Weekend Reading for Financial Planners (July 17-18)

Author: Michael Kitces

Team Kitces

Michael Kitces is Head of Planning Strategy at Buckingham Strategic Wealth, which provides an evidence-based approach to private wealth management for near- and current retirees, and Buckingham Strategic Partners, a turnkey wealth management services provider supporting thousands of independent financial advisors through the scaling phase of growth.

In addition, he is a co-founder of the XY Planning Network, AdvicePay, fpPathfinder, and New Planner Recruiting, the former Practitioner Editor of the Journal of Financial Planning, the host of the Financial Advisor Success podcast, and the publisher of the popular financial planning industry blog Nerd’s Eye View through his website Kitces.com, dedicated to advancing knowledge in financial planning. In 2010, Michael was recognized with one of the FPA’s “Heart of Financial Planning” awards for his dedication and work in advancing the profession.

Read all of Michael’s articles here.

After RIA Pilot Test Soars, Vanguard Buys JustInvest To Enter Direct Indexing Game (Brooke Southall, RIABiz) - This week, Vanguard Group announced its first-ever acquisition of an outside firm, buying direct indexing startup JustInvest, after an early pilot test partnership between JustInvest and Vanguard's RIA platform quickly garnered $1B in AUM. In fact, Vanguard specifically notes that it is pairing the new direct indexing capability with its "financial intermediary" business (i.e., the Vanguard segment serving RIAs, broker-dealers, and banks), meaning that Vanguard sees direct indexing as a particular opportunity in the financial advisor channel. On the one hand, the deal certainly makes sense, in that Vanguard is already a recognized leader in indexing through its mutual funds and ETFs, and so if direct indexing will be the next 2.0 version of indexing, Vanguard would logically want to be a part of it. Yet in practice, one of the popular applications of direct indexing is not merely to replicate an underlying index, but to customize it (JustInvest's "Kaleidoscope" offering), whether based on the advisor's own preferences (e.g., overweighting factors like value and small-cap), or the client's (e.g., for various ESG-based investment filters)... which, from the advisor perspective, can be an appealing form of investment differentiation, but runs somewhat contrary to Vanguard's traditional "own the entire market and don't try to change it" indexing approach. Nonetheless, direct indexing has gained rapid momentum over the past year, with deals from Morgan Stanley acquiring Parametric (via Eaton Vance) and Blackrock acquiring Aperio, to a slew of FinTech-based investments from Fidelity putting more capital into Ethic Investing and JPMorgan acquiring OpenInvest, and Vanguard's deal not only provides a huge signal that it sees direct indexing as not just a fad but a bona fide trend, and may also serve to catalyze its growth, given Vanguard's immense reach and distribution with more than $3 trillion in advisor assets. The only question now is how Vanguard may further modify both the application and the cost of direct indexing, given its own unique business model and low-cost investing philosophy?

Will Biden's Executive Order Impact Financial Advisor Non-Competes? (Miriam Rozen, AdvisorHub) - Last week, the White House issued a new Executive Order on "promoting competition in the American Economy" that specifically raised concerns about how the rise of non-competes across a wide range of industries is limiting worker mobility, and directed Federal agencies to develop new guidelines that would "ban or limit non-compete agreements". At this point, it remains to be seen how exactly the Federal Trade Commission may apply the direction with specific guidance, but the fact that the White House has stated it is targeting "the unfair use of non-compete clauses... that may unfairly limit worker mobility" suggests that non-competes in industries like financial services - where there are more bona fide reasons for firms to protect client relationships - may survive the new guidance. And of course, for many advisory firms, their employment agreements don't actually include a non-compete, but 'merely' a non-solicit that allows the advisor to continue being an advisor, but requires them to leave their existing clients behind and start over if they leave their firm. Still, though, when advisors' clients are impacted by the platforms they choose to affiliate with, a case can be made that limiting the ability of advisors to switch firms with their clients is not only a potential harm to advisors, but also a potential harm to clients. Which is important, as industry scrutiny on non-competes and non-solicits has already been on the rise, not only within wirehouses and other large brokerage firms, but even amongst independent RIAs where non-competes have been increasingly common. In the end, it will likely still be at least 2022 before new formal guidance or rules from the FTC actually comes out, pursuant to the Executive Order. But stay tuned for whether government regulations may soon force a change in the use of non-compete (and non-solicit) provisions in advisory firms?

