The Trends That Will Shape the Advisory Profession in 2023
I’m looking over my previous “trends” article, published at this time a year ago, and some of my ”fearless predictions” (I always make predictions fearfully) were outlandish then but now seem ordinary.
That means I did something right.
I predicted that the emergency measures adopted during COVID would become mainstream. The most important of those are virtual meetings with clients and remote work for staff. Clients, I said, would grow accustomed to the idea that they could meet with advisors without having to drive through traffic to their offices, and remote, face-to-screen client relationships would become the default rather than the temporary exception. And once that happened, staff members would resist coming back into the office every day. As a result, advisory firms would begin recruiting staff in remote locations, holding staff meetings via Zoom or some other remote technology, and client meetings would involve advisors and associates patched into the same calls.
I predicted an embryonic trend of hyper-niche marketing would start to become mainstream; instead of advisory firms marketing exclusively in their local communities, they would market to very specific target clients anywhere in the country. That would not only make advisors more attractive to specific segments, but it would mean that they could offer deeper levels of service custom-tailored to the challenges faced by that group of clients.
My 2022 predictions article suggested that many professional conferences would be live-streamed to remote attendees in an add-on to the in-person audience, and some exhibitors would forego the in-person booth experience altogether, preferring to host webinars instead.
Finally, I suggested that 2022 would be the peak of private equity investments in advisory firms, but if the markets experienced a decline, that money would dry up. In a bear market, advisory firms are not the cash cows that PE investors expected or needed.
At the end, I predicted that the sun would continue to rise in the morning and set in the evening, that the markets would go up and down and up and down again in unpredictable ways, and that there would be important events taking place in the coming year that none of us could foresee. I’m happy to report that this last set of predictions proved to be remarkably accurate.
With my fearless spirit, here is what to expect in 2023.
Recruiting supply and demand
The single most important issue facing advisory firms in 2023 is not the bear market, the prospects of a nasty recession, or the ongoing crypto collapse. It’s recruiting and retention issues.
In the olden days, by which I mean three to five years ago, recruiting was a simple matter of posting a job opportunity on the local FPA message board and on LinkedIn, and if you were especially aggressive, on one of the online recruiting sites. Then came the challenging part: sorting through all the resumes that filled up your mailbox, looking for the single most attractive candidate and the best fit. The articles and presentations on staff recruiting focused on the most effective ways to winnow the intimidating stack of resumes down to five or six ideal candidates, and then how to effectively grill those candidates to identify which of them was destined to become a superstar in your office.
That is laughable today. The supply/demand equation has shifted so far in favor of job candidates that most people coming out of college have at least five offers on the table, often more, and three of them will be from big firms like Vanguard and Fidelity offering starting salaries most advisory firms can’t afford, plus training and great benefits. You make an offer and you have less than a one-in-five chance of landing that person. This is inhibiting growth everywhere in the profession; capacity is stuck in the mud.
In fact, for many firms, capacity will be declining. One of the unexpected outcomes of today’s shift to remote work is that good staff people are getting calls from recruiting firms telling them they can make 20% more if they move (virtually) to this other firm on the other side of the Mississippi, which will also offer better career opportunities.
The situation reminds me of what broker-dealers went through when they were poaching one another’s advisor/reps by offering ever-higher payouts, and meanwhile trying to attract wirehouse reps the way today’s advisory firms are trying to bring in college graduates, only to find that somebody else is making a higher or better bid.
There are a few things advisory firms can do to address this challenge. I just wrote a comprehensive article on the topic in my Inside Information newsletter. The gist of it is that, just as a firm will dress itself up before putting itself on the market, firms have to start working hard to make their virtual and physical office environment more attractive to job candidates.
Meaning? The most obvious shift is higher salary offers to compete with the large firms that are hiring hundreds of would-be advisors out of college every cycle. Beyond that, RIAs will need to offer a flexible work environment, with flexible hours and the opportunity for remote work.
There are limits to this, however; younger advisors will want to be in the office at least a couple of days a week, because that’s how they get mentored and trained. That is another part of the ”dressing up” process: Advisory firms will need to create internal training programs and clear opportunities for advancement.
This newly competitive recruiting environment will impact the cost structure for planning firms. To ward off firms poaching their talent, RIAs have to raise the salaries of existing staff members. This will also be necessary to attract new staffers. You don’t want your current staff advisors to discover that, even though they’ve been working at your firm for five years, they are now paid less than this new graduate fresh out of college.
Private equity challenges
My next prediction is a continuation of the one I made last year: PE money in the advisory profession will dry up. And this will have several implications for our business landscape.
Private equity investors came into the business, a few at a time, then a trickle, and then a flood, as they noticed that virtually every advisory firm was generating margins above 25%, and for smaller solo shops the margins were double that level or higher.
