Price vs. Value: 4 Models Advisors Should Understand to Manage Profitability
Daniel T. Phillips, CFA®, CFP®
As Chief Investment Officer, Daniel Phillips has served as part of the core team that launched EverSource Wealth Advisors. He advises on the development of EverSource’s middle office services and technology platform with a focus on the investment consulting needs and experience of advisors.
“Price is what you pay. Value is what you get.”
You have probably heard this saying attributed to Warren Buffett. You may have even used it when describing your investment strategy to a client. However, I wonder how many advisors have applied this wisdom to their own practice, for example, when evaluating the price they pay versus value they get from their RIA’s Investment Middle Office. Well, to borrow another adage, “there is no time like the present.” As the U.S. economy plunges into recession, here are four alternatives to consider for your RIA’s Investment Middle Office that can optimize your time, increase your business’ net cash flow, and maybe even lower your clients’ overall costs.
What‘s an ‘RIA Investment Middle Office’ anyway?
Advisors spend most of their time thinking about client facing activity – developing new business, meeting with clients, delivering financial plans, discussing investment strategy. These client-facing and revenue-generating activities are what we call the RIA’s front office.
An RIA’s middle office includes professional investment management as well as the resources and technologies that support the front office functions. An RIA’s back office is largely outsourced to one or several custodians, but also includes a few other important functions for keeping an RIA running – HR, IT, facilities, and compliance.
The middle office will determine how profitable, efficient, and competitive an advisor is. Usually, the greatest expense of any RIA middle office is the investments function. While advisors may not be used to thinking in these terms, every advisor is familiar with the investment middle office functions, including:
Macroeconomic Research
Investment Fund/Strategy Due Diligence
Managing Model Portfolios
Trading & Rebalancing
Invoicing & Billing
Client Statements Management
Investment Operations & Technology
Performance Reporting & Client Portal
Creating Client Facing Resources
These responsibilities are essential to running a high performing RIA, but can leave even an efficient advisor wondering “where did all my time go?” or “how many clients can I effectively serve?” Notably, while each of these functions are “table stakes” for serving an informed client, none personally touches the client directly, even though an advisor may add tremendous value by personally explaining a firm’s value in these areas.
4 Middle Office Strategies
Independent advisors have long recognized this and have structured their investment middle offices through one of four strategies. When evaluating each, Ron Blue has a general piece of advice that applies here, “Any decision you make can never be better than the best-known alternative.” With that sage wisdom in mind, here are 4 typical middle office models.
Try to be Superman or Superwoman!
This advisor does everything – marketing, sales, compliance, financial planning, investments, operations, technology, and on and on. A few highly competent MBA and Chartered Financial Analyst-type advisors can do an excellent job of this without sacrificing quality of investment advice, service, or growth.
The problem is that eventually even these advisors hit a productivity wall and must start adding additional staff. In any service organization, people are the most valuable, expensive and hardest to manage asset. At this point, profitability takes a hit. However, what most advisors don’t recognize early on is that this model is hard to scale. Expenses and additional challenges rise at least as fast as revenue for a long time.
For solo advisors doing everything themselves, the real questions become:
What are your unique abilities?
What is your capacity and how are you (and your team) using your time?
How much is your time worth and does it have a more valuable use?
Do you have a client service contingency plan in place if something happens to you – even for just a couple weeks?
Hire an Investment Specialist
For advisors who lack a strong investment background, hiring a Chartered Financial Analyst can bring a high level of credibility to the team. A different version of this strategy is hiring an Outsourced Chief Investment Officer (OCIO) who is likely also a CFA charterholder. The downsides to this strategy are that both options come with high fixed price tags (ranging anywhere from $50,000 - $300,000), suffer from key man or woman risk, and may still leave you responsible for many of the day-to-day investment middle office functions.
An OCIO model can have real advantages though. These options may be more economical than just hiring an experienced CFA charterholder and may allow for far greater customization and less cost than a traditional Turnkey Asset Management Program (TAMP).
Crucial to analyzing the economics of an OCIO relationship are the following questions:
What responsibilities and resources will be retained vs. outsourced?
Are fees fixed and/or variable?
Are fees paid through the advisor’s P&L or the clients’ assets?
