Avoiding the Value Trap

Is the value you believe you offer the same as the one the client perceives?  I raise this question because I am meeting so many advisors who are confusing the idea that their clients trust them to manage their financial affairs with the idea that their clients trust only them to invest the money.  As a consequence, they are trapped: their businesses are often not growing and they feel unable to change course, all because they misunderstand the fundamental value proposition that underlies their client relationships.  In the past, this wrong turn was into the right neighborhood – asset management – which proved profitable regardless; but the neighborhood is changing and I argue that you should use this strategic planning season to reconsider your path and maybe even ask for directions.

As you know, we are talking to financial advisors across the country every day.  I would categorize them basically into three camps: (a) the money manager, (b) the financial planner and (c) the break-away advisor.  What fundamentally separates them is where they see their value-added to the client.  The latter two advisors see their role as quarterback of their clients’ financial affairs: identifying needs and bringing together the most appropriate resources to address those needs.  The focus is on the client, not the individual products.  And by not getting bogged down in the manufacture of products, these advisors deliver great client service, generate referrals and have enough time left over for new business development.

The independent money manager, on the other hand, consistently tells me that he/she is struggling to grow the firm.  These firms generally do not offer financial planning and when they do, it’s typically as a means to attract assets.  The advisor’s day-to-day responsibilities are really focused on money management.  So when I ask about their marketing plans, I typically hear (a) that there is not enough time to market, or (b) that marketing efforts have been ineffective or, surprisingly, (c) that the advisor really doesn’t like to spend time with his/her existing clients at all let alone prospecting for new clients – instead they would prefer to stay parked behind the Bloomberg screen.

Given the above, it stands to reason that the advisor needs to either partner with another advisor to serve as rainmaker or hire someone to lead the marketing effort.  Given the lack of scale at many of these firms (i.e. less than $100MM AUM), they explain both options are too expensive.  The usual “chicken and the egg” problem: they can’t afford to hire someone because assets are too low but they cannot add assets until they hire someone.  So they try to engage someone to work on a contingency basis to build their business: work for me for free and if you succeed in getting me any clients, I’ll keep 80% of revenues and maybe you can have 20%.  If you manage to convince someone, very often you get what you pay for.  More to the point, there is no business without the customer so the split seems slim unless you have such an outstanding money management product that sells itself … but then if you did you would not have a marketing problem.

Which begs the final question and the value trap: why don’t you partner or outsource the money management product to free your time to be a rainmaker so you can build your business?  And of course, the answer is always that their clients trust only them to invest the money and/or that they don’t trust anyone else to manage the money for them.  Well, as a former hedge fund manager, I hate to break it to all you aspiring money managers, but the retail client is not well enough informed to know whether your cooking is any better than anyone else’s and most academic studies show that on average it isn’t.  Most retail clients and many financial advisors cannot tell the difference between money managers because identifying someone who can manage risk is hard … it’s very intangible.  In other words, the business value is in the client not the money management.

And to make matters worse, the neighborhood – asset management – isn’t what it used to be.  As a former Wall Street Journal All-Star Financial Sector Analyst, I am here to tell you that there is a glut of money managers and a shortage of investors.  And since investors are unable to differentiate between funds, the advantage is accruing to money managers with the scale to support brand, marketing and lower prices.  They are taking share by squeezing smaller managers.  The retail investor finds it much easier to feel comfortable with Bill Gross at PIMCO because he appears every day on CNBC, leads one of the largest money managers in the world, meets regularly with world dignitaries and investors, and every investment platform in the country will cater to his marketing demands in order to have his firm be an anchor tenant on their platform.   So while you wonder how to hire a single person to market your fund, he has an army of people on staff and around the industry saturating the market for him.

What’s more, very often these large fund complexes will cut prices for business.  Why?  Because marginal profitability is so high for these large firms, they can still make a fortune by cutting prices and taking market share.  This fall I had an opportunity to sit down with an advisor friend of mine.  He runs a very successful practice, but even he described the pricing pressures out there for money management only mandates.  He was bidding for a client at prices about 0.75% until Schwab entered the fray and forced his price down to 0.50% to win the business.  The good news?  In a summer that saw markets and AUM fall, he was able to offset some loss of revenues with this business win.  The bad news?  He had to slash prices this time and will likely need to again because large players like Schwab will not relent.  What’s more, over time, legacy business may need to be re-priced lower if these new prices become pervasive.  I saw this in 2010 at a leading institutional research firm.  They rolled out a new research product that sold like gangbusters, but in this environment where everyone is cutting prices, he saw prices for his legacy research products cut in half so on balance he had a flat year.

In the 1980s there were lots of hedge funds in the sub-$100 million size.  During the late 1990s, the minimum effective scale increased to $100MM.  Today, I would argue the minimum effective scale is $1 billion.  The scale is required to support (a) a robust research effort in terms of people, research, and travel, (b) an equally robust sales and marketing effort, (c) an operations budget sufficient to support expanding technology, regulatory and compliance requirements and (d) declining prices.

So our recommendation during this strategic planning season is to set aside some time to (a) give real thought to where you are adding value to your clients and (b) make an honest evaluation of your progress toward your goals giving consideration to the discrete steps that can be taken to move your business forward.  As they say, time is money.  If you are so busy climbing the ladder that you fail to consider what wall the ladder is leaning against, you may find that failing to take this time is very expensive in the long run.

As always, Pinnacle Advisor Solutions is here to help.  Please feel free to use us as a resource to help identify the right solutions for your firm.  You can schedule a call with us right now by clicking on schedule a call.

And please stay tuned, we are near ready to announce a unique new partnership that may be a useful first step in identifying the most important needs of your firm at a previously unavailable price.  Thanks for listening!

About Pinnacle Advisor Solutions 

Pinnacle Advisor Solutions is a new division of Pinnacle Advisory Group that offers comprehensive, custom and private-label business solutions to emerging independent financial advisors who are committed to growing their firm profitably and developing the practice they always wanted. Designed by advisors for advisors, these solutions are proven in the field to (a) free advisor time to grow their firms, (b) produce alpha and reduce downside capture in volatile investment markets, (c) build equity in the business and (d) improve compliance.  In addition to more than twenty-years of experience growing its own firm to more than 700 families and over $1 billion AUM, these solutions incorporate more than a year of direct interviews with independent financial advisors.  (www.PinnacleAdvisorSolutions.com 

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