broker/dealer assume full compliance responsibility. From a regulatory standpoint, the hybrid independent RIA will still be supervised by its associated broker/dealer even if it has a CCO at the practice as SEC and FINRA rules mandate. Figure 11: Number of Compliance Supervisors at Practice Number of Compliance Supervisors (N=98) Average (n=54) 61% 26% 13% 0.65 (n=44) 32% 50% 18% 1.05 None/0 1 2 or more On average, hybrid RIA practice members spend more time on compliance-related tasks than do their peers with fee-only practices at corporate and independent RIAs (Figure 12). Also, while corporate RIA practices benefit from a greater reliance on their broker/dealers for compliance responsibility, hybrid and fee-only corporate RIA practice members spend slightly more time on 19

20 compliance issues than do team members with hybrid and fee-only independent RIA practices, respectively. Keeping up with regulatory changes consumes percent of practice members' time dedicated to compliance-related tasks. Figure 12: Time Spent on Compliance-related Tasks Please allocate the days your practice spends on compliance-related tasks across the following activities. (N=161) Mean (in days per quarter) (fees and commissions) (n=71) 26% 26% 11% 10% 21% 7% 5.6 (fee only) (n=21) 37% 28% 10% 10% 11% 4.2 (fees and commissions) (n=25) 13% 36% 17% 13% 16% 5.0 (fee only) (n=44) 24% 23% 9% 23% 19% 3.5 Annual risk reviews Regulatory audits Keeping up with regulatory changes Ongoing compliance supervision Compiling regulatory filings Other Despite compliance issues in the wealth management industry being characterized as a moving target due to ever-changing proposed and new regulations, advisors in all segments rate their confidence in their practice being fully compliant at between 77 and 90 percent. Hybrid corporate RIAs show the highest level of confidence, while hybrid independent RIAs show the lowest relative level of confidence (it is still fairly high, at 77 percent; Figure 13). Advisors in all segments indicate that their practice would be fully compliant by increasing aggregate team member time allocated to compliance by percent. The overall high confidence levels may be attributable to the relatively low number of practices that have been audited within the past two years (Figure 14). 20

21 Figure 13: Confidence Levels with Current Compliance Effort and Desired Improvement 90% 81% Confidence with Compliance (N=161) 77% 88% 11% 15% 15% 14% (fees and commissions) (n=71) (fee only) (n=21) (fees and commissions) (n=25) (fee only) (n=44) Q. How confident are you that your practice is fully compliant with all rules and regulations that apply to your advisory business? Q. How much more time would your practice need to spend on compliance-related tasks in order to be fully compliant? Figure 14: Recent Regulatory Audits Q. Has your practice been audited by a regulator within the last 24 months? (N=161) 71% 65% 29% 35% (n=92) (n=69) No Yes In terms of assigning responsibility for compliance at their practice, most advisors indicate that they would prefer to maintain their current setup than to change it. The majority of corporate RIA-affiliated advisors prefer that their broker/dealer maintains compliance responsibility, in 21

22 which the risk management is shared and due diligence requirements are supported. Around 50 percent of independent RIAs indicate that this responsibility should sit within their practice in the form of a CCO (Figure 15). Regardless of preference, a hybrid firm s sponsoring broker/dealer is required to maintain compliance supervision over both the practice's brokerage business and its advisory business. The degree of compliance supervision provided to a hybrid independent RIA by its sponsoring brokerage firm depends on the agreement between the two parties: either the broker/dealer is tasked with (or requires) full compliance supervision over the RIA business or the RIA has its own CCO in-house. Hybrid RIAs choosing to hand off full compliance responsibility to their broker/dealer may face more limited access to products and higher administrative costs, which is more similar to the corporate RIA model than to the independent RIA model. This choice could impinge on the perceived independence or control requirements of independent RIAs. Of note is the seemingly greater interest by independent RIAs in utilizing a specialist compliance firm. While only 10 percent of independent RIA practices use a specialist compliance firm (Figure 10), interest in outsourcing responsibility for compliance tasks is close to 20 percent. Figure 15: Desired Compliance Setup Q. Ideally, who should be responsible for compliance matters as they relate to your practice? (N=161) 64% 52% 29% 28% 19% (n=92) (n=69) Broker/dealer Chief compliance office (CCO) within the practice Specialist compliance firm Other 22

