It appears that reports of the retail registered investment advisor's death have been greatly exaggerated.
Motivated by a change in investor demand, however, as well as profitability, capacity and compliance issues, the intermediary distribution channel is undergoing a sea change, according to Kirby Horan, an analyst with the Boston-based research firm Cerulli Associates.
"People are always asking me, Are RIAs going to fail to exist?' No, they're not going to fail to exist, but they're not going to take over the investment world, either, because they have some constraints and some issues that cannot be overcome because of the nature of their business," said Horan, author of a new study, "Retail Registered Investment Advisors in Transition."
But why all the hand wringing over the fate of retail RIAs? Long a bastion for innovation in the client/advisor relationship, investor demands for greater personalization and costly new compliance issues have been weighing heavily on the channel, which is typically comprised of smaller firms with shoestring budgets.
Bigger players further upstream, meanwhile, have adopted a lot of original ideas of their own, like fee-based pricing and financial planning. Therefore, popular thinking in recent years is that the channel would perhaps evolve into a role that more closely resembles the independent financial advisor and that they might someday occupy the corner desk of a major broker/dealer, rather than a storefront on Main Street.
While consolidation is most certainly in their future, many retail RIAs are falling back on the very entrepreneurial spirit on which their business was built, to ensure their survival. Of course, there's also the fact they're just better at doing the little things than their big-budget rivals.
"RIAs are still very unique," said Horan, whose analysis leverages the cooperation of more than 25 industry executives who study, support or sell to the channel, as well as interviews with RIAs across the country.
"They've been doing fee-based pricing and financial planning, and all those things for years, so they're definitely better at it than most other advisors. And they still tend to have wealth management expertise beyond financial planning, but they're moving even further beyond that to what we've termed, life planning,'" Horan offered.
RIA as Investor's CFO'
In other words, today's best-practice RIA is quickly becoming a sort of "investor's CFO," where they're handling anything that might have a financial impact on any aspect of a client's life. This type of holistic financial planning is also driving RIAs to take on additional product and service offerings, and as the assets under management grow, so, too, is their support staff.
Instead of saving a few bucks and making everyone on staff a generalist, Horan explained, many best-practice RIAs are hiring specialists, such as someone to focus entirely on plan creation, or a CPA to work exclusively on tax issues, or perhaps an attorney to address estate planning. But since cost remains a major sticking point, many traditional RIAs are choosing to "rent," rather than "buy."
"They'll form a referral network, particularly for the services they don't perform quite as frequently, or when, profitability-wise, it just doesn't make sense to bring them in-house," Horan remarked. "But as more of them move towards wealth management and life planning, we'll see more specialists brought in-house and less of the renting."
Although the rise in assets under management among RIAs can be attributed to innovation, much of it is also due to a reduction in the number of firms that exist in the channel. That contraction, according to data from the Investment Advisors Association in Washington, seems to be occurring among advisors that manage less than $25 million in assets.
In its annual report on the investment advisor industry released last month, the IAA indicates that the number of entities registered with the Securities and Exchange Commission with at least $25 million in assets under management numbers 8,614, a 3.7% increase from 8,302 in 2004.
"It's not dramatic, but it's incremental," said David Tittsworth, executive director, IAA. Combined assets under management for those entities is now $26.8 trillion, up 21% versus 2002.
"Assets under management are generally going up. Most saw an increase in their AUM over previous years," Tittsworth added.
At the same time, however, a rapid segmentation is occurring within the channel, Horan contends.
The so-called "hybrid RIA," which tries to cater to both retail and institutional clients, is giving way to a more narrowly defined advisor, she said. While a combination of expense and profitability issues are forcing the hybrid RIA to choose a side, new compliance issues are compelling the independent broker/dealer RIA to choose between NASD and SEC registrations.
"Given the compliance nightmare that is going on right now, a lot of broker/dealers are cracking down on IBD-RIAs, charging them fees to review the business that they do under the RIA, forcing them to submit copies of all documentation and transactions from their service agents, so a lot of advisers are saying, It's too expensive, it's driving us crazy,' so we're seeing a real decline of firms that fall into that category," Horan said.
IFAs, which comprise 65% of the retail RIA space and control 70% of its assets, are expected to retain their current position for the near future, Horan added.
"More firms and more assets are falling into that category. As hybrids choose not to service institutional, they'll be an IFA, and as the IBD-RIAs sever their broker/dealer affiliations, they'll also fall into that IFA category," Horan added.
But few issues over the last 20 months have impacted retail RIAs more than the new compliance emphasis, and ripple effects from this environment are expected to be felt by advisors for years to come.
Even today, very few firms have a compliance expert on staff and the need to devote greater resources to that area is distracting RIAs from other revenue-generating activities, Horan said.
"It's becoming very expensive, and it's especially noticeable at the smaller firms, because there are certain requirements that have to be fulfilled, regardless of size," she said, echoing a refrain heard across the investment management industry.
The nation's RIAs also occupy one of the few corners of the industry that has not been implicated in any large-scale scandal by the SEC, NASD or state securities regulators. In fact, according to the IAA, the number of firms confirming that they had been involved in the violation of an investment-related regulation or statute has remained relatively flat over the last four years, fluctuating between 7.5% and 8%. Nobody's breathing a sigh of relief, however, Horan said.
"The SEC is cracking down on everything, in general, so everyone is afraid the SEC is going to come knocking on their door. As a result, we're seeing hyper-compliance," she said.
They're also beginning to see a measure of consolidation by smaller firms that are unable to sufficiently spread the new compliance costs across their assets and their revenue. Although only 2% of retail RIAs have merged because of compliance-related issues, Horan expects the amount to increase slightly.
Rather surprisingly, Horan's study finds, retail RIAs haven't embraced the Internet with the same vigor they have other innovations. Some RIAs don't have Web presence at all, while others are farming the responsibility out to a third-party marketing firm.
"RIAs are not as far along, maybe, as they should be, so it's an issue," she said.
But in terms of relations between RIAs and wholesalers, the more things change, the more they stay the same.
Do Your Homework'
Retail RIAs, in short, still resist meeting with wholesalers, but for the road warriors that do score a few minutes, Horan has a bit of advice: Do your homework.
"RIAs do a lot of research on their own already. They're very quantitative in how they choose their product. So, they want someone who will be more like an assistant to them, not pushing product, but instead saying to them, Here's how I see your business, here are some of the needs I think you have, and here's how I think my product is going to fit,'" Horan said.
"They don't want to be schmoozed," the Cerulli analyst continued. "They want someone who is quick, someone who will position their product correctly and someone who can help with some of the more difficult analyses that the RIA wants to see."
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