Carson Group Valued At Over $1B As Bain Capital Buys Stake (Andrew Welsch, Barron's) - This week, the Carson Group announced that it had received a new investment from private equity firm Bain Capital, that values Carson Wealth and its $17B of AUM and 37,000 clients at more than $1B of enterprise value. The transaction will replace current private equity investor Long Ridge Equity Partners, which bought a 29% stake back in 2016 for $35M, valuing Carson and what at the time was its $6B of AUM at approximately $120M back then. Notably, Carson emphasized that he remains both the majority owner and the CEO of the firm, and that he intends to leverage Bain's expertise in everything from operations to technology and artificial intelligence to help grow the firm to the next level. Nonetheless, with Carson's firm up "just" about 3X in AUM since 2016, but getting a more-than-8X valuation (which means Long Ridge Equity's stake grew from $35M to more than $290M in just 5 years!), has turned a lot of heads in the industry as valuations for RIAs - especially the largest firms - continue to garner ever-increasing, eye-popping valuations, with Carson raising capital at a significantly higher valuation than United Capital sold to Goldman Sachs (at $750M of enterprise value with more than $20B of AUM). On the other hand, with such a public deal, the Carson transaction is likely to simply set yet another 'benchmark' for other large advisory firms looking to raise capital themselves... which means the Carson transaction may not be a sign of a peak in RIA valuation, but instead set a new even-higher floor for the valuation of other large advisory firms (which in turn ripples down through mergers and acquisitions to the rest of the independent advisor community as well?)?

RIA Deal Activity Cools Slightly In Q2 (Michael Fischer, ThinkAdvisor) - As the second quarter comes to a close, the pace of mergers and acquisitions for independent advisory firms was down in Q2 (43 deals) compared to the prior quarter (58 deals), but is still up 51% over the deal pace in the first half of 2020, and is well on pace to eclipse the all-time high for advisory firm acquisitions (which was 159 total transactions in 2020). And notably, deal-tracking from DeVoe & Company 'only' includes RIAs with $100M+ of AUM, which means the total pace of deals is even higher. Overall, the rising pace of deals appears to be driven by the sheer magnitude of rising valuations, which is bringing even some reluctant sellers to the negotiating table, coupled with the stress of the 2020 pandemic that has driven at least some firm owners to reconsider whether they still want to retain the business risk of their ever-growing enterprises (especially in the $500M to $1B AUM bracket, which saw the biggest increase in deal activity). Notably, though, advisory firm transactions are still driven by a relatively narrow set of well-funded acquirers, with consolidators accounting for a plurality (41%) of the announced deals, and just 5 consolidators (Mercer Advisors, Beacon Pointe, CAPTRUST, Focus Financial, and Wealth Enhancement Group) responsible for more than 80% of those consolidator transactions. On the other hand, advisors selling minority stakes to raise capital for their own growth remains strong as well, with Echelon reporting that 2021 is on pace for 18 minority transactions (which appear to be especially concentrated amongst mega-RIAs looking for more capital to accelerate their own sub-acquisition trends).

Have Valuations For RIA Firms Risen Too Much? (Investment News) - There is no doubt that valuations of independent advisory firms are on the rise, as a rule of thumb of 1.5X to 2X revenue a decade ago is being supplanted by 2.5X to 3X and more for the largest and best-run advisory firms (albeit with still much-lower valuations for firms that have not yet reached critical mass and transferrable value beyond the founder). Yet the rise in valuations is setting off a broader debate about whether the trend is actually healthy or not. On the one hand, some contend that the rise in valuations is simply an acknowledgment of the robust value of providing fiduciary advice, and that the broader industry is finally recognizing just how much more valuable an advice relationship is over a commission-based transactional one (as brokerage firms continue to see far lower valuations on their commission-based revenue). On the other hand, a rapid acceleration in valuations can also be a sign of 'over-commercialization' of advisory firms, an environment where a focus on valuations and profits can supplant the otherwise healthy balance between the profitability of the firm and its depth of service to clients. Still, some have also raised concerns about whether advisory firms are simply getting overvalued - an industry version of the Dutch tulip mania - though in the end, the narrow buying activity is the exact opposite of a classic 'mania' (where "everyone" is trying to buy in, blind to the price, value, or risks). But the fact that buying is occurring from a relatively small subset of well-funded buyers is also concerning, as it still raises questions of what happens when those PE firms no longer have so much dry powder to deploy, and the level of buying demand decreases. Nonetheless, as long as advisory firms continue to experience organic growth rates with client referrals, coupled with a rise in revenue due to the associated rise in AUM that comes with market growth over time, there still appears to be some healthy and rising 'floor' on the valuation of advisory firms that should stick around even if buyer demand slows?