Their reasoning seems to have been that they could shovel dollars into very large firms on the proviso that those 'hub' firms would become serial acquirers of these smaller firms and those tasty 50+% profit margins. Everybody would get filthy rich when this combination of offices scattered everywhere around the country, with margins that would make an investment banker blush, was sold or taken public.
That’s how it must have looked to those PE outsiders. But the profit margins in this profession are fragile and largely dependent on a rising capital markets. In the past, when the markets went down and AUM declined, that 25-50% margin would largely evaporate, and the firm owners would have to cut costs and, if they were smart, stop taking personal distributions so they could maintain the cash flow to continue paying staff salaries.
An insider might also notice that the acquired firms tended to be run by aging advisors who needed to sell because they had never managed to create an internal succession plan. The person who held the client relationships would retire hours after the deal was done, and recruiters would be calling the staff advisors who were never consulted about the acquisition and were uncertain how they would fit into the large national firm that now employed them. I’m told that savvy recruiters keep track of these acquisitions and know exactly when to pounce.
Finally, many of the PE firms were, at the height of their interest in the advisory profession, borrowing money using six- or seven-times leverage (at negative real rates). That was where their investments in our profession were coming from. As interest rates have gone up, so too have their debt payments.
The bear market, inflation and rising rates created a perfect storm, which was entirely predictable if you knew the economics of the PE business and advisory profession. The once-rosy investment picture now includes declining or negative profit margins due to the bear market, clients who no longer have a personal relationship with the acquiring firm, staff defections and (as mentioned earlier) higher staff cost structures to replace or retain them, and the new person at the table (the PE firm) needing to take more money out of those nonexistent profits in order to keep servicing the debt.
How will this impact the profession at large? The most obvious prediction is that the larger RIA firms that have been financed with PE money will slow down their acquisitions precisely to the extent that the PE money dries up. The biggest impact will be on the multiples that the founders-without-a-succession-plan can expect when they decide to sell. The days when a solo advisor with minimal internal infrastructure could get 7-10 times EBITDA are over. We are not far from the day when that same firm would be considered a distressed sale.
A second impact is more interesting. If the PE firms need to pull out more of the large firm’s profits, they’re going to have to impose fiscal discipline. It won’t be possible to reduce staff costs (those, as mentioned earlier, will be going up), so the obvious place to tighten is staff efficiency. Advisors will be told to work with more clients – from 75 to, say, 150, and they will be told not to waste too much time on client meetings and client services. Those larger serial acquirers already tend to have high minimums; we can expect those minimums to go up.
Sound familiar? Wirehouse office managers have, for decades, forbid their staff brokers from spending too much time building (God forbid) personal relationships with their customers; this is a business, after all, not a schmooze-fest. And some have declined to pay their brokers any compensation for smaller accounts they might be servicing, which are unprofitable for the firm. The larger acquiring RIA firms will adopt similar service standards, imposed by the PE firm.
In the olden days – by which I mean two to three years ago – executives at advisory firms with less than $1 billion under management were wringing their hands and wondering how they could compete with these larger entities that were growing up around them. Starting in 2023, that dynamic will turn itself around. Smaller, more flexible advisory firms will be better at adapting to the shifting realities in the marketplace. They will offer more personal service and recruit staff members from acquired firms, who will bring with them clients that the larger firms no longer want. They will pursue niches while a large national brand will be forced to serve as a general-practitioner advisor. Unlike the larger firms, they’ll be able to service, profitably, the blue ocean of less-wealthy clients by being flexible with their service structures and revenue models.
Plus, when the markets go down, their owners will forego distributions and double down on client service, cementing client relationships at a time when anxious clients might not be getting prompt return calls from large firm advisors who are suddenly handling 150 client relationships.
As a result, starting in 2023 and continuing into the next year, larger firm executives will be wringing their hands and wondering how they can possibly compete with these smaller firms that have proliferated under their feet.
Efficiency versus effectiveness
That previous trend will give rise to a new one: a debate about how to balance the conflicting demands of efficiency and effectiveness.
For decades, the mantra in the profession has been how to drive increasing efficiency, and there was always plenty of room for improvement. Many advisory firms had dysfunctional tech stacks or were using software that was no longer state-of-the-art. Workflows were a keen new idea that had yet to be implemented. Back-office staffers were doing, manually, things that software could do more accurately and easily.
Some of that still exists, of course. But now we have more sophisticated software and new machine learning systems like the robo-investing platforms. There has been a gradual commoditization in asset management and (with increasingly sophisticated online planning calculators) the most basic financial planning advice. The profession's value proposition will have to move to higher ground, to things that only humans can do, like spending personal time with clients, brainstorming creative solutions to their life challenges and serving as thinking partners during their most difficult transitions.