23 CHOOSING THE RIGHT RIA SETUP For financial advisors, choosing the right RIA setup is a tricky undertaking, especially as advisors frequently do not have the benefit of experiencing both setups firsthand. Figure 16 and Figure 17 contrast the views of independent RIAs and IARs leveraging corporate RIAs. Figure 16: IAR Setup Perceptions IARs prefer a corporate RIA for achieving the following goals. (N=92) IARs prefer an independent RIA for achieving the following goals. (N=92) Minimize risks due to regulations 46% 17% Maintain independence 41% 24% Optimize technology support 38% 23% Minimize operations burden 36% 25% Maximize the time available for clients 25% 17% Maximize economic proposition 27% 14% much better positioned to achieve goal somewhat better positioned to achieve goal much better positioned to achieve goal somewhat better positioned to achieve goal 23

24 Figure 17: Setup Perceptions s prefer their current setup for achieving the following goals. (n=69) s prefer a corporate RIA for achieving the following goals. (n=69) Maintain independence 41% 25% Minimize risks due to regulations 23% 20% Maximize economic proposition 20% 23% Optimize technology support 22% 19% Maximize the time available for clients 17% 20% Minimize operations burden 16% 25% much better positioned to achieve goal somewhat better positioned to achieve goal much better positioned to achieve goal somewhat better positioned to achieve goal Of the six areas evaluated, four clearly point to one setup or the other, while the two groups of advisors have conflicting views on the two remaining ones. The following section provides an overview of these considerations. THE CORPORATE RIA SETUP FOR MAXIMIZING THE PRACTICE'S ECONOMIC PROPOSITION The most obvious goal for a practice maximizing the practice's economic proposition involves the direct earning power of advisors. Less obvious is the desire to build up the value of a practice so that it may be sold at a later date. Fortunately, the two are closely related. From a pure valuation perspective based on metrics such as production, expenses, normalized earnings, growth rate, revenue mix and client profiles, RIA practices are valued similarly in corporate and 24

25 independent structures. 2 s have a leg up, though, with regard to the ease of selling a practice to another firm or RIA rollup firm. Advisors in both the corporate RIA and independent RIA segments feel that their current affiliation best enables them to maximize the economic proposition for their practice. From a pure income perspective, income for practices with assets of less than $100 million is, for both categories of RIAs, proportional to their book size. s with assets of more than $100 million fall behind their similarly sized corporate RIA peers and have to be around a quarter larger to keep up. Clearly, scale can be a major issue for independent RIA practices once they surpass $100 million in client assets, as these practices are often reluctant to change their technology and operating infrastructure. It is expected that independent RIA firms that are willing to adjust their infrastructure will be able to achieve improved profitability through scale given an appropriate expense structure. Typically, independent RIA firms with more than $200 million in client assets have been successful with making this transition. FOR OPTIMIZING TECHNOLOGY SUPPORT Technology is critical to every part of an advisor's business and runs the gamut in terms of functionality. Similar to reducing operational burdens, both corporate RIA- and independent RIAaffiliated advisors feel that a corporate RIA setup is more conducive to optimizing technology. s likely have a perceived advantage because of the centralized nature of technology management, in which advisors are basically users. On the contrary, many independent RIAs are much smaller, and the technology support falls to people within the firm supporting only that firm. The typical independent RIA does not have the budget or technological wherewithal to build the same level of technological sophistication as a larger firm. Advisors who put a premium on technology may find it challenging in the independent channel to dedicate the resources (time, expertise and money) to building a similar technology setup as a larger advisory firm. Bundled solutions will likely be of greater support in maximizing efficiency due to the inherent integration; a la carte, best-of-breed solutions may be more attainable in a piecemeal fashion, but the lack of integration could be a hindrance to small firms seeking greater efficiency through technology provisioning. As independent RIAs often lack the expertise and technology budget to conduct technology integration efforts, leveraging a pre-integrated platform offered by outsourcing providers is the most realistic way for them to obtain a fully integrated technology environment See NFP white paper authored by Aite Group, The Efficient Frontier of Succession: Maximizing Practice Value. May See NFP white paper authored by Aite Group, RIA Technology Integration: The True Opportunity Cost of Inefficiency. July

