Last time we introduced the idea of ‘financial repression’ – an economic environment in which inflation is high and interest rates are low. We looked at what this consistently higher inflationary environment would do to a financial planning firm, and it was not a very positive story. To summarise, we identified three things that are going to affect the business:
» You cannot borrow
» Costs go up, particularly staff costs
» AUM defines revenue – if it goes down so does revenue
Here we want to discuss some ways to mitigate these headwinds.
It’s worth saying at the outset that you do not need to agree with the Ruffer outlook for this to be relevant. Whether it’s a deflationary bust, runaway inflation or a controlled erosion of debt levels through low interest rates and historically higher inflation, we are overdue an environment that severely tests a financial planning firm’s business model (the same applies to most platform businesses, asset managers or discretionary managers.)
So let us go through the problems and consider some potential solutions:
You cannot borrow
This is the trickiest one to deal with. Unless owners are willing to put in personal capital or seek private investment then there simply is not much you can do about this. Having savings in reserve, or an idea of some kind of external finance you may be able to call on may seem like motherhood and apple pie, but it is probably about all you can do.
Costs go up, particularly staff costs
Staff cost money and if you cannot pay them they will leave. Beyond a relatively low threshold size of firm, this could be a serious problem quite quickly. A simple way to increase the robustness of the business in a downturn would be to widen the ownership base. If there are key staff angling for a share of the business, perhaps let them buy in?
Paying people with an ownership stake is a cheap thing to do until it’s a nice problem to have. It also makes the business more robust: people think much more deeply about deserting a business they partly own.
AUM defines revenue – if it goes down so does revenue
Most planners charge a percentage of a client’s wealth as their fee. This means that when economic conditions are good and asset prices are increasing you get a good share of that upside.
But in the reverse scenario of a difficult economy and falling asset prices revenue goes down. This could make long term survival harder.
One solution could be to move to flat fees. This removes the dynamic of revenue falling in a crisis. It also means that you can raise costs in line with inflation when other costs are rising too. When you charge a percentage of AUM your fees are almost inevitably left behind. In an inflationary environment structuring your fees as a percentage of revenue could be a bad idea – the last time this kind of environment persisted in the UK, in the 1970s, asset prices fell precipitously and then went sideways for a decade.
At Ruffer we think there are lots of indicators that we are in a ‘pre-crisis’ moment in financial markets.
The latter two issues here often get construed as moral ones.
Employee ownership is often portrayed as a good thing, in and of itself. The reverse is true of selling to large consolidators. Fees are an emotive issue that often see moral arguments deployed to make the case for one position or another.
What I hope we have done here, though, is demonstrate that there are commercial reasons for flat fees and staff ownership. Both can make a firm more robust through market cycles and, in our view, it is often the ability to make it through the really hard times that separates the strong and the weak.
Next time around we’re going to look at what the prospects for selling or buying an advice business in a prolonged bear market might be.
We’ll see you then.
A limited liability partnership, registered in England with registered number OC305288 authorised and regulated by the Financial Conduct Authority © Ruffer LLP 2019. The views expressed in this article are not intended as an offer or solicitation for the purchase or sale of any investment or financial instrument. The information contained in the document is fact based and does not constitute investment advice or a personal recommendation, and should not be used as the basis for any investment decision. References to specific securities should not be construed as a recommendation to buy or sell these securities.