The financial advisory business is highly fragmented, with a few large firms and many independent registered investment advisories (RIA) forming the industry. As of July 2023, just under 15,400 organizations were registered as an RIA with the SEC, up from around 14,800 at the beginning of 2022. Private equity (PE) firms, attracted to the industry’s stable recurring revenue streams, have actively pursued the consolidation of RIAs, a trend that has accelerated in recent years. These PE firms use acquisition as a lever to pool assets under management (AUM) with the goal of spreading costs and recognizing synergies that together improve profitability. However, this trend may create unfavorable consequences for clients, issues often mitigated by the client-centric business models employed within independent RIAs.
Consequences of Integration
A 2021 paper written by three professors of finance at the University of Oregon (Private Equity and Financial Adviser Misconduct) closely studied these consolidation-driven effects. The key takeaway from this paper was that misconduct rates increased materially after RIAs were acquired by PE. One key nuance found was that PE firms generally target RIAs with below-average rates of misconduct; after acquisition, misconduct occurrences rose toward the overall industry mean. Of the group that was acquired, the number of misconduct incidences nearly doubled. Furthermore, the study traced 50% of this increase to behavioral changes in the advisors who continued to work at the firm after its acquisition. Bottom line, being acquired fundamentally changed these RIAs.
The increase in these misconduct rates is likely driven by internal changes at these firms. With a shorter-term horizon, PE owners are motivated differently, aiming to quickly increase the value of the business. They will have different expectations for the growth rate of the business and may consolidate or change management teams, alter advisor incentives, or introduce new members to existing teams to achieve this. It has been shown that PE ownership increases job dissatisfaction and insecurity of employees. Ultimately, these shifts trickle down to the client level.
Where Independent RIAs Shine
So, what would a PE owner mean to you as an individual investor? The most prevalent impact, as with many large companies, is personally tailored service may become available to only the largest clients. Independent RIAs are the best place to get personalized service tailored to your specific needs. These firms thrive on client retention, referrals, and community presence versus the sheer quantity of clients or national advertising campaigns. This driver fundamentally changes the business model; service is key, so management concentrates efforts on client satisfaction above bottom-line profitability. To accommodate this, independent RIAs will generally spread work less thinly. Your advisor will know you personally, and vice versa. As your life evolves, this relationship will better prepare your advisor to tackle emerging challenges. This more balanced view on firm growth and service and the manageable workloads assigned to advisors ensures that your goals are always of the highest priority.
In some cases, consolidation may even cut deeper as acquired RIAs are pushed to transition clients toward parent-provided investment strategies. Financial advisors that work closely with research teams may have a greater comprehension of the strategies, which will flow through in their ability to match clients with investment vehicles that parallel their needs. Siloing investment and client relationship teams essentially makes it more difficult for advisors to leverage research personnel. Tightly-knit RIAs will have the upper hand in this arena.
PE firm ownership is not inherently negative and could benefit certain firms’ clients in some instances. It is, however, important to recognize the potential impact it may have and make a decision in accordance with your own personal investment goals and preferences. For those who feel a more personalized element will improve the experience, an independent advisor is the way to go.
Written by: Ryan Boettiger