A Matter of Trust 2007A Matter of Trust 2007

Halah Touralai

IN 2002, together with fifteen colleagues, Mark Feldman fled the rapidly imploding accounting firm Arthur Anderson, where he and the others worked in the firm's financial advisory unit. Feldman and his friends promptly launched a registered investment advisory (RIA) named Inlign Wealth Management, bringing with them about $368 million in assets and 75 clients. In just five years, Inlign's book of business grew by more than fivefold, bringing its assets under management to about $2 billion; the firm's book of clients doubled to 150.

In the past two years, a good chunk of Inlign's new assets have come directly from clients decamping wirehouses, says Feldman, CEO of Inlign, which, he says, is essentially a multi-family office. Recently, one former wirehouse client alone brought in $20 million in assets, plus an additional $80 million when he sold his business. That's some serious dosh. How is it that an RIA — run by advisors potentially tainted by the Arthur Anderson scandal — can grow so quickly, even stealing clients away from a wirehouse, the putative kings of the business? Feldman claims it's a combination of superior service, Inlign's focus on advice rather than product and the firm's location in the city of Phoenix, a community that he says is underserved by true financial advisors.

But Inlign is not the only RIA that is growing at such a rapid clip — and drawing blood from the big Wall Street firms. Total assets in the RIA channel hit $2.1 trillion in 2006, up 62 percent from $1.3 trillion in 2001, according to Schwab Institutional. Of course, that number is dwarfed by the wirehouses' aggregate $6.7 trillion in client assets. But clearly, RIAs are doing something right. The bigger they get, the greater their economies of scale, which means more resources and services for clients, and more potential competition for the biggest financial firms.

The RIA Advantage

There are a number of things working to the RIAs' advantage: Put simply, the biggest RIAs can already offer most of the same products that the wirehouse firms offer, says Philip Palaveev, a senior manager for consulting firm Moss Adams. And some of them offer even more services than a typical wirehouse rep does, such as in-depth tax planning and accounting.

In areas where wirehouses do have some product edge — in, say, alternative investments, such as funds of hedge funds and private equity offerings — most wirehouse reps aren't taking advantage, says Alok Kshirsagar, a partner at McKinsey & Co. Only a fifth of wirehouse reps actually offer these products to clients, according to Kshirsagar. “Wirehouse reps have access [to these vehicles], because they are part of global firms that have a wide array of offerings extending all the way to China. They have access to banking, lending products and structured products. That's hard to replicate,” he says. But until the majority of wirehouse reps really tap into this product wealth, the RIAs will continue to win assets, he says.

Another factor driving growth in the RIA sector is the lure of independence, says Palaveev. Some of the best advisors are attracted to the RIA channel because they see it as “a space to take their practice and turn it into a business.” Sometimes those advisors, too, come from the wirehouses. Schwab Institutional's Dave Welling, vice president of marketing and advisor business management, says in 2005 the average broker moving to an RIA from a wirehouse had about $65 million in assets under management. One year later, in 2006, that average went up 54 percent to $100 million in assets.

More important, RIAs may have a compelling marketing advantage in that, because they act as fiduciaries across the board, and don't manufacture their own products, investors see them as free from conflicts of interest. After all, the sins of Wall Street during the boom years, and subsequent regulatory bloodletting, are still fresh in plenty of investors’ minds. “To be able to say to a client, ‘At the end of the day, you are my only concern and you are my only business,' is very powerful,” Palaveev says.

And then there is the fact that at least some wirehouse reps seem to be making unfortunate mistakes with client accounts. It's clients with that kind of experience who are moving to the RIAs. According to a Schwab Institutional study of over 1,000 of its advisors, 49 percent of respondents' new clients came from full-service brokerage firms in 2006. And 75 percent of those clients came in without investment guideline statements (essentially financial plans that identify a client's financial goals and create systematic review processes that are aligned with those goals). In addition, over half did not have “appropriately” structured estate-planning documents. And 60 percent of advisors surveyed say that new clients from wirehouse firms came over with portfolios showing evidence of performance chasing. That's one of the reasons Welling says he expects an additional $80 billion in assets to shift over to Schwab from the wirehouses within the next four years. (Of course, wirehouse reps might ask: What other conclusion would Schwab Institutional, a platform for RIAs, come to?)

