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RIAs between $100m - $500m an enigma to the industry, rampant lack of support from external wholesalers

Monday, August 13, 2012
Opalesque Industry Update - The emergence of the registered investment advisor (RIA) business model is transforming the priorities of asset management sales organizations. Cerulli projects that RIAs, including dually registered advisors, will expand their marketshare of advisor-held assets to 14% by the end of 2012. Within the RIA channel, asset managers have traditionally targeted practices that have $500 million or more in assets under management (AUM). Practices managing between $100 million and $500 million have been an enigma to the industry because these practices do not fit well within the existing external salesforce service model.

Much press coverage has been dedicated to the growth of the RIA channel and the implications of advisors transitioning to independent business models. Though asset managers dedicate resources to the channel (up to 16% in 2011), they are generally focused only on the largest firms. National sales managers have attempted to extend the same sales model used to support broker/dealer (B/D) relationships to the RIA segment. In serving wirehouses and large RIAs, external wholesalers can target a large pool of assets on a single visit. However, these same firms are frequently targeted, have greater internal research capabilities, and are more likely to use a greater number of asset managers. As such, lower marginal value is derived from wholesaler relationships. In addition, these large firms are best positioned to extract revenue sharing from asset management partners, which further reduces profitability.

The most frequently cited problem among field wholesalers is access. Shelf space on RIA service agent platforms is easily acquired, with limited restrictions compared to the gatekeepers of B/D platforms. While service agents ask for event sponsorship and ancillary marketing support, managing platform relationships pales in comparison to the support required for wirehouse or even independent broker/dealer (IBD) relationships. On the individual firm level, practices have not matured to the point where revenue-sharing payments are mandated to access placement within centrally managed portfolios. As such, the profitability of the RIA channel for product providers is rated the highest of all advisor distribution channels due to lower sales and service costs. As a whole, the RIA sales process is free from the costly impediments that burden B/D channels. Additional benefits accrue to asset managers that target the mid-sized segment of the RIA channel due to current sales support, product preference and screening, and projected growth trajectory.

"Primary sales challenges of access and organizational influence are removed when dealing with mid-sized RIAs," according to Tyler Cloherty, senior analyst at Cerulli Associates. "Since the average advisor within the RIA channel managed $63.7 million in 2010, they are attractive targets for asset managers."

Cloherty goes on to say, however, that when it comes to servicing RIAs in the mid-sized segment, a lack of support from external wholesalers is rampant. In fact, according to Cerulli research, 56% of all RIAs indicate never receiving in-person contact. Advisors who transition into the RIA channel from roots within the wirehouse and IBD channels are accustom to greater wholesaler access from their experience in prior positions. Additionally, B/D home-office resources provided market commentary, individual security research, and asset allocation guidance. Now forced to go without, mid-sized RIAs must bridge the gap with a patchwork of resources including third-party software, publications, and asset manager support. The lack of resources available to the mid-sized RIA provides the opportunity for asset managers to meet the needs of the underserved segment.

"Industry experts quip that 'every RIA is different,'"says Cloherty, "but they neglect the fact that distinct product preferences separate mid-sized firms from their larger counterparts."

Product distinctions are driven by scale, client demographics, and portfolio construction philosophy. Mid-sized RIAs are primarily consumers of mutual funds, which account for nearly half of their portfolios (almost 10% more than the portfolios of large RIAs). Advisors within mid-sized practices have neither the time nor the accumulated expertise to personally manage client relationships alongside well-diversified portfolios built upon individual securities. Thus, these advisors rely on fund managers to fill gaps in the money management expertise of the RIA practice.

Though increased mutual fund use makes mid-sized firms attractive targets, these firms are proponents of using passive exposure to acquire cheap beta. Among RIAs, 46% say that low relative expenses are one of the most important factors when choosing an asset manager; only style consistency ranks higher. Cost-conscious advisors choose to minimize expenses of market segments perceived to be commoditized. Philosophical inclination toward market efficiency will push active managers to focus on segments where perceived alpha is available, such as small-cap, emerging markets (equity/debt), and alternatives.

Unfortunately for active managers, these advisors have also been slow to adopt alternative investments in their portfolio in comparison with large RIAs. A justification may be the demographics of their client base. Many large RIAs have a legacy as multi-family offices, serving ultra-high-net-worth clientele whose product preference and risk tolerance allows greater use of alternatives. However, since these mid-sized advisory firms have shown a predilection for alpha-beta separation, asset managers may find a growth opportunity in securing a spot within the alternatives mandate of mid-sized firms and working to grow their share of the portfolio. Additionally, numerous executives with whom Cerulli has spoken have mentioned the demand to bring alternatives down market to their non-high-net-worth clientele. Asset managers that provide liquid alternatives that retain their potential for outperformance will present a strong case for increased allocation within mid-sized RIA portfolios.

Additional findings in this research include:

  • Asset managers name "differentiating their offering in a crowded marketplace" as their primary challenge. Cerulli contends that with distribution success increasingly elusive, managers must focus on addressing pockets of opportunity.
  • Use of passive investment strategies among different advisor channels varies meaningfully. Managers must seek to understand the distinctions in order to tailor their product development and distribution strategies.
  • The move toward specialization in advisory practices is another example of the continuing maturation of the advisory profession. As advisors deliver more sophisticated advice, product manufacturers must be prepared to meet this evolution with equally thoughtful messaging.

(press release)

These findings and more are from The Cerulli Edge: U.S. Asset Management Edition, August 2012 issue. Source

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