When we published our recent paper, ‘No small change’, we generated some bizarre reaction in parts of adviser world. One anonymous commentator implied very foul language, indicated that disagreeing with him would be brave and referred to ‘grassing up dinner ladies’. The last comment rather lost me, but hey ho. These unpleasant remarks were addressed at an IFA who had the temerity to agree with our findings.
So lets go back to this apparently contentious issue – size matters.
Our hypothesis on this one is that RDR creates a much greater load for the adviser business to carry, in terms of regulatory requirement, research and operations. If one intends to run an independent, directly regulated practice (which may be IFA or whole-market restricted), the hurdles are much higher than they were. The requirements to demonstrate due diligence on all aspects of process and advice are onerous. This amounts to a core cost to the business in time and money.
The question we initially asked ourselves was how many advisers are required to amortise the cost of this load? In answering the question, we are looking at three issues:
• Profitability • Quality of advice • Succession
I will not dwell too much on the first. If anyone believes a non-profitable financial advice business is sustainable or desirable, please stop reading – we will not agree on anything. Our benchmark is a margin of >20%. Anything lower will not attract capital, and good businesses should attract capital; the sector needs to attract capital to survive and prosper; businesses need to be profitable to have a value.
The issue of quality of advice is crucial. If a solitary adviser is IT director, compliance officer, in charge of operations as well as advising on investment, pensions, protection et al AND conducting all requisite research, he is super human. IT CANNOT BE DONE!
As a client, why on earth would I trust my financial planning and investment needs to a jack-of-all-trades rather than a proper business where there are full-time experts on all key areas?
Finally, there is the issue of succession. I might live until I am 90. As my wife and I become old and probably infirm, our dependence on our adviser increases. Most advisers are of similar age to their clients. Long after they retire, their clients will continue to need financial advice.
Even if advisers are much younger, they may die, become disabled, leave the industry or emigrate. They may leave the industry because they fail to keep up with regulatory demands e.g. qualifications. I repeat, why as a client, would I take the risk.
I am sure many will attempt to run one/two man firms. They might survive for some years, but their income will drop. They will become uncompetitive because they will not have the resource of their better structured peers. They will probably lose clients, as clients will make informed decisions. Their business will have very little value as they with fail to achieve industry benchmarks that will become the norm.
We estimate that the minimum optimal business has three managers, five advisers, three paraplanners and a couple of administrators. This is an educated stick in the ground. It does not mean that a good business cannot be smaller. I doubt if it can be that much smaller.
A couple of other points:
1 We are assuming a certain amount of outsourcing. We expect an efficient firm to outsource investment research to Morningstar, FE or RSM or similar; we expect some compliance to be outsourced; we expect an outsource facility be set up for paraplanning, at the very least to handle high volumes. 2 We are not talking networks here. Whilst we believe that there will be successful forms of networks in the future, the days of the traditional network of self-employed IFAs, doing their own thing whilst being ARs of a firm, largely dependent on insurer and fund manager “contributions” to remain profitable, are over.
Ultimately, those who matter most, customers, will be better off in brave new, post-RDR world, because advisory firms employ professional advisers with specific competences in properly resourced practices. They will provide good advice at a sensible price, – good for staff, for shareholders or owners and for clients.