Highlights from Capital Group RIA Symposium, September 22, 2017, Los Angeles

Sweeping technological, regulatory and demographic changes are challenging advisors to alter the way they create value with clients. Some advisors might view these changes as a threat, but forward-looking professionals are finding opportunity instead, according to a lively discussion between Donnie Ethier, director of high net worth at Cerulli Associates and Gabe Garcia, managing director and head of relationship management at Pershing Advisor Solutions. Find out what these industry professionals see as the biggest changes advisors face and what they should be doing to prepare.

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Transcript

On the growth and opportunity in the RIA market

Donnie Ethier:  What I wanted to cover to kind of kick off was just asset share: Asset growth, who's winning the market share. Combined, the wire houses and private banks control 70% of a trillion dollars in high net worth assets. RIAs [registered investment advisors] and MFOs [multi-family offices] combined about 14%. But what we're seeing is explosive growth in the independent space. One-, three-, five-year growth of double-digit numbers in the independent space between 12% and 15% over those time periods.

The softer services, which is where we see the independent practices gaining the most traction over the wire houses. The kind of thing we hear is that the wire houses just have too much on their table, too many products to sell, can't focus on true goal-based wealth management planning. Obviously being independent firms, there's an advantage of being lean. Are you able to spend more time, concentrate on that goal-based planning?

Gabe Garcia: Quite frankly, there are better options and more options to serve your clients in the manner you wish. Whether it's managing the debit side of the balance sheet through private banking or lending services, insurance solutions, world-class technologies, just core access to markets, currencies, international, etc. None of that has been ringed off, it is now fully available through any of the major custodial platforms that exist out there for our advisors to use. So it's an exciting time; I love the space that we are in, and I'm excited for all of you because there is an oversupply of clients and an undersupply of professionals like you in this room.

Donnie Ethier: Ten or 15 years ago, if you went fully independent, you were going to have to buy computers, pay a lease, pick out rugs, hire an admin, hire staff [and build an] investment portfolio, [perform] due diligence [and] all these processes and, as we know, it's a lot easier these days. [There are] a lot of firms out there, custodians included, that will help RIAs get [up] to speed. The other advantage is new talent and this is arguably probably the industry's biggest challenge right now. There's not many 24-, 25-year-olds coming into the industry like there were 15 years ago. And when they do, they tend to choose the mega team structure. They want to specialize, they don't want to come in and just do a little bit of everything. They want to come in — maybe [it’s] charitable causes, maybe it's ESG [environmental, social, governance] — wherever that passion is, and that team-based environment that we see growing within independent firms is really supporting and attracting that younger talent.

On the trend for RIAs to add additional financial services

Donnie Ethier: What services do you offer, how do you offer them, do you charge an extra fee? We can connect back to our sizing. We can see who controls high net worth assets and we can see the services that they offer. It is, and I mentioned this before, asset allocation in a way is being commoditized. There still are a good amount of practices out there, a good amount of firms across all channels that that is their value proposition.

We see a lot of family offices that came out of the asset allocation world, for instance, and that's their DNA. But overall, asset allocation is less of a competitive edge in the high net worth and ultra high net worth marketplace. It's what else can you do for me, those softer services? Estate planning, obviously goals-based financial planning — estate planning offering trust services or at least partnering with a trust company to offer those services.

Gabe Garcia: What I find as firms evolve from a practice to a business to an enterprise is the clear need to have an optimal target market, clearly defined so that you can create a set of services and experiences and create unique expertise to that client base. The fear when we go in and consult with firms and do an analysis of what does your client base look like today, and we'll ask them a series of six to eight different attributes of these clients.

How long have they been here, what is their average age, what was the need that was presented at the time that they hired your firm? What profession are they in? What is their psychographic makeup? What are their personal attributes? Are these people that like traveling, sports, reading, opera, private, public, etc.? When you begin to create a framework around that, there are multiple needs that you can fulfill. What I would say is be cautious with adding services because the marketplace is adding services. Once you identify those clients, and I tell people this frequently, don't be fearful of the opportunity you will miss.

So think of the sweet spot of your business. Once you've identified that, any of those services are great to offer and we are seeing a proliferation of more services beyond investment management. Now, I don't want to have you walk away and say, “Well, Gabe Garcia got up there and said that investment management isn’t important.” It is critically important, it is the engine that drives all the other outcomes, but this need to be the top performer quarter in and quarter out and have clients that value you primarily or solely for that, quite frankly, I think is a business that will create quite a bit of attrition and turnover and not really create an enduring firm, if you will.

On the use of technology by RIAs

Donnie Ethier: I think the two that we're focused on and that we get the most questions on are digital or robo, how do I use it, how do I implement it as well as other aggregation tools? I am still amazed by how many firms we do talk to and how many practices we talk to, independent firms that are not using what we would at least find as efficient aggregation tools, yet they believe they're offering goals-based planning. I think we could debate whether or not you can actually offer goals-based planning if you don't have a 360 view of clients’ assets accounts.

So robo, when Cerulli started sizing, so two years ago, we sized the digital channel for the first time and we projected it was going to reach about $60 billion over the next three years. That growth has slowed quickly and what we started to realize internally is that digital or robo, whatever you want to call it, is not a channel, it's a service. And internally we took a big step back and realized we're not seeing digital compete against RIAs, not to even mention the direct providers, it's the direct providers and the asset managers that are actually delivering them to the marketplace.