The F Word

It's taken some time, but clients have wised up to the difference between a product salesman and a fiduciary, and are seeking out the latter, says Rudy Adolf, CEO of Focus Financial Partners, an RIA holding company based in New York. “Investors are starting to understand the concept of a fiduciary. They have been dealing with a sales guy selling the latest product placed on his shelf, but now they are discovering this advisor who, by law, has to put their interests first. There's no question RIAs are winning because of their independent, fiduciary status as well as being entrepreneurs.”

Investment advisor reps (IARs), the term for advisors who work under an RIA, are required by law to follow the provisions of the Investment Advisers Act of 1940 stipulating that they act as fiduciaries. In other words, IARs must always put the best interests of their clients before their own. Registered reps must adhere to looser suitability standards.

Adolf, a former American Express executive, is betting that accelerated growth in the RIA industry will continue. He launched Focus Financial in early 2006 on the premise that he could acquire fast-growing RIAs and help them grow even faster. Essentially, Focus is a holding company that buys stakes in fee-only investment advisors, taking anywhere from a 40 percent to 60 percent stake, and aims to add incremental growth of 3 percent to 7 percent by offering assistance in marketing, business development, recruiting and technology. The model has become a popular one. Several holding companies like Focus have taken off in the last few years, and many are backed by private equity money, relying on the growth of the individual RIAs they acquire to fuel their own growth.

Consider Resnick Investment Advisors of Westport, CT. The firm is one of Focus Financial Partners' recently acquired RIAs. In 2006, Resnick Investment Advisors gained $100 million in assets and Resnick says there has been a steady 30 to 35 percent growth every year. And here's the rub: Resnick's principal owner, Marty Resnick, says 99 percent of its $540 million in assets have come from wirehouse firms.

Still, most wirehouses say they're not worried, and counter that they hardly lose any clients or advisors to the independent channel, RIA or otherwise. “We closely track asset shifts, that is, inflows and outflows of client assets from and to various competitors,” says a spokesman for Morgan Stanley.“The assets flowing to and from our main ‘wirehouse’ competitors far dwarf the flows to and from other competitors, including independents, by a factor of nearly three.” James Gorman, president of Morgan Stanley's Private Client Group, told Registered Rep. a few months ago, “It's definitely not hurting us. We've lost very, very few people to the independent channel who were strong advisors.”

While wirehouse executives say it's not hurting their own businesses, they do acknowledge that there has been a slow shift of assets and advisors to the independent world, including RIAs. But most of them describe it as a short-term trend. Gorman says it is like a pendulum that has swung too far in one direction and is bound to swing back. In other words, the assets and advisors that have defected will soon return to the wirehouses. “I think a lot of people are turning independent and they're going to regret doing it,” Gorman said.

But for now, at least, Welling says it's rare to see an advisor leave an RIA to go back to a wirehouse. “Once they move, it's a move for life. In my 10 years at Schwab, I've seen less than 10 [RIA advisors] move back to a wirehouse,” he says.

No Longer Boutiques

Growth in the RIA industry has been generously spread around. In 2001, median RIA assets under management stood at $42 million, according to Moss Adams' Compensation and Staffing Study. That number soared to $116 million in 2006, Moss Adams says. And asset growth in the sector reflects the fact that the RIAs are serving wealthier clientele, and grabbing a greater share of wallet, rather than increasing the numbers of client accounts they manage. The median number of clients RIAs served edged higher to 145 in 2006 from 130 in 2002.

Capture of wealthier clients has been good for business, of course. Average RIA revenues shot up to $1.8 million in 2006 from $752,000 in 2001. “In the last four years, the typical RIA practice has at least doubled in assets and revenue,” Palaveev says. “That's phenomenal growth. RIAs are going from unknown local boutique firms to large organizations with a true ability to compete and a significant presence.”

Adds Dennis Gallant, principal of Gallant Distribution Consulting in Sherborn, MA, “Ten years ago, you'd have trouble finding an RIA with more than $1 billion in assets under management.” Now there are almost 100.

And in another ten years? If the industry's champions are right, there may be 200 RIAs with $10 billion in assets under management. But Wall Street's giant wirehouse firms probably won't wait to find out.

