Why is adviser compensation flat?

Adviser compensation is not growing with the same exuberance as it has in the past.

Prior to 2017, adviser wage growth exceeded 5% per year and reached as high as 8% in 2016. Over the past two years, however, average compensation to advisers has struggled to keep up with inflation and has even been negative.

This changing trend is the resounding headline of the 2019 InvestmentNews Adviser Compensation & Staffing Study, and it produces many signals about the direction of the industry.

As our team at The Ensemble Practice prepared to write this year’s study, the flattening trend of compensation begged for attention the way my dog begs when there is peanut butter on the counter: quietly, stoically, yet obviously and obnoxiously.

Advisory firms are exercising proper compensation management. The industry is managing human capital, aligning performance with results and paying attention to the labor market. In other words, advisory firms aren’t just paying employees what they can, they’re paying for what makes sense.

My path to this conclusion took some processing. Holding compensation flat could be a knee-jerk reaction by managers hedging against the risks of a market correction and not wanting to increase expenses in the face of potential decline in revenue, but there are many other factors that point to a change in how the industry is choosing to manage compensation.

In some ways, flattening compensation is an inconvenient inclusion to the overall narrative of an industry that has grown for 10 straight years. Historically, compensation has grown with firm revenue growth, and while compensation increased in this year’s study, this increase was lower than the industry’s median revenue growth of 11.1%.

Indeed, most increases in adviser positions were lower than the cost-of-living adjustment prescribed by the Social Security Administration (see table below). Now you tell me who should be more conservative with compensation growth: an advisory firm or the liability-strapped Social Security system.

One potential compensation narrative is owner greed and, in fact, average income per owner is near an all-time high ($734,000). However, if that story were true, then hiring and personnel development would be down to cut costs. They aren’t.

The real story is that compensation is flat because firms are in the midst of their human capital plans and are aligning compensation with results.

Evolved career ladders, refined compensation models

Compensation is flat because the market for advisers and staff is more developed than it has been in the past. As a result, there is more consistency across the industry.

Historically, the average advisory firm was much smaller and staff served very general roles. Each member of the team did whatever was needed to be done to keep the ship sailing. Now that the average firm size in the industry is $4.4 million in annual revenue, positions on the team have specific roles.

The adviser career ladder is no longer just a step stool. Large firms may have as many as five rungs on their career ladder, taking an adviser from entry-level analyst through to practicing partner. Each step in the career progression is well described, and firms are better at expressing the performance expectations for staff to satisfy the needs of the role. This has led to better-managed compensation.

As the industry continues to evolve and mature, we will see more differentiated roles, each with its own compensation growth expectations. Super ensembles, which represent the largest organizations and have annual revenue greater than $10 million, have been the fastest growing segment of advisory businesses over the past two years. These organizations have distinct roles and responsibilities that maximize the specialty skills of staff versus the general skills of everyone.

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Tying compensation to results

Take a look at revenue per professional, an industry-level adviser performance metric. Revenue per professional measures the productivity of advisers.

The fact that adviser compensation increases haven’t exceeded a simple cost-of-living adjustment is at least partially due to advisers not being more productive than they were five years ago, as seen in the chart below.

Productivity is a measure of adviser output. The metric tracks the amount of revenue advisers and other professionals can produce per person.

If the team of professionals generates more revenue, then the productivity ratio increases. However, if revenue declines or more staff are added, then the ratio decreases. In 2018, both revenue and the number of professionals per firm grew, effectively neutralizing productivity.

The addition of new staff is a necessary investment by advisory firms, but if the net result of new staff is the same level of revenue generation per professional, then there is no reason for general compensation to increase.

Of course, there are some advisers who contribute more and deserve higher compensation, but a bevy of new and developing advisers are at a point in their careers where they are contributing less than what is expected for their position.

There have to be results in order for you to pay for results. Compensation should be designed to support adviser development, but it can’t promote it. While firms are in the process of developing their own talent, they are also controlling the cost of it.

Firms invest in developing young talent

The choice by leading firms is to hire advisers early in their careers, then develop them into lead advisers. Compensation is flat because many advisers have been hired or promoted in recent years and are at the low end of the compensation range for their position.

In 2019, 82% of super ensembles had an adviser career path in place rather than hiring lead advisers.

As we saw in the 2017 edition of the InvestmentNews Compensation & Staffing Study, almost 40% of super ensembles hired for the support adviser position (the entry rung on the ladder), while only 14% recruited a lead adviser. Super ensembles are betting on successfully guiding early stage advisers on the career path, managing their growth and eventually promoting them to lead advisers, rather than investing in more experienced and highly compensated employees.

Growing the share of entry-level advisers in advisory firms is great news for an industry that in the past few years has been wailing about an adviser shortage. Wipe away your tears and build your own lead adviser.

Training early career advisers takes a lot of time because they must be mentored and managed, so perhaps this is easier said than done. Development programs, like the Ensemble Practice’s G2 Leadership Institute, are emerging to facilitate that professional growth.

For an industry that is validating its place among leading professions, it’s a good sign that advisory firms are investing in the next generation.

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What to do with this information

The maturation of firms in the industry is leading a more strategic approach to compensation. The goal is not to stagnate compensation in your firm but rather create a long-term human capital strategy and align compensation to your strategy.

In the short term, this means managing a more controlled rate of compensation growth with a disciplined approach to rewarding performance that will drive future growth in your firm. Answer the following questions for your firm:

• What people will your firm need in the coming years?

• What results do you expect from every position?

• How can each role impact the value of the firm?

• In a case scenario, if two employees have the same role, what activities and behaviors would make one employee more valuable to the team?

Industry compensation is flat today, but I see good reasons why that is true. The industry isn’t withholding pay, it is accruing new talent that just happens to be less expensive, and this has caused the growth of industry compensation to slow.

As an industry, we pause every few years from rampant growth to pick our heads up and see what we’ve learned. The current lesson is about managing the development of human capital, the most valuable resource of the advisory firm.

Brandon Odell is an industry management consultant and partner at The Ensemble Practice. He and his firm lead development of the annual benchmarking study of advisory firms in collaboration with InvestmentNews.