Outside-IN

Building a "fortress P&L" that can get firms through a market downturn

Run projections now on what would happen if the market falls, and make the tough decisions to ensure your P&L is variable in the right places

May 16, 2019 @ 2:10 pm

By Gordon Ross

After a long period of market growth, are advisory firms protected if the market were suddenly to go through another downturn? How can you tell if your firm is one that could be in trouble? What do you need to do to turn your firm's P&L into a "fortress P&L"?

Why is this important?

The impact on revenue from a downturn is clear. Cerulli reported that total RIA and dually registered assets fell from $3.8 trillion in 2007 to $2.8 trillion in2008.I am willing to wager many firms don't know what their P&L would look like if their AUM fell 26%.

What is not as obvious is the missed opportunity. If a downturn were to happen, those firms that have prepared for that moment and already have a fortess P&L will be better placed to take advantage of the situation and buy assets at lower prices.

(More: Advisory firms' value is tied to the market's value)

So how do you turn your company's financials into a fortress P&L? We help firms work through a four-step process:

1. Know your true growth rate. Firms can be losing ground without even knowing it. In 2017, Cerulli reported that average growth for RIAs was around 16.7% but factoring out market performance and increases in wallet share from existing clients, new asset growth from new clients was only 9.1%.

The best CEOs in this industry know by heart their net new asset figures and net new number of client households. If you don't, it's a good sign your technology infrastructure needs an upgrade.

2. Be honest about your P&L assumptions. If you look at revenue first, don't be fooled into thinking that transaction-based revenue (if you have any) will hold steady during a downturn. Our experience is that this can fluctuate too.

Moving onto costs, office rent and other expenses like technology are obviously relatively fixed. The big factor here is the compensation for support staff. Some CEOs might claim that this will vary with market trends too, but the number is often more fixed than you think because management avoids having difficult conversations.

For example, is the bonus structure for support staff "discretionary" or is it tied to the revenue of the overall firm or the team that the support person works on? It is an understandable problem. Management feels they need to keep discretionary bonuses stable to hold onto talent. Building a revenue-based formula into those calculations helps avoid those tough conversations.

(More: Raising the bar on happiness at work)

We worked with a firm focused on turning the company into a "growth culture." The concern was that many staffers would still expect good bonuses if a downturn were to occur. The firm built a compensation structure that tied part of compensation to the overall growth of the firm. So if the firm were to contract, all parties would feel it. The results have been impressive and the leadership now enjoys the "one team, one dream" atmosphere.

Don't ignore the elephant in the room: overstaffing. It is one of the most common problems we see in this industry.

How can you tell if you are suffering from it? We typically recommend that non-adviser payroll should be around 9% of revenue. Obviously there might be variation depending on geography, but if your number is significantly higher than this, you need to take a hard look at your operations and technology infrastructure.

A common place we look is the client reporting process. Many firms have teams of people working hard to manage workarounds for their poor client reporting software. Hint: If your client meeting materials are created on spreadsheets, that is a bad sign!

3. Run scenario analyses. Now that you have your set of assumptions, run projections on what happens if the market falls. Equally important, run projections on what happens if it continues to grow, because that will help you plan out when you legitimately need to hire more people. It helps build discipline on not hiring too early.

4. Make the tough decisions now to ensure your P&L is variable in the right places. This is the hardest part and the most overlooked. Typical decisions might include:

• Are there advisers who perhaps should be moved from a salary and bonus structure to something tied to production?

• How much of support staffers' bonus is tied to the growth of the firm or the team they are part of?

• What should be outsourced or built in-house? Plenty of roles can now be outsourced at a much lower cost than building in-house, such as outsourced CFO, chief compliance officer or technology services.

Using an outsourced investment management solution has an added advantage in that the cost is often tied to AUM, thereby turning a fixed cost (hiring people in-house) into a variable cost.

This is controversial because firms often view portfolio management as their secret sauce. However, many firms have realized that their secret sauce is the client experience and excellent service.

One of the fastest growing firms we work with specializes in managing wealth for professional athletes. They outsource portfolio management to a outside firm, which they monitor closely and can replace if necessary, while they focus on providing an amazing client experience and comprehensive financial planning, and bringing in new clients.

Are there storm clouds on the horizon? Maybe or maybe not. What is clear is that the best managed firms in our industry are fixing their roof right now while the sun shines. This article has hopefully given you an idea of where to start.

(More: Drive growth today and be positioned to thrive in future markets)

Gordon Ross is director of the enterprise group at Dynasty Financial Partners.

0
Comments

What do you think?

View comments

Upcoming event

Nov 13

Conference

Top Advisory Firm Summit

Formerly known as the Best Practices Workshop, this new one-day conference will also include content from the Best Places to Work event!The Top Advisory Firm Summit will provide CEOs, COOs, CTOs, CMOs, and Managing Partners from the... Learn more

Most watched

Events

Finding innovation in your firm

Adam Holt of AssetMap explains how advisers understand they need to grow, but great innovation may be lurking right under your nose.

Events

Finding your edge from Tony Robbins

Guru Tony Robbins has helped a lot of people, but armed with his psychology Financial Advisor Josh Nelson has helped his practice soar.

Latest news & opinion

Redtail CRM data breach exposes personal client data

The information exposed includes names, addresses, dates of birth and Social Security numbers.

This strategy can double your estate-tax exemption

'Portability' allows a surviving spouse to tack the decedent's exemption on to his or her own. Despite the higher threshold for paying estate taxes in the 2017 tax law, experts recommend filing for the benefit.

Couple in Morgan Stanley advisory account wins $519,000 arb case over unsuitable investments

Plaintiff's lawyer says junk bonds, futures contracts and derivatives were inappropriate for his clients.

The growth of factor-based investing

Advisers are making decisions about clients' portfolios by using the same characteristics that govern factor-based ETFs.

Finra makes its list to target hundreds of rogue individuals

The regulator sees patterns in the behavior and disclosures of high-risk brokers.

X

Hi! Glad you're here and we hope you like all the great work we do here at InvestmentNews. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting investmentnews.com? It'll help us continue to serve you.

Yes, show me how to whitelist investmentnews.com

Ad blocker detected. Please whitelist us or give premium a try.

X

Subscribe and Save 60%

Premium Access
Print + Digital

Learn more
Subscribe to Print