Over the long run, markets rise, and for that reason, advisory or wealth management fees based on a percentage of assets managed are a long-term win for passively growing advisory firm revenue. While quarterly billing dilutes the effects of market volatility, it will not protect a firm that collects the bulk of its revenue from asset-based fees from a bear market. Fortunately, many analysts are still predicting the S&P will land closer to 3,000 than not, but it's an interesting and worthwhile exercise to reflect on how this increasingly popular advisory firm business model is tied inextricably to the fortunes of the market.
50% of all AUM growth since the crisis.
The accelerating growth of the asset-based fee model has coincided with a nearly 10-year market bull run that has helped pad assets under management and boost revenues. According to an analysis of the InvestmentNews/Moss Adams benchmarking studies, compounding market appreciation has contributed on average over one out of every two dollars (51%) of new assets under management since the beginning of 2009. In the typical year during that span, 43% of new AUM came from market growth.
An independent advisory firm that had $100 million of assets under management at year-end 2008 and experienced average AUM growth would have had $287 million at the close of 2016 — and likely more than $300 million at the close of 2017, for which data will be collected in this year's benchmarking study. (Sign up for the InvestmentNews Research Rewards panel here to be the first to know about our study launches and promotions.) Agnostic of market contributions and assuming average increases (or decreases, from distributions or lost clients), our $100 million advisory firm grew to $191 million — or what would probably be $200 million once 2017 growth assumptions are available.
The difference over the course of nine years is easily understood accordingly: With the bull market, firms tripled their assets under management; without it, firms would have doubled their AUM over the same nine-year span. Assuming a standard yield on assets of 0.72%, that's a difference of $688,000 in annual revenue between our two hypothetical firms.
The obvious correlation
Unsurprisingly, our data showed a high correlation between markets and firm growth. The connection is reinforced by the fact that the only two years in which S&P growth was under 10% were the only two years in which growth in average advisory firm assets failed to eclipse 10% (2011 and 2015).
Because of the widespread adoption of quarterly billing arrangements — e.g., fees are calculated based on quarter-end balances — there's often a lag between market moves and their effects on firm revenue, especially if market swings occur in the fourth quarter. Consequently, declines in revenue growth have often materialized the following year: In each of the years following the three lowest points in the market since 2007 — the crash of 2008 and the low-growth years of 2011 and 2015 — revenue growth was down from the prior year.
In 2015, the growth rate for advisory firm revenue crept down to single digits for the first time since 2009. In 2016, after a year of slow growth in the markets, that trend only deepened, with the average firm reporting just 5% growth in revenues. With all the elements squeezing the industry — competition, fee compression, regulation, and technology — continued volatility and the potential for a bear market will only deepen the pressure facing advisers.
Asset-based fees ascendant
According to the InvestmentNews 2017 Adviser Compensation & Staffing Study, the average registered investment adviser collects approximately 93% of its revenue from asset-based fees, and brokerage channel firms have spent the past decade racing toward a similar model, with the independent broker-dealer firms that participated in the same study collecting 68% of their revenue from asset-based fees, up from 54% in 2007.
Technology-fueled, low-cost entrants are driving the cost of asset-based investment management fees to the ground while advisories are increasingly measured, tested — and marketed — on their ability to deliver a broad menu of services that deliver holistic, goals-based service and differentiated investment advice.
Under this challenging environment, firms that traditionally have relied heavily on asset-based fees increasingly are diversifying their revenue mix in favor of retainer, contract or other fee models. Such models not only reflect the new generation of financial advice delivery, they also mitigate market risk. The IBD industry as a whole, according to InvestmentNews' annual survey of IBD home offices, collected 34% of its total revenue from fees in 2016, up from 23% just five years earlier, in 2011. Inevitably, lower asset-gathering totals lead to lower revenues, but that is especially true at firms that predicate their business model on asset-based fees.
Matthew Sirinides is senior research analyst at InvestmentNews.
Digital production: Ellie Zhu