Six years ago, for instance, Mark Hurley made a case for a coming consolidation in the investment advisory business.
Mr. Hurley isn't just anyone. He's the prime mover at Undiscovered Managers and a talented researcher. He's one of a handful of people working to turn the lessons of behavioral finance into good money management. In addition, the acknowledgements in "The Future of the Financial Advisory Business and the Delivery of Advice to the Semi-Affluent Investor" included three other people I take very seriously--- Richard Lee, David Diesslin, and David Folz, all in the Dallas/Fort Worth area.
Big firms, the 1999 study declared, would trump small firms because it was impossible for small shops to have the inventory of skills and talents required by today's financial markets. Equally important, it was very difficult for a small firm to achieve the economies of scale that only large firms can achieve. Finally, only large firms had the staying power to defer making a profit.
This is no academic matter.
There are lots of "semi-affluent investors" out there. Their numbers are growing rapidly. They have a big stake in how this works out.
What does it take to be considered "semi-affluent"? You need a net worth of at least $1 million but less than $10 million. (I cringe to think what they call all those people--- the vast majority of Americans--- who have less than $1 million.)
So now it's six years later and what do we learn from Investment News, a trade publication?
Small is doing just fine, thank you.
The latest figures on advisor firms show that small firms (those with assets under management less than $1 billion) have grown quite nicely between 2001 and 2005. The number of big firms has also grown, but not as much.
The main reason this is important to the semi-affluent is cost. The typical large firm aspires to earning 200 basis points a year on its smaller customers. They may settle for less, but most of the difference will come out of the sales representatives' cut.
What investors actually need is quite different. Investors need the lowest possible costs for managing their money. Fortunately there is growing evidence that small firms can thrive while charging much less than large firms.
How can they do this?
Here are four powerful drivers:
• Small advisory firms can be profitable on lower charges. Merrill Lynch, Morgan Stanley, UBS--- all the traditional brokerage firms---would die on fees that averaged 50 basis points a year. They could not survive because their brokers have to share so much of their revenue with legions of higher-ups whose compensation expectations are measured in millions. Ditto the insurance industry and its products. Most of the large financial service firms have a business model burdened with overhead costs as crippling as the costs General Motors has for retired workers's medical expenses. Small firms don't have such overhead. Have $100 million under management--- no more than 100 "semi-affluent" accounts--- and a 50-basis-point advisor has $500,000 of annual revenue. Far less revenue has been known to keep the wolf from the door.
• Technology drives toward decentralization, not centralization. Big computers have been supplanted by small computers. Large manufacturing plants have been displaced by smaller local plants. Large corporations haven't been a source of job creation for decades.
• The overhead cost of investment management continues to decline. Software and data that cost $20,000 a year nearly 30 years ago can now be had for $2,000 a year. Sometimes it is free. Skeptics should check the tax return data provided by Fidelity Investments for its online investors and any number of investment data websites.
• The cost of investment "products" continues to decline. While brokerage and insurance products continue to be priced at damaging levels, the emergence and proliferation of Exchange Traded Funds now provides a clear alternative with nominal trading costs.
On the web:
Tuesday, October 12, 1999: The Next Revolution in Financial Advice
Sunday, October 24, 1999: Are You "Semi-Affluent?"
Mark Hurley research on investment management firm size
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