The Misguided Fear of Consolidation in the Advisory Profession (Bob Veres, Advisor Perspectives) - Nearly 20 years ago, there was a huge stir in the advisory profession, when Mark Hurley wrote a series of white papers that predicted a massive consolidation of the financial advice business, where a small number of firms would consolidate all of their competitors and then use their economies of scale to drive small firms out of business altogether... stoking a race amongst independent advisory firms to grow to at least $1B of AUM so they could be the 'survivors'. Yet as Veres notes, 20 years ago there were already mega-firms that had national reach and huge economies of scale... they were known as wirehouses, and it was the smaller firms that were taking market share from them (not losing to national-scale competitors). In addition, while other service-based professions (e.g., law and accounting) do have national mega-scale firms, there are still a number of smaller regionally based firms that are doing just fine, and in both of those professions, the majority of the profession is still made up of smaller firms - solos or small partnership of 3-10 principals - who aren't being put out of business by their national-scale brethren. Accordingly, in the 20 years since Hurley's white papers, the independent advisory movement has flourished, taking market share every year from its larger competitors, and 'smaller' advisory firms are more profitable than ever (due in no small part to the boon of advisor technology that has made firms leaner and more efficient than ever). Still, though, Veres notes that as advisory industry consolidation is on the rise as valuations increase, there is buzz once again that the mega-firm may soon reign, and that smaller independent advisory firms will struggle to compete against their mega-RIA brethren. But in the end, Veres suggests that the prediction isn't any more likely today than it was 20 years ago, as smaller firms still continue to be more nimble and more able to form deep relationships with clients, the rise of technology continues to make smaller firms more and more efficient (and the largest technology providers now are independent tech firms, not proprietary tech offerings from the advisor platforms!), and smaller firms in some ways have less financial pressure (as they don't have private equity investors to answer to). Ultimately, then, Veres concludes that the future doesn't necessarily belong to the largest firms - after all, many of the largest firms of the past that are still around today aren't viewed as dominators, but dinosaurs(!) - but those that remain the most nimble and able to navigate the changing times... which is what dictated success in the face of the Hurley white paper, and remains just as relevant today?

When Less Is More (Philip Palaveev, Financial Advisor) - The typical homepage of an advisory firm features a happy multi-generational family... a tacit acknowledgment of the firm's long-term focus and its ability to serve any client, regardless of their age or stage of life, from the (retired) grandparents to the rising wealth of their mature-career children, to the next generation (and future-heir) grandchildren. Yet as Palaveev notes, that message of "we listen, we care, and we help you achieve your financial goals [whatever your situation may be]" is so generic that in some cases, it's possible to even find the same stock photos of those 'ideal' clients across multiple advisory firm websites! In practice, this is part of the natural progression for any type of good or service; initially when a new solution first arrives, availability alone is important, and service or capabilities tend to be generic (e.g., in March of 2020, we just wanted to buy any face mask we could, even if it was $50 for a dozen disposable masks via Amazon!). However, as the market matures and becomes more competitive, the only way to survive and thrive is with narrower and more targeted offerings (e.g., today the generic masks are often available for free, and the money is in specialized masks for everything from sports to fashion to personal expression). When it comes to advisory firms, though, Palaveev suggests that the industry has already passed the crossroads of competition from generalist to specialist... even as most firms are still clinging to the generic approach, with founders who are stuck in the 'old days' when generic was enough (because the marketplace had less competition) but haven't recognized that the current landscape is different. Nonetheless, when looking to the fastest growing firms today, niches are increasingly dominating, and the largest firms are often simply ones that develop multiple niches over time (e.g., Palaveev's own former firm, Moss Adams, generated $600M in revenue, of which more than 80% came from a series of niches that it focused on). After all, the reality is that consumers generally don't seek out a financial advisor "just" to get a comprehensive financial plan; instead, they seek out an advisor to solve a specific problem, which means the more specific the advisor is at solving that problem (especially if it's a high-stakes problem), the more likely the advisor is to get noticed and win the business in the first place. Ultimately, Palaveev suggests that if advisors can't convince their firms to focus into a niche, that younger, next-generation advisors should simply start specializing themselves.

