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How advisory firms can enhance their performance benchmarking skills

Benchmarking is how advisers become better at interpreting their firms' financials, helping to project future success

Apr 13, 2016 @ 11:49 am

By Brandon Odell

Benchmarking is an important part of planning for the success of your business. Currently, we use expected financial results as a tool to exercise good managerial sense and assess risk. However, advisory firms struggle to make accurate statements about the future of their businesses.

Financial results are the primary determinant of success for your advisory firm, and benchmarking is the barometer used to gauge your level of achievement toward your goals. So how do we enhance our benchmarking skills? Participating in the InvestmentNews Financial Performance Study of Advisory Firms (which opens for participation on April 18th) is one step in the right direction. But specifically, how will it help you improve as a firm owner and executive?

First we need to understand why advice industry executives generally lack the ability to accurately forecast the financial success of their firms. For comparative purposes, we can look to a profession that depends on forecasting accuracy: meteorologists.

(Related: Detailed data on adviser compensation, staffing and financial performance)

Like advisory firm owners, weather forecasters must use available data, models, knowledge and experience to make predictions, and a study shows they are much better at it than financial firms are.

In a 2002 research report by Tadeusz Tyszka and Piotr Zielonka titled “Expert Judgements: Financial Analysts and Weather Forecasters”, they conclude that weather forecasters had a higher probability of prediction accuracy, and we can see that in real time. For much of history, the weather forecast print was more useful for lining the birdcage than it was to read. Now they can reasonably predict when there will be rain in my hometown of Seattle versus a light shower or sprinkle.

They have become so good at forecasting the weather that they can detect the intensity of rain. The report's authors reason that weather forecasters are more accurate than financial analysts because they attribute more importance to the likeliness of things changing while learning from past predictions. They accept that there is more than one possible outcome for the weather, but learn from current data and past scenarios to pick the most probable alternative.

The reason weather forecasters are better at predicting the future is also why benchmarking is so important for your advisory firm. The accuracy of predictions relies heavily on understanding the risks that could impact your future success through frequent updates of financial metrics, and additionally learning from historical results. It is too easy to manage with overconfidence in a small or outdated set of metrics. But the more recent and trending data the firm has, the better it can enable effective management as well as see better results.

The 2016 InvestmentNews Financial Performance Study of Advisory Firms is the opportunity to produce updated metrics for your firm and benchmark against the most comprehensive study of independent advisory firms. Particularly, this year's study will focus on the risks impacting the success of your firm to grow and compete in our changing industry.

With a refreshed outlook on benchmarking, let's put it into action and examine a few of the factors that will be included in this year's study:

Growth: In last year's InvestmentNews Adviser Compensation and Staffing Study, we found that the average firm grew slower year-over-year from the prior period, and all firms were enduring a multi-year trend of finding it difficult to attract new clients. We will look at what the successful firms are doing to stimulate new business development growth. Perhaps there are strategies and utilization of firm resources we can glean and apply to our own firms and the industry.

If we look deeper at the data there are risk factors that influence firm revenue. New business development is one aspect of growing revenue, as is retention of current clients. Revenue is exposed to the risk of your client demographics, such as age and liquid assets, and sub-factors such as account type, service expectation and net asset accumulation versus withdrawal. The Department of Labor's fiduciary rule is one example of a risk factor that may impact a segment of your revenue.

Fees and Services: There is a sentiment that competition will contract average fees. However, there are many factors at work and in the 2014 Financial Performance Study we found that more advisers actually increased fees versus reduced them. About one-third of advisers changed their fees in the two years prior to the study, and 73% of those that changed fees opted to raise them higher.

The impact of robo-advisers, industry consolidation, the DOL rule and pressure from clients are all possible influences on fees, but so are the services that your firm provides. We can't compare average industry fees if we aren't evaluating similar client services. The scope and depth of firm services will have as much impact on your firm's ability to charge fees than the singular risk of pricing competition.

Productivity: The profitability of client services is dictated by how much you can charge (i.e. fees) and how much it costs (i.e. expenses), but we also use an active metric called productivity. This ratio reflects how much revenue is produced per resource. Our most important resources are clients, advisers and staff. We use the term professionals to account for advisers, and, in 2014, the industry median productivity of professionals was $478,000 (revenue per professional). Overall professional productivity was down from previous years and the average varied by firm size.

The variance in productivity demonstrates the influence of many risk factors. Growing revenue and servicing clients with efficient operations to manage your productivity means managing risks to revenue, market environment, clients, organizational design and compensation. Hiring a new professional is necessary to grow, but it also lowers your productivity. The optimal productivity ratios for your firm require understanding the risk factors as they apply to your service model.

We encourage you to participate in the 2016 InvestmentNews Financial Performance Study of Advisory Firms to best examine the factors that impact your business. The journey is as valuable as the destination. As a proud partner of InvestmentNews in writing the study, The Ensemble Practice will attempt to capture the trends and risks evident in the industry. But your contribution will be worth more than we can give back. This exercise in benchmarking is how you and I become better at interpreting our financials and the projection of success for our firms.

Brandon Odell is director of business consulting with The Ensemble Practice, a strategic partner to InvestmentNews Research and the 2016 InvestmentNews Financial Performance Study of Advisory Firms.

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