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Why Scalability Doesn't Work in Wealth Management

May 23, 2013

Scalability is a proven business strategy across many industries, but is it right for high-end wealth management?

Evidence suggests that it isn’t — and probably never will be.

The recent defections of advisors from RIA aggregators and large Wall Street firms are more fresh proof that scalability doesn’t work in high-end wealth management.

It’s also a lesson for advisors trying to figure out how to run their business. The scalable model that enhances widgetmaking won’t enhance individual wealth management. It neither serves clients better nor offers advisors more personal satisfaction and control.

The lack of scalability in individual wealth management runs counter to the conventional wisdom in financial services. The six largest international banking companies, all of which have large wealth management units, control 50% of the industry’s revenue, according to a recent special report from The Economist.

Jeff Spears

Size matters in international banking because it translates into efficiency and lower costs. The banking giants have grown enormously, powered in part by cheap funding and supported by the predictable fees from their wealth management businesses. However, as banks get bigger and bigger, wealth management’s contribution diminishes.

While the institutional asset management and trading businesses will continue to consolidate, because they do benefit from scale, the business of serving individual clients with $5 million or $10 million won’t. That’s a good development for clients and advisors alike.

Why Bigger Isn’t Better

There are two reasons scalability doesn’t work in serving high-end clients.

First, high-end wealth management requires truly customized service. In a scale business, like international banking or manufacturing, big investments in infrastructure support higher volume, which in turn drives greater profitability. But clients don’t all want the same thing. Individuals and families all have slightly or even wildly different circumstances and goals.

Second, wealth advisory is capacity-constrained on two levels: staffing and client load. Wealthy clients have complex needs that demand experienced, skilled practitioners who are in short supply. The wealthy often require multiple services, from investment management to family governance — often all at once. Very few advisors can make the grade. The largest wealth management firms try to meet the advisor talent shortage by writing hefty recruiting checks, because the current staff at Wall Street firms simply can’t meet the sophisticated needs of these highly prized individual clients.

But wealth management is personal. It’s not simply business. An advisor plays a disproportionately large role in the life of a high-net-worth client. It’s normal to want to keep tabs on the person helping finance all the fun. Thus, a reasonably competent wealth manager shouldn’t be handling more than 25 to 40 clients with assets of $5 million or more.

A successful client relationship also requires ongoing trust. That requires more time and personal attention. Given the mistrust created by the financial crisis, an advisor needs to continually earn a client’s trust. That, too, takes time; there are only 24 hours in a day and no shortcuts.

How Much Is Enough?

For independent advisors, a lack of scalability isn’t necessarily bad.

Compared with wirehouse advisors, independents who have $250 million or more in fee-paying assets will keep significantly more of their revenue. They’ll make a very comfortable living, sleep better and enjoy work more. Such advisors reap the psychic rewards of seeing people succeed.

On the other hand, if money is the overriding motivation — which it used to be for many who ventured into the business — an advisor is ultimately destined for a grim choice: me versus them. Do I take more for myself at the expense of my clients? The big firms have already sold out. Proprietary products and scale clearly say, “It’s us before them.”

All of which raises one more philosophical question: How much is enough? If an advisor is living well and truly making a difference in the lives of others, isn’t that more than enough? In the go-go days of Wall Street, wealth management was a ticket to riches. Those days are gone, but that’s all to the good.