To Build A Thriving Niche Practice, Learn When To Say No (Joe Elsasser, ThinkAdvisor) - As advisory firms get past the initial stage of survival, their focus turns from just trying to get 'any' client to instead trying to attract the 'ideal' client. Yet for even the most mature advisory firms that have identified their ideal client profile, the ideal client is just that - an ideal, that they would like to get if they can... even as the firm continues to work with whoever it can. But Elsasser notes that in the end, being competitive for an advisory firm's ideal clients - who are often another advisor's ideal client as well (thanks to their affluence and business potential) - means being truly excellent at whatever that particular ideal client needs. Which means, in practice, that the firm must focus on what it does for those ideal clients, as it's the repetition of services for those ideal clients that builds the firm's experience, expertise, capabilities, and reputation. Or stated more simply - if the firm continues to work with ideal and non-ideal clients, the work it does with non-ideal clients will limit how much time, opportunity, and focus the firm will ever have to truly excel with its ideal clients. Accordingly, success within a niche ultimately means that the firm must truly focus there - and say "no" to clients who are not in the firm's ideal focus - because if the firm doesn't make room to deepen its expertise for its ideal clients, it never will. Notably, this doesn't mean that the firm will never work with any other type of client - in fact, niches themselves often evolve over time, and working with one type of focused clientele can itself lead to another type of focused clientele as the advisor goes deeper into the niche. Nonetheless, the point remains that while firms are often tempted to accept any client they can - especially when they don't feel like they have enough of their ideal clients coming in - the reality is that by accepting more and more non-ideal clients, the firm so distracts its focus that it may never achieve traction with its ideal clientele; or viewed another way, the only firms that can afford to focus within and beyond their ideal niche clientele are paradoxically the ones that already have more prospects than they need, while the rest need to focus more to actually break through to the next level.

Building a Niche Advisory Firm From the Ground Up (Samuel Deane, Morningstar) - For most of its history, the financial advisory business has been a business of generalists, who were focused on trying to work with any client regardless of their background or situation... as long as they could buy the advisor's products for sale (from stocks to mutual funds to insurance to annuities to managed accounts). Accordingly, advisors were primarily hired for their "natural markets" - the lists of their friends and family, to whom they might be able to sell those financial services products to get their careers going. As Deane started his own advisory business - as a young 20-something advisor with no natural market - he realized that he would have to find another way to differentiate and succeed... and so he decided early on to focus his own practice (working with millennials in the technology industry). After all, most consumers seek out an advisor when they have a particular problem; as a result, if you imagine an employee of a tech startup looking for a financial advisor because they're about to have a liquidity event when their company IPOs, and they talk to three advisors - one of whom specializes with tech employees, and the other two are generalists - who, realistically, is going to be chosen? The advisor who best solves that individual's specific problem. Still, though, Deane notes that as he's built his niche, it has evolved over time, leading to deepening expertise in specific areas, and a refinement of his own business and service model. Still, though, the point remains that Deane's ability to grow - especially as a newer and younger advisor - was focused on the fact that he wasn't trying to build an advisory business, per se... he was trying to solve a specific client problem, and then attract clients who had that problem that he could solve. In turn, once you're clear on the particular problem you solve, it's far easier to market - which simply becomes a matter of sharing that expertise (i.e., creating content, from written blogs to videos), to be seen as a trusted resource in the community regarding the specific problem you solve. Which is what eventually brings ideal clients to you, instead of having to seek them out! Or viewed another way, while it takes time to develop specialized expertise in the first place, the differentiation it creates becomes a form of "free" marketing in the digital age!