Recall that the larger advisory firms (per my previous prediction) are going to be searching for increasing efficiency, and suddenly we will have a new professional debate about how much efficiency is too much. When does the drive for more efficiency (and profit margin) start compromising effectiveness, the personal service, which can be antithetical to efficiency. (More time with clients means less efficiency but more effectiveness.)
This is going to be a complicated discussion. In my white paper with Matthew Jackson, I noted that the ”encroachment” of time-efficient software was most often seen taking tasks off the plate of back-office staffers. We predicted that those operational professionals are accordingly going to be spending more time with clients, and some of them are going to become full-time relationship managers, allowing higher-cost advisors to better leverage their time without sacrificing personal client service. There will be cases where a firm can become more efficient and more effective.
If, as I predict, larger acquiring firms with multiple small offices push efficiency to the limit and reduce personal service to clients, then that becomes a talking point in the profession. If, as I predict, personal service becomes a competitive advantage for firms with under $1 billion AUM, then there will be a serious conversation about selectively reducing efficiency in the name of effectiveness. My point is that the conversation (in articles and conference presentations) is going to shift from how to become more efficient to the more nuanced topic of how to balance efficiency and effectiveness, and more broadly, how to navigate the constant upward migration of service as technology commoditizes more and more routine tasks and advice.
And, even more broadly, as the value proposition shifts to humans providing the increasingly personal service, and as those humans (see my first prediction) become more costly, we might see the margins diminish, overall, in financial planning firms. How much is hard to predict.
The next scandal
These forecasting articles are not complete without a bold (outrageous?) forecast. My last prediction, for which I have no evidence, is that the brokerage industry will experience yet another terrible, awful, customer-harming scandal in 2023.
I can’t tell you much more than that; all I can do is lay out my logic. Back in 2008-2009, and in previous scandals before that (remember the analysts being paid to issue ”buy” recommendations on what they privately called ”garbage?”), the primary motivation behind bad behavior was an incentive system driven by greed. Brokers were paid to generate revenues and profits for the firm – the more their recommendations were profitable for the firm, the more money the firm stuffed in their pockets. Stare at that equation for a minute and try to find where and how the customers are supposed to benefit.
A compensation structure founded on greed incentivizes the sale of products or other advice that is far more beneficial for the firm than for the customer. Left to its own devices, the greed-incentive will deliver ever-more-profitable, consumer-harmful products or services. This takes place gradually, sneakily, kept carefully out of sight of the regulators as it gestates and builds until finally some horrible explosion exposes the whole scheme. These things tend to blow up roughly every 10-15 years as they culminate, doing serious damage to the financial services industry.
What will it be this time? There are many possibilities. It could be highly leveraged bets on certain outcomes in the investment markets, through very complicated vehicles which are sold as ”safe” to consumers who pay high commissions for the privilege of owning them. It could be something to do with cryptocurrency, or packaging investment ”opportunities” that buy whatever securities the firm wants to sell out of its own account because of alarming reports from its analysts. It could have something to do with SPACs.
They say that when the tide goes out, you see who isn’t wearing a bathing suit, and when the economy goes into recession, you see where the money was misallocated. If we do, as many predict, experience a significant recession in 2023, it will expose a major self-dealing scandal in the brokerage industry.
And what would be the implications of that? Logic would tell us that thousands of brokers will flee the yet-again-toxic brands of the company on their business cards, and consumers will pull their accounts in droves, moving their money to fiduciary RIA firms. Congress will enact meaningful consumer protections, the regulators will tighten down on their oversight of Wall Street activities. We will finally see a meaningful push toward a fiduciary standard for everyone who gives investment advice to the public.
But my long experience tells me that, no matter how bad the next brokerage scandal will be, none of this will happen. Instead, the incentive structure will be allowed to go on as before, grounded, as ever, on the compelling principle of greed. As soon as the headlines die down, the seeds of the next awful portfolio-destroying scandal will be sown, to grow and ripen gradually over a 10- to 15-year maturation period, when once again we’ll be confronted with an awful mess that nothing, ultimately, will be done to fix.
In last year’s article, I said that the sharply divided political landscape would force advisors to choose sides, because their clients would force them to. I see some of that now, and expect to see more of the same in 2023. I predicted that more advisory firms would offer advice on clients’ crypto holdings; I now applaud advisory firms that resisted that trend. I predicted an acceleration in wirehouse brokers moving to independence, and that trend did indeed become visible, but slower to play out than I anticipated. We might see more of it in 2023, driven not by my predicted scandal, but because brokers and brokerage teams discovered during COVID that they weren’t quite as dependent on their firms as they thought they were.
And I’m still onboard with the prediction that the sun will rise and set, the markets will stay unpredictable, and many events taking place in 2023 will surprise even astute (fearful) prognosticators like me. It’s always an adventure, and I’m looking forward to it.
Bob Veres' Inside Information service is the best practice management, marketing, client service resource for financial services professionals. Check out his blog at: www.bobveres.com.