The registered investment advisory business had a knockout year in 2005, according to the recently released seventh-annual Rydex AdvisorsBenchmarking Survey. The average RIA created a much more profitable, efficient and client-focused business. There is just one fly in the ointment: 2005’s strong performance left some overly optimistic about the future, the advisory research and consulting firm says. (The unit is a division of Rydex Investments, the Rockville, Md., mutual fund and ETF manager.) The survey also showed that RIA use of ETFs shot up, while their use of hedge funds plummeted and their interest in separate or managed accounts waned. (For a copy of the full survey, click here.)

The national survey of 630 RIAs, released Aug. 1, showed RIAs increased median assets under management (AUM) by 18 percent, to $124 million; raised median revenues by 22 percent, to $1.32 million; and boosted median earnings by 30 percent, to $382,000, in 2005 versus the previous year. That puts median profit margins for the group at almost 29 percent—up from 22 percent in 2004. That’s not bad, especially when you consider that the retail brokerage arms of the major wirehouse firms tend to have margins between 10 percent and 22 percent.

So what was behind this growth? Not just market performance: After all, the S&P 500 rose just less than 5 percent last year. Instead, Rydex attributes it to the RIAs’ ability to expand client lists over the past three years and to acquire wealthier clients. In 2005, the median number of clients per firm increased 12 percent versus 2004, to 314. And these clients came from two places: retirement-plan rollovers (38 percent) and competitors (33 percent).

RIAs also raised client minimums and spent more time on their clients. Average client asset minimums rose 18 percent versus 2004, to $408,000, while advisors spent an average of 27 percent of their time on client service in 2005, up from 19 percent in 2004.

But some firms, particularly the mid-tier firms—those with AUM between $100 million and $200 million—may have amassed clients more quickly than they could tend to them, Rydex wrote. These firms have a much higher number of clients per principal than the smallest and largest firms, and had the lowest margins of the group—at 21 percent. (See p. 13, Chart 19). “Also, higher expenses and operating costs shrank the profit margins for these firms,” Rydex wrote in the report.

By comparison, the largest firms—those with AUM of $200 million and up—had margins of over 31 percent; the smallest—those with AUM of $50 million to $100 million—had margins of 29 percent.

As for asset classes, hedge funds were snubbed while ETFs surged in popularity. Only 11 percent of firms offered hedge funds in 2005, a steep drop from 43 percent in 2004. Meanwhile, 74 percent of firms offered exchange-traded funds, up from 42 percent the previous year. Separate or managed accounts were offered by 43 percent of firms, down from 61 percent.

Rydex warned that a strong 2005 may have gone to some advisors’ heads. Nearly a third (32 percent) project 30 percent-plus growth over the next five years, something that Rydex thinks may be overly optimistic. Although the median earnings growth rate for firms in 2005 was 30 percent, the average was closer to 17 percent. Only the top firms—identified as those with AUM over $200 million that offered at least four services, including financial planning and investment management—actually posted growth rates in excess of 30 percent. At least the rest of the firms have something to aspire to.