In the advisory world, size matters

The bad news: those headwinds you face — low rates, volatile markets, weak economic conditions, cautious investors — are so persistent, it’s as though they’re the new normal.

The good news: despite those challenges, the advisory business has been profitable the past five years, thanks to increases in portfolio valuations and the demand for services from aging investors.

On average, retail revenue rose about 6% annually from 2011 to 2015, outstripping annual operation cost increases, which are only about 2% per year, says Ian Russell, president and CEO of the Investment Industry Association of Canada, in an industry letter.

But that profitability often depends on size.

Large integrated firms do better, because they can capitalize on scale to spread increased fixed costs over production. Among independent retail firms, profitability varies, with principal-agent models posting good earnings and smaller retailers proving unprofitable the last five years.

Read: What’s in store for independent advisors?

In fact, 36 retail firms have resigned from IIROC since 2011 — some through mergers and acquisitions. And an estimated 30 more retail boutiques are under considerable earnings stress, reports Russell.

He says small firms that do well have made “herculean efforts” to control costs, as evident in that small 2% annual rate of cost increases, despite substantial outlays for tech and compliance.

Still, those costs are substantial, and put downward pressure on advisor payout.

At small boutiques, it’s difficult to reduce advisor payout without damaging recruitment efforts to expand operations, not to mention losing existing advisors. Yet advisor payout must move into better alignment with firm revenues, says Russell, to compensate for rising costs and business risk (increased suitability scrutiny and cyber attacks), so small firms can improve net income and attract shareholders to acquire assets and build scale.

He says industry-wide efforts to adjust the payout grid will mitigate competitive market resistance to such adjustments and give smaller firms with the traditional compensation model additional scope to make the necessary adjustments or move to a principal-agent model that achieves a better alignment of revenue between firm and the advisor.

Read: MFDA bans advisor for secret side business

“There may be further attrition among small and mid-sized firms in the investment dealer retail business in coming years, but the many firms that survive will be effective and profitable purveyors of wealth management advisory services, with their clients the big winners,” concludes Russell.

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Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.