26 FOR MINIMIZING THE OPERATIONS BURDEN The ability to minimize operational burdens is paramount to operating a profitable practice. Operational efficiency allows advisors to spend more time on value-added tasks like client acquisition and prospecting, and it is the bedrock upon which client experience is built. -affiliated advisors feel that their setup is better equipped to minimize operational burdens, as do advisors in the independent RIA channel. This stance likely is the result of the difference in business models: corporate RIA-affiliated advisors leverage their firm's operations infrastructure, whereas an independent RIA performs operations in-house. While on the surface the corporate RIA setup seems preferable with regard to minimizing operational burdens, advisors also need to consider outsourcing some or all operations tasks. Outsourcing operations allows independent RIAs to maintain their autonomy while reducing operations headaches. Examples of operational outsourcing include utilizing third-party vendors for data reconciliation, fee billing and performance reporting. Many firms are also outsourcing related technology that supports operational functions, such as portfolio accounting, as opposed to installing these systems on site. FOR MINIMIZING RISKS DUE TO REGULATIONS Compliance is always top of mind in the financial services industry, and firms seek to minimize regulatory risk to keep their business running smoothly and to maintain their reputation. Corporate and independent advisors both indicate that the corporate RIA structure is preferred in terms of minimizing regulatory risk. s are much more reliant on their affiliated broker/dealer for compliance responsibility than are independent RIAs. s rely more heavily on in-house compliance supervisors. -affiliated advisors who are also registered representatives of a broker/dealer (hybrid firms) may have their affiliated broker/dealer assume full compliance responsibility or may choose to maintain compliance responsibility for their advisory business by having their own CCO. Hybrid independent RIAs that maintain a CCO inhouse are falling under increased scrutiny from regulators in regard to the potential conflict of interest involved with having their broker/dealer take compliance responsibility for brokerage business while the advisor maintains control or owns their own advisory firm. Advisors seeking to start an independent RIA while maintaining brokerage affiliation through dual registration will need to decide whether they want to rely on their affiliated broker/dealer for compliance responsibility over their advisory business or choose to have their own CCO handle these functions. Those choosing the latter will likely fall under increased scrutiny during audits as well as feel more pressure from their sponsoring broker/dealer to hand over full compliance responsibility to them to appease regulators. THE INDEPENDENT RIA SETUP 26

27 FOR MAINTAINING FULL INDEPENDENCE AS A FINANCIAL ADVISOR The holy grail for financial advisors is to provide the best possible financial solution to each client on a fully independent basis, without letting advisor compensation influence product choice. Running one's own advisory firm and being compensated through fees based on assets under management, which are negotiated with the client, is the closest the wealth management industry has to offer when it comes to independence. Clearly, being tied to a broker/dealer can influence the independence of a financial advisor if the firm's compensation grid makes certain products more attractive than others. Advisors in both corporate RIAs and independent RIAs agree that the independent RIA channel is most conducive to maintaining independence (Figure 16 and Figure 17). In fact, independent RIA-affiliated advisors cite the ability to maintain independence as the only area where the independent RIA model is more advantageous. Ultimately, independence is a subjective measure, the importance of which can only be evaluated on an individual basis. Independence is often described as having control over business decisions and having more freedom in the choice of operating model. The proposed fiduciary standard for U.S. broker/dealers, if implemented, may result in a leveling of the playing field between advisors in corporate RIAs and independent RIAs, as it may make advisors at corporate RIAs feel like they have more independence. EITHER SETUP FOR MAXIMIZING THE TIME AVAILABLE FOR CLIENT ACQUISITION AND PROSPECTING Face time with clients and prospects is important for advisors and is key to maintaining existing clients while bringing on new ones. Any other use of advisor time, including operations and client management, takes away potential time spent with clients. -affiliated advisors believe that their setup is preferable to maximize time with clients and prospects. Advisors with independent RIAs feel that their setup is more suited to maximizing time with clients. There is no inherent advantage to affiliating with a corporate RIA or independent RIA with regard to maximizing time spent with clients and prospects. A host of variables needs to be considered on an individual-firm basis to help advisors gauge how much time they could potentially dedicate to client acquisition and prospecting. On the surface, the corporate RIA setup would seemingly favor advisors spending more time with clients, as they do not need to run business operations as does a proprietor of an independent RIA. But likewise, the primary advisor with an independent RIA can shift operational and compliance tasks to other personnel more easily than corporate RIA-affiliated advisors. 27