AMERICA'S TOP 100 RIAs

Ranking compiled by Moss Adams LLP from data provided by Discovery Databases of Financial Intermediaries. Rankings are based on overall firm assets under management for firms meeting “retail firm” criteria, including the requirement that high-net-worth clients make up at least 50 percent of the firm's client base.

THE BIG KAHUNA

Born as a one-man shop, Oxford leads the RIA market in assets under management.

BY HALAH TOURYALAI

Oxford Financial Group

City: Carmel, IN.

Established: 1981

AUM: $7.5 billion

Number of Clients: 610

Number of Partners: 12

Number of Staff: 110

Like many small businesses, Oxford Financial Group began as a vision. In 1981, when Oxford's founder, Jeffrey Thomasson, was nearing the end of his MBA program at Indiana University, he realized that few were offering comprehensive financial advice to families. Sure, there were retail bankers, stockbrokers and insurance salesmen. But there were few providing all of that advice in one place, he says. (Of course, in those days, Glass-Steagall was a big barrier to all but RIAs acting as one-stop shops.)

“My vision was to look at families from a holistic standpoint to deal with estate planning, life insurance and investment management needs on an objective, independent platform,” says Thomasson. He was just 22 years old then, and launched Oxford Financial by hiring a part-time secretary. Thomasson cold-called lawyers and CPAs for the next three years in search of referrals.

By the end of its third year of operation, in May, 1984, Oxford had three employees and managed assets for about 50 clients, including some with investable assets of $5 million — “monster clients back then,” Thomasson says.

Oxford has come a long way: With $7.5 billion, it is the leading RIA in the market in terms of assets. There are now 12 partners and 110 employees, and a typical client at Oxford today has between $50 and $500 million in assets. Thomasson says the firm advises clients on another $7.5 billion in non-marketable (illiquid) assets, such as real estate and small businesses, that are not reported on its Form ADV.

While the general scope of wealth management services has stayed the same, Thomasson says the level of sophistication has increased since the firm's inception. For example, the firm has offered clients a wide variety of alternative investment vehicles for the last decade. Thomasson says his firm has devoted billions to alternative investment classes for clients, and boasts that few other RIAs are able to compete on the same scale as Oxford.

Scale is important in allowing the firm to access a variety of alternative investments. “We're able to look at hedge funds, private equity, real estate and natural resources. We're able to manage risk instead of placing a large bet on one hedge fund,” says Mark Green, Oxford's chief investment officer.

Another advantage the firm's large scale offers is that it can negotiate with money managers. For example, if there is a separately managed account manager with a $3 million minimum for an individual portfolio of small cap equities, Green says he can ask to have the minimum lowered. “When choosing a manager we look at the people involved and the performance as well. The philosophy has to be lined up with ours,” Green says.

Meanwhile, the firm continues to grow. In the last five years, Thomasson says assets, clients and revenue have doubled. He says he expects the same kind of growth for the next five years. “We've largely grown because we've stayed ahead of the curve on the needs of affluent families and their desire to invest in things other than traditional equity markets.”

THE INVESTMENT SPECIALISTS

The Quantitative Group sticks to what it does best.

BY HALAH TOURYALAI

The Quantitative Group

City: San Antonio, TX.

Established: 2004

AUM: $4.4 billion

Number of Clients: 325

Number of Partners: 6

Number of Staff: 16

The Quantitative Group hasn't bought into the hype surrounding “wealth management.” Instead, the San Antonio-based RIA sticks to what it does best — investment consulting. The group does not offer estate, financial or tax planning. The firm refers all of those services out to trusted business associates. CEO Joseph Sammons, his five partners and a staff of 16 are dedicated to the investment consulting process, which includes determining investment policy and asset allocation, the search and selection of managers, performance evaluation reviews and tweaking, when necessary, the portfolios they manage.

Basically, it's the institutional consultant model of yore. “Maybe we're a dinosaur firm. I'm not sure. But we really enjoy what we do and we're good at it,” Sammons says.

Mark Tibergien, a consultant with Moss Adams, says The Quantitative Group's model is evidence of the RIA world's roots in money management. “They are certainly not dinosaurs,” Tibergien says. “They are a good mutation of dinosaurs having emerged from a wirehouse and adopted a model to be advocates for clients on a fee-basis.”

