While early adopters of the assets-under-management (AUM) model got started in the late 1980s or early 1990s, the model only really began to become widely adopted in the early 2000s. Yet as the AUM model has become increasingly popular, and firms have had time to build, the “typical” advisory firm has grown significantly, from an average of only $25M of AUM in 2002 to more than $200M of AUM in 2013. And with an average profit margin of about 22%, the typical advisory firm owner with an AUM practice is enjoying record take-home pay.
Yet the caveat is that as advisory firms on the AUM model have grown, their growth rates seem to be slowing, a combination of both the ongoing crisis of differentiation for advisory firms, and the simple fact that as the firm gets bigger the denominator of the growth rate fraction is difficult to overcome; after all, adding “just” $4M of new assets a decade ago would have been double-digit organic growth, yet the same new asset flows yielded barely a 4% growth rate for a typical firm in 2009 and would be less than a 2% growth rate for the average firm today!
The significant danger of this situation is that advisory firms with now-low growth rates will not be able to grow through the next bear market as they have in the past. And in fact, at an average profit margin of “just” 22% and the risk that the next bear market could lop off 25% or more from a firm’s assets and revenue, the reality is that not all advisory firms may even survive the next downturn! Or at least, not without laying off significant staff or forcing owners to stop taking any profits and actually plow money back into the firm just to ensure its survival. To say the least, the next bear market may be the worst one ever for advisors and their firms!
These risks – which seem somewhat inevitable, given that a market downturn will eventually happen, and so many advisory firms are too large to just grow their way through it – mean advisory firms should be focusing, now, on whether they have sufficient flexibility to their overhead costs, other means to stabilize revenues, or enough profit margins to absorb the next market decline when it comes. While many have been critical that advisory firms are “too profitable” and due for some competition in today’s environment, the reality is that judging profit margins after a 5-year bull market may not be the best measure, and in fact the greatest risk for most firms may be that their profit margins are still too small to withstand the next bear market when it comes along!