Why PE can’t get enough RIAs

The relatively young market and its reliable, asset-based fees are very attractive to investors.

It’s no secret that private equity firms see a lot of value in wealth management – the volume of deals has been increasing, and the cash behind them increasingly comes from PE.

Last year, there were 178 PE-backed RIA deals, up from 171 in 2022 and just 61 in 2020, according to a report by Fidelity. Those accounted for 78 percent, 75 percent, and 47 percent of total M&A for those years, respectively.

Despite its intense interest in the market, private equity does not appear to be changing the wealth management business much – aside from the considerable aggregation that it’s funding. That’s a reflection of the value that PE firms see in RIAs and independent broker-dealers – they tend to buy financially strong, well-managed businesses, rather than look for a distressed asset to fix and flip.

“It’s been a pretty symbiotic relationship,” said Larry Roth, managing partner at RLR Strategic Partners. PE firms “are spending probably most of their time providing capital and helping the wealth management teams and managers identify potential acquisitions.”

IF IT’S NOT BROKEN

Asset-based fees are extremely attractive to PE investors. The RIA acquisitions have been considered very low risk amid strong equity markets and the fact that advisors and their firms have seen virtually no competitive pressures to lower the fees they charge clients.

“The fees that financial advisors and RIAs charge clients have not been compressing at all,” Roth said, adding that that’s been the case in the more than 10 years since PE started taking a strong interest in wealth management.

The demographic aspect of the business is also a big draw, as younger households are accumulating wealth and increasingly seek professional management – the market keeps growing, he noted.

The fact that the industry has been doing well has meant that PE firms “are very reluctant to set strategy or work closely with you in terms of how to run the business, because it’s not their specialty,” Roth said.

PE investors have their exits planned anywhere from three to seven years after acquisitions, and they tend to target returns of three to five times what they invested over five years, he said.

Last year, all the top 20 strategic acquirers, those that did three or more deals during the year, were backed by PE, according to Fidelity. Among the 41 companies it identified as strategic acquirers, 38, or 93 percent of them, were backed by PE. And of the 96 companies that made any acquisitions at all, 60 percent were PE-backed.

“PE firms are asking the owners of RIA firms, ‘What are your specific goals? What are you looking to accomplish?’” said Laura Delaney, vice president of practice management and consulting at Fidelity Investments.

RIAs have welcomed the investments in part

because having PE backing gives a governance boost to the acquisitions they can make, she noted. “I don’t see the interest waning anytime soon. The RIA market is still very fragmented and still growing.”

Compared with other industries – accounting, insurance, or even airlines – the wealth management area is young, in an early stage of the consolidation curve.

“PE firms know right now that valuations and multiples aren’t yet going down. They’re still holding strong,” Delaney said.

Eventually, that will change.

“Some of the largest firms will start merging with one another,” leaving three to five major competitors in the market, Roth said. As the market matures, big firms can acquire other big ones, be sold, find a massive PE investor, or do an initial public offering, he said.

RE-UPPING THE INVESTMENT

As the appetite for dealmaking has continued, along with the competitive pressure for deals, the average size of acquisitions has declined. Five years ago, for example, acquisitions targeted firms with $5 billion in assets or more, but that has since gone down to less than $1 billion, Roth said.

A consequence of the recent wave of acquisitions is that the RIA or broker-dealer buyers face a lot of work afterward in integrating the smaller firms they took on. Companies like Hightower, Osaic, Cetera, and Focus Financial Partners have been on buying streaks that have consolidated the industry.

In Cetera’s case, its PE owner Genstar recently made a reinvestment in the firm, rather than cash out.

That is one example of the initial investment being a “bigger opportunity than they expected,” Roth said. “The firms [and] the investors have had the opportunity to do more acquisitions than they anticipated when they bought these firms.”

The trajectory of PE investments in the wealth management business “looks like a classic PE rollup and scale-up model,” said Paul Nary, assistant professor of management at the Wharton School at the University of Pennsylvania. While PE firms focus on returns on investment and value, their approach to getting returns in the RIA space appears less focused on improving struggling businesses and more about packaging up a lot of small entities that can be sold later at multiple, he noted.

“The important part is whether PE is the right owner or even partner for these firms,” Nary said.

For example, firms that sell when they are distressed or mismanaged can be undervalued and sell too low, he said.

STEADY FEES

Even though asset-based fees charged by advisors haven’t changed much, clients have benefited through lower investment costs, as portfolios are increasingly built with ETFs rather than mutual funds, for example, Roth said. That has made the overall cost of their wealth management services go down, and it’s part of why there hasn’t been pressure for advisors to lower their fees, he said.

“All along the way, the quality of service for the advisor and end clients is improving because [PE firms are] investing a lot of money in technology and services,” Roth said. “The clients themselves are seeing more value for less money, and it’s not coming out of the pocket of the financial advisor.”