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This is part one of a three-part series. Parts two and three will appear in the next two weeks.
We have a lot to reflect on this year. Here’s what I’d like to see more and less of in 2021.
More RIAs
I’ve given up expecting the SEC to adopt a fiduciary requirement for brokers that protects investors. The securities industry has done a masterful job of lobbying and muddying the waters on this issue.
RIAs are legally required to place their client’s best interest ahead of their own and to disclose any possible conflicts of interest. While brokers are required to act in the “best interest” of their clients, consumer advocates believe this vague standard isn’t “the same thing as putting the client first.”
It’s always been a mystery to me why any investor would entrust their life savings and financial security to someone who doesn’t have the highest fiduciary obligation to them.
By encouraging brokers to become RIAs, more investors will be served in an ethical, professional way.
I hope there will be more of them.
Less private equity
I’m under no illusions about the boom in mergers and acquisitions in the RIA space. It’s massive and getting bigger. By some estimates, there will be one-third fewer firms in the U.S. in seven years.
There are valid reasons for these mergers. Larger entities enjoy an economy of scale that permits access to expensive technology, sophisticated management and superior back-office support.
A fairly recent development has been the entry of private capital as major players in funding these mergers and acquisitions. These investors frequently own an equity stake in the acquiring entity.
Private equity provides many benefits to acquired firms, including capital and access to research that helps these firms grow their practice.
Private equity also creates, “a robust market of buyers and sellers in the industry.”
But is this good for investors and, ultimately, for the acquired firms?
While there’s a long way to go before a few large advisory firms dominate the market, fewer firms means less competition, giving the dominant firms the power to set prices.
Private equity in the RIA space may also create conflicts of interest. According to Brooks K. Hammer, in this article from Mercer Capital, the goal of private equity is to, “generate large returns to investors.” Typically, private equity firms look to flip their investment in five to seven years, “to a new buyer at two or three times what they initially paid.”
Hammer believes private equity firms may be incentivized to, “put pressure on RIAs to take on more clients and/or reduce costs, so they can maximize profitability for a prospective sale.” These conflicting interests between the profit motive of private equity and the legal obligation to always act in the best interest of the client can place advisors in a particularly challenging position.
Another issue for the firm that sells to private equity investors is that, once the new owner flips its interest, the acquired firm now must deal with a new owner, who it had no role in vetting.
It’s ironic that advisory firms that would never recommend hedge funds to their clients or advise them to buy stocks on margin, have shareholders that are hedge funds and fund their acquisitions with borrowed capital.
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Fewer expectations of trust. More demonstrations of it.
Advisors have an uneasy relationship with trust. Every advisor wants prospects and clients to trust them, but few reciprocate.
Here’s a radical idea that would convert more prospects into clients. When dealing with a prospect who is reluctant to make a commitment, make this offer:
I can understand your hesitancy. Selecting an advisor is a leap of faith. Would you be willing to retain us for a (three month? six month?) period on a trial basis? At the end of the trial period, if you are happy with the relationship, you will pay us our standard fee. If you aren’t, we can part company and there will be no charge for our services.
This offer is not right for every firm and every situation. I use it as an example of how you can show you respect and trust your prospects.
Shift the focus from expecting trust to giving it in 2021.
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