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Best Practices of Top Advisors

Who's faring the best with their advisory business plan--and how are they doing it?

Morningstar, 01/11/2013

Pricing services and targeting the most profitable clients are ongoing challenges for any business, but doing so amid a volatile market and a big industry shift in pricing models has made the task even more challenging for financial advisors.

To get some insight on who's faring the best with their advisory business plan--and how they're doing it--we sent some questions over to Pat Kennedy, Vice President of Product and Client Services for PriceMetrix, and his team. Based in Toronto, PriceMetrix directly measures aggregated data on millions of investors, transactions, and fee-based and transactional accounts representing over $3.5 trillion in investment assets. It crunches the data and pulls out insights to help wealth-management firms grow revenue and profits--and it also publishes some insightful reports on the retail wealth management industry.

1. Your research discovered that the outperformers raised their prices and opened more accounts while the comparison group (those in the bottom quartile), lowered their prices but still struggled to add more business. This seems contrary to basic economics. What's behind the willingness of the outperformers' customers to pay more, even amid a tough market environment? Can you point to any specific pricing strategies that tend to characterize the outperformers?

On the surface, it does seem to contravene the principles of economics that a higher price could create higher demand. But at the core, different investment advisors are not offering the same product. There are premium, basic, and discount services.

In our experience, advisors who are able to charge a premium have a well-defined and differentiated value proposition, which is communicated and demonstrated regularly to the client. They are confident that their price, while it may be at a premium, is competitively fair and reflective of the value they deliver. They are willing to discuss pricing openly with clients and are more likely to say no to a prospect because of a poor fit with their proposition or an unwillingness to pay.

Essentially it is the investors' perceived value of the service that the outperformer is providing that warrants the premium price/fees.

We also found that outperformers are more likely to have a pricing strategy and policy--for example, tying their pricing to a household segment. A pricing policy leads to price integrity, which is one of the most important and often overlooked attributes of effective pricing.

2. In your studies, you talk about something called 'sympathy pricing'; what is that?

A Sympathy Pricer is an advisor who tends to discount more when markets are falling. As the recent past has shown us, the role of the financial advisor is put to the test during volatile markets. Our data shows a higher incidence of discounting during turbulent markets amongst a subset of advisors.

Sympathy pricing is a dangerous practice. When markets weaken and Sympathy Pricers lower their price, they affirm to clients that value is best measured by market performance. What an advisor charges tells their clients a lot about the value they bring to the table.

While Sympathy Pricers follow the market on the way down, it is important to note that they do not reset their pricing as quickly when markets trend upward. Intuitively, it is much tougher to raise prices than it is to lower them!

Conversely, for an outperformer, poor markets are a time to shine. They are a time to remind clients about their long-term objectives and to reassure them of the advisor's value proposition and long-term plans. They also represent an excellent opportunity to grow--by attracting new business from other financial advisors who may be losing the confidence of their clients.

3. You've found that customer mix was a big distinguishing factor between the outperformers and the comparison group. Importantly, aggressively closing less-productive smaller accounts and opening more-productive mid- and high-net-worth accounts gave outperformers a big boost. On the flip side, although the comparison group also closed smaller accounts, the new accounts it opened weren't nearly as productive (or numerous). Why do you think the outperformers were so much more successful with the new accounts they opened and with their overall client mix improvements?

There are a lot of small households in the full-service retail wealth management industry today. In a typical book of business, more than half of the clients have less than $100,000 invested, and 40% of North American households pay their advisor less than $100 per year. Small, unproductive relationships produce a huge drain on advisor time and productivity and can represent a major compliance risk.

Many advisors mistakenly believe that small households will eventually become big ones. In this case, our data and analysis proves the saying "hope is not a strategy"--small households are 108 times more likely to leave than become large.

Our data shows, over and over again, that advisors grow faster when they reduce the proportion of small households in their business. In fact, a 1% reduction in the proportion of small households yields $7,700 more in annual production for the typical advisor.

Most advisors intuitively know that small households can be a drain on overall productivity, but still have trouble saying "no." Outperformers recognize that, by saying "no" to some, they will have the capacity to deliver more to those who fit with their core value proposition--turning clients with greater potential into more productive relationships. In the long run, this more-focused approach to running your book will be more attractive to those clients that you do choose to work with.

4. Your research found that outperformers are moving to fee-based models and products at a faster rate than others are. What are the business implications for advisors who transition to a fee-based model?

The shift away from traditional, commission-based business toward fee-based models is an ongoing and clearly important trend in the industry. In the last three years alone, the percentage of full-service assets in fee-based accounts has grown from 21% to 28%.

Receiving an asset-based fee offers more consistency in revenue stream, something that is attractive to many advisors, as well as investors. As an advisor, you are delivering value to your clients all the time, not just when you place an order, so aligning the timing of value delivery and the payment structure has its advantages.

As well, investors like knowing that they're paying their advisor more as their portfolio grows, and less if it gets smaller. This has been brought to light with the turmoil on Wall Street over the last few years.

Households that have one or more fee accounts generate an ROA that is 40 to 70 basis points higher than households that are purely transactional, across all household sizes. The average fee-based account is 46% larger than the average transactional account, and generates revenue that is more than three times higher.

Because households with fee accounts tend to have more productive, larger relationships, there is a strong correlation between outperformance and transitioning aggressively to fee. Advisors who increased their assets in fee-based accounts by 25 percentage points or more have seen revenue growth of 47% over the past three years, more than double the average growth rate of 21%.

5. Despite the trend toward fee-based management, you also discovered that outperformers are still very careful about managing their transactional business (and the mix between fee and transaction). What steps are they taking?

The proliferation of fee-based management is hard to ignore: 91% of advisors in the North American retail wealth management industry have at least one fee account in their book of business. While fee-based accounts are increasingly a part of everyday life, few advisors have completely abandoned the transactional model. Of the advisors we track, only 1% have 90% or more of their assets in fee programs.

Clearly, both clients and firms are demanding that advisors offer a breadth of products and services to satisfy a wide variety of client objectives. Increasingly, individual clients are choosing to hold both fee-based accounts and transactional accounts. The percentage of these "hybrid" households has grown 41% since 2008. In this case, advisors need to think about their price models holistically at the household level--and seek to have a very good understanding of what and how each household is paying.

Similarly, advisors need to really understand what's driving the revenue in their book. For example, deeply discounting your transactional business because you are in the midst of a transition to fee can have a significant impact on your near-term productivity.

Outperformers are proactive in addressing the changing needs and demands of their clients. Many have learned to service both fee-based and transactional accounts, ensuring they are able to define the features and benefits of both and explain the differences in pricing models. Just like variable and fixed-rate mortgages, there is a market for both types of accounts, and consumers may choose one or the other, or, increasingly, both.

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