What Fast-Growing RIAs Have in Common, According to DFA

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It's easy to "grow" as an advisory firm when equity markets are rising. But when you look at registered investment advisors that are truly growing organically—and not simply riding the wave of a bull market—some interesting attributes emerge, according to Dimensional Fund Advisors' most recent RIA benchmarking study. The asset management firm's study compared firms in the top quartile of growth rates with firms in the bottom quartile. 

Contrary to popular belief, the firm found that the high-growth RIAs had lower profit margins than their low-growth peers, suggesting they are putting more money back into the business and, more surprisingly, relied less on referrals for new business, according to Bryce Skaff, co-head of the global client group at DFA. High-growth firms share a few things in common, he said. They are focused more on technology training, they incentivize client-facing employees, and they diversify their channels of business.

Speaking to advisors at the DeVoe 2019 M&A+ Succession Summit on Thursday at New York City's Harvard Club, Skaff said his company analyzed 140 firms with more than $3 million in revenue and found that in 2017, their assets grew 23%. But when you strip out market performance—14% based on a 60/40 globally diversified portfolio—firms really grew just 8.5% during the year, 6.2% of which came from new clients. DFA's benchmarking study is not publically released, but Skaff shared some insights at the DeVoe conference.

When you parse out high-growth firms from the low-growth firms, there’s a high amount of dispersion between their growth numbers (31% on average for high-growth firms, versus 12% for lower growers), an indication that the firms in the top quartile are doing something different. For these high-growth firms, only 11% of the growth came from new clients; the rest of the non-market-related growth came from a combination of new business from existing clients (3.5%) and acquisitions (2.6%).

That diversification of business initiatives could be one reason the top-quartile firms have lower operating profits, at 26%, compared with 32% for the bottom-quartile firms.

Yes, they are spending more on technology, but it’s not materially different from the low-growth firms, Skaff said. They tend to use the same CRM systems, portfolio management and financial planning software as other firms. But they are spending more on integrating their technology and training their staff to use it. Integration and training can often be more expensive than the technology itself, he said. 

High-growth firms are also less likely to discount their fees, with 68% of their clients, on average, paying the full fee schedule, versus just 46% for low-growth firms. The leading firms are better at articulating their value proposition to their clients and connecting value to the fee they’re paying, so they don’t feel the need to discount fees as much, he added.

Human capital tends to be the highest expense at any given RIA firm, and the high-growth firms spend more on staffing. They have about the same number of total full-time employees as other firms of comparable size, but they have more client-facing (and therefore usually more expensive) employees. They’ve done a better job at stripping away the nonessential functions of the advisor and centralizing a lot of those activities in the back office, so advisors will spend more time in front of clients, reenforcing the value of the relationship, he said.

Top firms also pay those client-facing advisors more money, with incentives tied to growth. At these firms, the average advisor takes home a 32% payout as a percent of total revenue managed, versus 21% at the bottom-quartile firms.

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Top-quartile firms also place a greater emphasis on ownership, with over 20% of full-time employees at these firms having an equity stake, versus 10-15% at low-growth firms. Top-growth firms are more likely to express a wish to expand their equity holders, with 69% indicating plans to add a new owner in the next two years.

The industry often stresses the importance of client referrals, but Skaff said these high-growth firms take a more-diversified approach to growth. Low-growth firms indicated that 74% of new clients came from client referrals, compared with 36% for the top quartile. High-growth firms also said that 21% of new clients came from employee referrals (compared with 8% for bottom firms). Skaff attributes the high rate of employee referrals to these firms’ culture of ownership and a focus on creating a rewarding employee experience.

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