Outsource to a TAMP
For many RIA owners, this is the equivalent of hitting the big red easy button. And, there are significant benefits. The most important of them is significantly lowering the opportunity costs of an advisor’s time necessary to learn and manage all investment middle office functions. Outsourcing also significantly reduces fixed costs and key man or woman risks.
But there are also risks and downsides. In this strategy, the client pays the variable cost of AUM percentage fees charged. As a fiduciary, an advisor has a duty of care to the client. The fiduciary duty does not require an advisor to select the TAMP with the lowest fee structure, but it does require advisors to regularly evaluate whether their TAMP is providing the best value to the client and fees are a significant part of that equation. Many TAMPs still charge very high fees (0.50%+/-) for the services they provide, which are difficult to justify and significantly reduce clients’ returns.
Often, there are significant and sometimes inadequately disclosed conflicts of interest, including funneling client assets toward proprietary strategies with high fees or benefitting from back-end revenue sharing arrangements. While there is nothing morally wrong with revenue sharing arrangements, advisors must clearly disclose the full fee their clients are paying and any conflicts of interest.
The key questions for analyzing a TAMP’s economics include:
What are the all-in costs to a client? These fees include the advisor’s fee, TAMP platform fees, TAMP strategist fees and fund expense ratios, to name a few.
Are these fees reasonable on an absolute basis? Regulators will/should rightly question fees in excess of 2% of assets.
Are there excellent but less expensive options which meet my needs and my client’s needs?
Are those fees appropriate for the value and services provided?
Align with a Corporate RIA
This option is often overlooked but partnering with a corporate RIA has tremendous benefits. The key distinction between a Traditional RIA and a Corporate RIA is who owns the client relationship. In a Traditional RIA, the firm owns the client. In a true Corporate RIA model, the advisor owns the client relationship. This is important to understand because it affects how control and economics are shared.
In any wealth management model, including an RIA, revenue is approximately split in three ways:
40% goes to the Advisor for client relationship management, providing advice on financial planning and investments, and client service – the front office.
30% is allocated for overhead expenses and operating the RIA’s middle and back office. This includes all the investment functions listed above, operations, software, IT support, HR, compliance and marketing support. The quality of these services and resources will vary significantly between RIAs based on the level of professional management.
The remaining 30% of revenue is profit to the owner, either the independent advisor in a Corporate RIA or the firm in a traditional RIA.
As revenue increases, an efficient RIA business can deliver a higher percentage of revenue to the advisor and/or the owner. However, advisors should critically evaluate claims of firms that are advertising 90%+ payouts. One of two things is happening, either 1) RIAs are taking the revenue elsewhere through high cost proprietary investment strategies and/or revenue sharing arrangements, or 2) they are pushing most of the middle office functions back on the independent advisor and not providing quality middle office support.
Like a TAMP, advisors evaluating a Corporate RIA should ask:
What are the all-in costs to a client for the firm’s strategies?
What are all the ways a firm earns revenue off the client and advisor and what conflicts of interest does that introduce?
Who owns the client relationship?
If the advisor leaves the RIA, are there any non-solicitation or non-compete restrictions?”
Picking the Right Model for Your Business
In our experience, there is a wide dispersion of value and pricing that independent advisors and smaller RIAs receive and pay for managing their investment middle office. Some costs are clearly visible, but many are hidden - by advisors themselves through personal opportunity costs or through RIA firms they affiliate with for investment services. Transparently disclosing and evaluating fees is not just a good fiduciary practice. It’s good business. As you carefully evaluate your business’s cash flow, don’t overlook the big picture economics and value equation you are delivering your clients.
If you have any questions about your current investment middle office model, or if after evaluating it, you realize you need to change, we would welcome the opportunity to talk with you!
EverSource Wealth Advisors© is a Corporate RIA model that empowers independent financial advisors to realize their aspirations for Kingdom impact in the lives of their clients. The EverSource Total Support SystemSM provides advisors full back office support in the areas of technology, investment management, operations, compliance and client services. Both our culture and technology platform are specifically designed to incorporate biblical principles into the financial planning and investment management process. As part of a like-minded community, with freedom to focus on what matters most, EverSource enables faith driven independent advisors and their clients to “Smile at the Future.” To learn more about joining the EverSource platform, schedule a call today.