And we actually do believe that I think some of the biggest broker dealers still do truly see digital as a threat, but in the independent space we're starting to see a little bit more embracement, not [seeing it as a threat], and seeing it as a complement.

Gabe Garcia: So I don't see digital providers or robo providers as a threat whatsoever. I think it will enhance the industry, it will be a pathway to new technologies. It will shed some insight, quite frankly, when you look at the Personal Capitals of the world or the Betterments or the Wealthfronts or even the Schwab Intelligent Portfolios will begin to see data as to what does that mean? What happens behaviorally when we have a major market downturn? How will they react to that? What kind of communication? What is the loyalty factor in those relationships? What do we need to do to enhance it?

On the role of RIA aggregation firms and the place of the standalone firm

Donnie Ethier: To compete as a standalone. I mean I would say from our perspective, I mean the $100 million AUM [assets under management], if that's what you're referring to, is obviously — and I know most of you in this room are bigger than that. That is the absolute line when we see you really kind of turn into that small- [to] medium-sized business at that hundred million [mark], that's when we see more services start to be pulled internally, start competing for talent. Our mega team definition at Cerulli usually falls in right around $500 million in AUM.

The one thing that we find that is a large challenge for RIAs is succession planning. I can’t remember the exact figure, I want to say it was about 36% of RIAs do not have a succession plan in place, and we expect there's going to be about a third of RIAs in retirement over the next 10 to 15 years. So there's a lot of money up for grabs. We separately surveyed private banks and trust companies. Out of the ones that we surveyed over the last two years, there's about 70 firms, 48% of them now own an RIA.

Out of the 52 that don't own an RIA, a third of them plan or hope to acquire one in the next five years. So it's that idea of scalability, efficiency, a lot of firms and there's a lot of private money circling the industry looking for that fee revenue. So I think from the scalability the rollups — we work with all the rollups, they’re clients of ours. They add value I think from a succession planning, they can offer very attractive options, obviously, but I think there’s obviously challenges that come with that, and we know a lot of firms that have grown to a certain size in AUM and they just get to that point where the business is so complex they need more services and sometimes tapping on that aggregate model or that rollout model is the most efficient way, or at least they believe it's the most efficient way, to scale their business.

Gabe Garcia: This industry continues to evolve, as I mentioned earlier, from a practice, a book of business and a wirehouse, to a practice, to a business, to an enterprise. The largest firms are getting larger. The average revenue of what we defined as our super-ensemble firms in our study is just shy of $20 million. The average revenue of all firms is about $3.9 million. The delta between those two has continued to separate, not in an exponential rate, but it's getting wider.

On the challenge of finding, training and retaining talent

Donnie Ethier: There are a lot of universities now that are bestowing financial planning degrees. Texas Tech [University] has certainly gotten a lot of headlines, but San Diego State [University], we have engaged pretty deeply with Utah Valley [University] if you can imagine this. It is actually producing the largest number of CFP degree graduates out of all those universities on the East Coast; Virginia Tech, there's a couple in the New York area.

Gabe Garcia: And that the new way of doing things is to create a career path for folks to progress through the different job levels and be mentored and see different parts of the business and be trained and engage with clients and potentially end up in a client-facing, revenue-producing role or not.

But for those in a revenue-producing role, a couple interesting things: So 2015 was the first year in our industry that we saw more employee advisors than practicing partner advisors. Does that make sense? Did I say that clearly enough? So historically this has been an industry of practicing partners; you, a couple partners, set up your business, you're the drivers of growth, you're running the business and you typically take your risk for ownership out of the profits of the firm and deviate that up in whatever form.

On the importance of changing demographics on RIAs

Gabe Garcia: The amount of wealth controlled below the age of 51 versus over the age of 51 is equivalent, meaning [baby] boomers and then [Generation] Xers and millennials. The challenge is that these are rough numbers, there's 80 million millennials, 80 million boomers and 48 to 50 million Generation Xers.

So it is a natural bridge. So I caution when you think next gen, don't just think millennial, think Gen Xers, they're the clients who can use your services, who are willing to pay [for] services, who like to build the relationships first and do business second as opposed to the millennials who don't want to talk to you, who just want to click a box and hire you and maybe later, we’ll talk. We need to get there, but that bridge of technology and experience, complexity of needs, is something that I encourage you to think about how you drive organic growth in that demographic.

Donnie Ethier: I understand the baby boomers; there's a lot of them and they own the most assets and they have the most needs right now. They're entering that de-accumulation phase, and in many cases you've had relationships with them for 15, 20, 25 years. At the same time, there’s this wave of millennials coming — they're driving technology, they're buying everything online, they review everything online, and we need to meet their needs. There's an enormous Gen X population in the middle, which, by the way, currently has seven times the asset base of the millennials. Seven times the assets.

Point number two is, and Gabe talked about the distribution of total assets, but according to our high net worth data, over two thirds of high net worth households are led by clients over the age of 70. Can you name one 70-year-old client or one 70-year-old you know that at least has a biological child that is a millennial? So not only from today’s standpoint in needs is Gen X being overlooked with seven times the assets of millennials. But from a wealth transfer strategy, everyone defaults back to the millennials. Of course there’s going to be grandchildren, and there are going to be baby boomers that pass away and do have millennial children, but if we look at that longevity and who is really going to be the first wave of the wealth transfer, which has already happened, [it] is actually going to be younger baby boomers and older Gen Xers for the most part.

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