Discipline Equals Freedom (Joseph Wells) - The natural state of the world is entropy... a natural progression towards increasing disorder, which takes some affirmative step or action to contain. In the context of our lives, this means that the longer we take to address a challenge, from minor to significant, the more complex it ultimately will be to fix when the time comes. For instance, Wells notes that every morning, his father used to walk into the driveway and quickly wipe the bugs off his truck (which was easy with the freshness of the flies and the morning dew), which meant he could easily maintain a shiny spotless car; by contrast, though, if he waited, he'd inevitably end out spending hours with a bucket of hot, soapy water, working in the summer sun to clean off the car (a battle he may or may not even win). The key point: by taking an ongoing series of small disciplined steps, we can buy the freedom we want to achieve by preventing entropy from taking over. Accordingly, in the words of Jock Willink, "discipline equals freedom"; thus, we apply the discipline of stretching to enjoy freedom from injury, and we apply the discipline of saving to enjoy the freedom of retirement. Yet in practice, few apply this approach, leading to binge efforts (e.g., the wedding diet to lose weight for the wedding pictures), instead of trying to adopt a habit of fitness that makes the wedding diet a moot point. Or stated more simply, "staying ready means you never have to get ready". In addition, having the habits of discipline also provides greater freedom to have exceptions from the discipline; for instance, Wells didn't have to stress about missing his workouts for a busy few weeks, because he had spent years exercising daily, and was able to take a lower-paying, more-enjoyable job because he had spent years with the discipline of saving a high percentage of his income in his prior role. Unfortunately, though, we rarely recognize the benefits of good habits, until we experience the discipline droughts when they come. But the fact remains that while discipline may feel restricting in the moment, it can actually be the most liberating thing in the long run.

Attention Is The Cash Value Of Time (Tony Isola) - These days, there is a growing focus on the fact that our scarcest resource isn't really our money, it's our time. But Isola makes the case that it's not really time that is truly our scarcest resource either... it's attention, and how we focus that time. After all, having more time - e.g., by living to 100 - doesn't guarantee happiness; what determines happiness in our lives is how we focus the attention we have (thus why forgiveness is so important, as ruminating on our challenges and sleights ultimately just focuses our attention on the very thing that brought us sadness). Which means it's extremely important to be conscious in determining how we focus our attention. In this context, money is still important, because it provides the resources that give us more freedom to focus our attention as we wish, on the things that we can enjoy the most. Unfortunately, though, we often don't realize this until our later years... when our health may have declined to the point that we can't enjoy our money as much as we used to. In fact, Isola goes so far as to raise the question of whether we might be happier by choosing to live paycheck-to-paycheck when we're young, precisely because that's the time when we can best maximize the enjoyment of our dollars (because we have the health and energy to do so)? Nonetheless, the point simply remains that, regardless of age, the growing focus is not just on money, nor time, but how we focus our attention with the time that we've got... such that a recent InvestmentNews article highlighted a survey that current retirees state that the non-financial aspects of retirement are equally important to the financial parts, including how to live a healthy life, how to maintain or improve family relationships, and how to find activities that impart a sense of purpose as we focus our attention for the time we have left.

The More Options You Have, The Happier You Are (Darius Foroux) - In his book "Too Soon Old, Too Late Smart", Gordon Livingston highlights how one of the greatest drivers of our mental health is our ability to choose; in other words, the more choices we have, the happier we tend to be, often even regardless of what those choices are (as even being able to have some control over a number of less-than-ideal choices is still better than having no control over our situation and no choices at all!). Yet the irony is that because human beings are typically risk-averse, we tend to resist change and remain with the status quo (e.g., sticking with the same job until we get fired or retire, even if we're otherwise unhappy with it); in other words, even though we tend to be happier with more choices, when it comes to careers, in particular, we tend to resist putting ourselves in a position to even have choices in the first place! Or stated more simply, "if we take counsel of our fears, particularly our fear of change, it is hard to choose a life that makes us happy"! In Foroux's context, he focused on developing skills - ones that can have application across a wide range of industries - because that gave him more choices and flexibility around the career (and even the industry) that he chose. Of course, taking on that focus - to build the skills, savings, or whatever it takes to have more career and other options - does itself take discipline and personal sacrifice. But that's also the point - while having more choices can build happiness, it does come at a cost of taking the risk of investing into ourselves in the short term, in order to gain that long-term benefit. So the question is: how are you investing in yourself today to create more choices (and happiness) for yourself in the long run?

I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!

In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Craig Iskowitz's "Wealth Management Today" blog, as well as Gavin Spitzner's "Wealth Management Weekly" blog.