28 Time spent on client acquisition and prospecting must be considered in light of the resources available to carry out other business functions. Advisors operating a solo practice (one clientfacing advisor) in a hybrid model spend similar amounts of time on client prospecting and acquisition in both a corporate RIA and independent RIA setup, as each has the benefit of its broker/dealer's infrastructure to support client management and operations tasks. Fee-only independent RIA-affiliated advisors spend less time on client acquisition on average than do feeonly corporate RIA-affiliated advisors, as they are tasked with maintaining their own operations. As team size grows and additional client-facing advisors are added, senior advisors in the independent RIA model spend slightly more time on client acquisition and prospecting than do corporate RIA-affiliated advisors, although the distribution of time spent is not all that different. SUMMARY OF DECISION POINTS Putting all aspects together gives the picture in Table B. Table B: Decision Points Overview Maximize the economic proposition for the practice Optimize technology support Minimize operational burdens Minimize risk due to regulations Maintain independence as a financial advisor Maximizing the time available for client acquisition and prospecting Independent RIA with book size of <$100 million with book size of <$100 million Independent RIA with book size of >$100 million and <$1 billion with book size of >$100 million and <$1 billion = = = = = = Source: Aite Group Analysis Table legend entries are defined as follows: (-) disadvantage; (=) no advantage or disadvantage; (+) advantage; (++) strong advantage. 28

29 CONCLUSION -affiliated advisors believe that the advantages of their business model primarily rest on maintaining independence and, to a lesser extent, on maximizing their economic opportunities. While a large share of independent RIA practices are small, they generate proportionally the same annual income for their advisor owners as do corporate RIA practices. This changes for practices that surpass the $100 million asset mark. The inability to embrace change and to upgrade their technology and operations setup requires independent practices to have, on average, 27 percent more assets to match the income of financial advisors at corporate RIA practices. With economic opportunities not maximized in the independent RIA model for high producers, except for the very largest practices with client assets of several hundred million dollars, the explicit cost of maintaining full independence seems to manifest itself in reduced take-home pay. Only once an independent RIA practice has greater than $200 million in client assets does it gain a significant edge over corporate RIA practices. Few independent RIA firms reach this size, however. -affiliated advisors agree that the independent RIA model is most conducive to maintaining complete independence; however, they believe the corporate RIA structure is more conducive to minimizing operational burdens and regulatory risk while offering more optimized technology. Especially when starting out, advisors leveraging a corporate RIA platform find better support for growing their practice without sacrificing advisor income. Once corporate RIA practices surpass $100 million in client assets, these practices have an income lead over similarly sized independent RIA practices. Only independent RIAs that manage to grow their practices beyond the $200 million mark surpass their corporate RIA peers when it comes to maximizing the economic proposition for the financial advisor. 29

30 RELATED RESEARCH NFP ADVISOR SERVICES GROUP WHITE PAPERS RIA Technology Integration: The True Opportunity Cost of Inefficiency, July To request a copy, visit The Efficient Frontier of Succession: Maximizing Practice Value, May To request a copy, visit The Missed Opportunity: Guaranteed Income as an Asset Class, August To request a copy, visit Multidiscipline Practices: The Business Model of the Future Today, October To request a copy, visit AITE GROUP RESEARCH Top 10 Trends in Wealth Management, 2012, January Financial Advisors' Use of Social Media 2011: The Bloom Is Off the Rose, December U.S. Retirement Income: The Shift from Accumulation to Decumulation, November Managing Wealth: Advisor Perspectives on Investment Products and Fee Business, November Efficiency in Wealth Management: Mobile at the Gates, October Wealth Management on the Move: The Moment of Truth, June CRM for Wealth Management: Approaching Total Practice Management, April

31 ABOUT AITE GROUP Aite Group is an independent research and advisory firm focused on business, technology, and regulatory issues and their impact on the financial services industry. With expertise in banking, payments, securities & investments, and insurance, Aite Group's analysts deliver comprehensive, actionable advice to key market participants in financial services. Headquartered in Boston with a presence in Chicago, New York, San Francisco, London, and Milan, Aite Group works with its clients as a partner, advisor, and catalyst, challenging their basic assumptions and ensuring they remain at the forefront of industry trends. 31

32 98541 (04/13) ASG Copyright 2013 NFP. All rights reserved.