FINANCIAL PLANNING
How Small Wealth Management Firms Can Become Hugely Valuable
By Mark Hurley
Early 2022 marked the end of an incredible decade for wealth managers. A raging U.S. equity bull market had inflated client assets and fees, tripling and even quadrupling the profitability of many wealth management firms, even if they added no net new clients.
Unfortunately, all good times must come to an end. In March 2022, the Federal Reserve began to aggressively combat inflation. Markets corrected in a sign of more challenging times to come. Now, owners are trying to figure out what comes next and what they must do to continue to flourish.
The Rise of Specialist Wealth Managers
A key aspect of research recently conducted by my firm considered what smaller firms—wealth managers currently with $200 million to $2 billion in AUM—must do to remain successful. Indeed, we concluded that, notwithstanding a much more competitive environment and that every wealth manager will have to do much more for the same fees, a select group of smaller participants will be extraordinarily successful. They will be specialist wealth managers.
These are niche competitors, which exist in every field of business. They provide services and goods required by narrow groups of clients and for which the demand is insufficiently large to make them attractive opportunities for bigger competitors.
Niche competitors in wealth management will help small groups of clients in certain geographic areas diagnose and solve very complex problems. Money is only a means to an end, and wealth management is fundamentally about helping clients first to diagnose their problems and opportunities and then organize their finances to solve their problems and meet their goals. Specialist wealth managers provide those answers by developing extraordinarily deep and broad expertise.
Some Firms Don’t Specialize Narrowly Enough
Certainly, many advisory firms already view themselves as specialists. Many focus on physicians, business owners, or corporate executives. However, we found that most aren’t that specialized. The groups they target are too broad, and their advisors possess only limited expertise in the unique problems confronting these individuals.
For example, the economic models and the resulting complex problems faced by different types of doctors vary widely. Many surgeons generate the preponderance of their income from owning surgery and rehab centers rather than performing procedures. Dermatologists run capital-intensive enterprises involving lasers and other cosmetic equipment. Anesthesiologists’ earnings are tied to the number of patients they and their nurse anesthetists can treat.
Similarly, the type of business, more than being an owner, is a key factor in determining the problems that certain clients must solve. And executives’ careers vary widely not only by industry but also by subsection of that industry. For example, clients who own manufacturing businesses often make capital investments in new equipment. Their specialist wealth managers will help them identify the best potential sources of—and negotiate the terms for—the necessary debt funding. In contrast, clients who own businesses such as restaurants increasingly rely on technology to improve efficiency. Their specialist wealth managers will use their expertise in current and emerging restaurant technology platforms to help their clients identify and select the right ones for their company.
Helping to Build Wealth Instead of Simply Managing It
Rather than just helping clients manage wealth, these wealth managers also will help them create and build it. Those who advise executives will be as knowledgeable as executive recruiters. Those who advise business owners will understand the broad dynamics of the underlying industry as well as its best consultants.
These firms will also oversee every aspect of their clients’ financial lives, both unburdening and empowering them. And given that taxes effectively make the government a minimum 40% partner in everyone’s earnings and a 23.5% one in every enterprise, specialist wealth managers will have deep expertise in federal, state, and local tax laws as well as international and cross-border tax issues that affect their clients, their careers, and their businesses.
An essential aspect of their success will be brands that communicate this expertise to targeted prospects. As part of this, specialist wealth managers will identify and build relationships with groups with which these individuals affiliate. They will publish expert articles and contribute videos on websites and in publications that potential clients regularly read.
Certainly, all specialist wealth managers will have to become larger businesses than they are today to remain profitable. Every participant will have to do much more for clients. Fortunately, their scale will enable them to spread the associated fixed costs and reduce some pressure on margins. Additionally, they will be able to charge a premium price for their enhanced services. Their brands will also “pull” potential clients seeking their expertise to their firms. In contrast, large organizations will have to spend millions of dollars on sales and marketing to “push” clients to their businesses.
Eventually, a handful of these smaller firms will buy similar companies in other geographic markets, creating much bigger specialist enterprises. They also may acquire wealth managers with different specialties. Through a combination of high growth and acquisitions, some firms that today manage $200 million to $2 billion of client assets will manage more than $100 billion in 10 to 15 years.
One need only look at the investment management industry to get a preview of what will happen. Twenty-five years ago, it looked remarkably like the wealth management industry does today—i.e., highly fragmented with about 100 firms managing $25 billion to $100 billion and thousands of much smaller companies. Over time, 250 specialist investment manager firms emerged. Today, they manage between $5 billion and $200 billion of client assets using sophisticated, limited-capacity investment strategies designed to address relatively small allocations in client portfolios.
That said, building a specialist wealth manager will be extremely challenging. It requires decisive owners with very long-term investment horizons who are much more focused on creating enterprise value than sustaining short-term profitability. As described in our study, they will have to reengineer their companies’ operating models, recruit key staff, and make numerous investments that will not pay off for many years.
However, in 10 to 15 years, they will own some of wealth management’s most profitable and valuable businesses. More importantly, they will have materially affected and improved their clients’ lives.
Mark Hurley (mark.hurley@digpp.com) is CEO of Digital Privacy & Protection LLC. His white paper “Welcome to the Jungle – The Next Phase of the Evolution of the Wealth Management Industry” can be downloaded for free from his company’s website.
image credit: istock.com/imaginima