In 1994, Sammons and two of his current partners moved from Prudential Securities to Smith Barney, where they added three more advisors to their group and became part of the firm's Consulting Group, a division of Citigroup Global Markets.

But after a decade at Smith Barney, the group felt the regulatory climate of the wirehouse model was keeping them from “developing our expertise.” Well, that and they figured they could keep more of the revenue they generated if they went off on their own.

So The Quantitative Group was launched in 2004, bringing with it $3 billion in client assets from Smith Barney. Today, as a dually licensed firm (affiliated with Dallas-based independent broker/dealer Williams Financial Group), Quantitative has about $4.4 billion in assets, and about 325 clients split more or less evenly between institutional and retail investors. (About 90 percent of its assets are on the RIA side of the business.)

The firm focuses on matching clients' goals with the right managers. The team uses three to four databases to select managers, narrowing down the options by risk, return and consistency. “We are a value-driven, small to mid-cap shop. We don't like high-growth, high-volatility managers. We don't have any index mandates, we're all active management,” Sammons says.

In an industry where more is often better, Sammons says the firm's clients (mostly former business owners and former officers of private companies) haven't voiced any complaints about the lack of estate or other planning offerings at the firm. On the contrary, the firm has grown at a pace of 15 percent annually in terms of assets, and between 15 and 20 percent in revenue.

In any case, Sammons says he is cautious about the firm growing any faster for fear that it would damage the quality of service. More growth would mean more employees — and that's not easy. “The challenge is finding people for the firm who look at your clients the same way you look at your clients,” Sammons says.

TEAMING WITH SUCCESS

Kochis Fitz' growth is built upon teamwork, and that culture is built into the firm's management structure.

BY CHRISTINA MUCCIOLO

Kochis Fitz

City: San Francisco, Calif.

Established: 1991

AUM: $1.9 billion

Number of Clients: 330

Number of Partners: 10

Number of Staff: 34

Tim Kochis and his colleague Linda Fitz launched Kochis Fitz in 1991 in downtown San Francisco with just a secretary for support. The following year, they brought over a number of loyal clients with about $20 million in asets (from former employer Deloitte), who had begun asking the pair to manage their accounts on a discretionary basis. It wasn't something they were able to do at Deloitte, so “rather than frustrate our clients,” says Kotchis, they jumped ship.

Today, Kochis Fitz has close to $2 billion in assets and is one of the largest registered investment advisors in the business. Kochis, a 34-year veteran of the financial advice business and CEO of the firm, says Kochis Fitz is not interested in growth for growth's sake. “We hope to have the right kind of pacing, in terms of staff and clients,” he says. “We're looking for a relatively small number of relatively rich individuals.” And yet, the business is growing at a robust pace: Over the past five years, Kochis Fitz has experienced 20 percent compound growth in EBIDTA (earnings before interest, depreciation, tax and amortization), and Kochis projects a similar growth rate for the forseeable future, while pre-tax profit margins are an astounding 40 percent.

Kochis points to the firm's culture of service and teamwork, which are supported by its compensation and management structures, as the keys to its success. For one thing, all of the firm's clients belong to the firm rather than to a particular advisor. According to Kochis, it's an absolute no-no to refer to anyone as “my client.” He explains, “The primary reason for doing it is the notion of teamwork, and complete avoidance of internal competition.”

This standard is reinforced by the fact that advisors are not compensated based on assets or account revenues. Instead, all staff (including principals and support employees) are paid base compensation, plus bonuses tied to established performance goals and cash profit-sharing equivalent to 5 percent of the firm's net profits. (Principals also get dividends based on their share of ownership.) With 10 principals, Kochis Fitz also has a very large number of co-owners for its size — according to Kochis most RIAs have no more than three. “That creates a lot of loyalty, a lot of people having a stake in the success of the business.”

Kochis Fitz offers a full suite of planning services, from taxes to insurance to estate planning, as well as access to real estate and private equity, and today the average portfolio size is about $8.5 million. As the firm has grown, Kochis has raised its client asset minimums and fees for service, but has lost very few clients. It charges hourly, project or retainer-based planning fees plus 85 basis points on assets, with a declining scale for accounts with over $5 million.

“We're often in competition with the wirehouses for people who have new wealth they want to manage. We win our fare share and more in those competitive environments,” says Kochis. “And the investment offering we have is just as good.”