The economy is on pause and scores of businesses are facing huge losses, but for private equity the hunt for wealth management firms continues. Why? Because the demand for financial advice may be even more acute now and advisory firms offer a welcome annuity stream of reliable income in spite of overall market volatility.
“We think that the RIA space is just a terrific industry, for all of the reasons it was two months ago, and for the reasons it was two years before that, and five years before that,” says Roy Burns of Boston-based PE firm TA Associates, whose firm owns Wealth Enhancement Group, said. “The tailwinds of independent advice and supporting clients through thick and thin really doesn’t change based on economic activity. It’s a needed service, clients need advice, and the best way to get that advice is through a fiduciary.”
Hightower CEO Bob Oros, whose firm has acquired numerous broker teams and wealth management teams the last ten years and has the financial backing of Boston-based private equity shop Thomas H. Lee Partners, said that his firm is continuing to do deals while working completely remotely. On April 1, Hightower announced it would buy tax and estate planning specialists, Wellspring Associates of Atlanta, and has several acquisitions in its pipeline.
“We haven’t really seen much, if any slowdown,” Oros said, discussing how the introductory visit for newly acquired firms to the Chicago headquarters has gone fully virtual, with introductions and tours being done through video conferencing.
Flush with capital from years of unabated fundraising, private equity has been slurping up wealth management firms for the last 10 years. Outside of the big wirehouse brokerage firms like UBS, Wells Fargo WFC and Bank of America Merrill Lynch BAC, the advisory business is fragmented — many firms have aging advisors and are lacking viable succession plans. The industry, which has flourished despite the rise of robo-advisors and passive investing, is ripe for consolidation. Ultimately, the payback of investing in wealth managers could be greater than the typical investments in their two-and-twenty buyout funds. The high net worth clients of wealth managers are increasingly investing in alternative assets, the stock-in-trade of PE firms.
In the last quarter of 2019, according to PwC, mergers of wealth management firms combined for $26 billion in disclosed deal value across 50 deals. Over all, there has been a steady growth in deals in the business, last year more than 100 wealth management firms were snapped up compared to about 20 in 2010 and about 80 in 2015 (see chart).
“We still see this industry as poised for consolidation,” says PwC partner and deals leader Greg McGahan, noting scores of retiring advisors, economies of scale and dry powder at buyout firms.
Private equity has been buying, fueling and funding many of the major aggregators—firms like Hightower and Mercer Advisors that own multiple advisory teams and centralize back office, custody and other administrative functions. Last September, Texas’ Oak Hill Capital (formerly the Bass Brothers family office) purchased Colorado aggregator Mercer Advisors, which has $16.5 billion under management and has acquired dozens of registered investment advisories in the past five years. In July 2019, Wealth Enhancement Group, a firm with nearly $12 billion in assets was sold to TA Associates by another PE firm Lightyear Capital. A month prior, Austin’s Kestra Financial, a firm with approximately $93 billion in assets, was acquired by New York private equity firm Warburg Pincus.
“It’s a growth industry and with such fragmentation in the wealth management and RIA space you have the ability to add to that organic growth with inorganic M&A growth.”says Oak Hill Capital managing partner Steven Puccinelli.
This arrangement between PE and wealth management has worked especially well in a rising stock market. PE firms have tended to be hands off, according to Silver Lane Partners managing partner Elizabeth Nesvold. The partners at buyout firms are mostly content to leave the underlying asset management and client relationships to the actual firms.
They do step in to improve operating efficiencies, just as they would with any operating company.
“Our industry has grown up with practitioners growing into business leaders,” Oros added. “While some are better than others, PE brings rigor and discipline to an industry that hasn’t always had it. Altogether it makes for a really nice opportunity.”
Oros adds, “There is more that PE likes about the industry than just the scale, efficiency and growth opportunity. They realize that these are sticky relationships between advisors and clients. Every Jan. 1 you are not starting over again.”
Echelon Data from 2015 and 2016 showed that private equity was far and away the largest acquirer of firms with more than $1 billion in assets under management, adding $198.5 billion in assets for 40% of the total (see chart).
According to Cerulli Associates, the RIA market currently has $2.4 trillion in assets under management that could be ripe for acquisition in the next five to 10 years. Some $1.6 trillion of the total is in the form of impending advisor retirements (more than 32% of RIAs plan to retire in the next decade), $469 billion of breakaway advisors, and $348 billion of growth-challenged RIAs. Typical deal values starts around seven times EBITDA, according to research firms that study deal flow.
Cerulli projects roughly one quarter of advisors planning retirement are unsure of what their succession plan will be. However from the buyers standpoint, the most well-structured firms will be most well-positioned to set up succession through career paths and plans for the next generation.
The RIA channel has been historically comprised of small businesses and recent developments have gradually moved towards more national enterprises, according to Cerulli senior analyst Marina Shtyrkov . Despite the movement in that direction, there is still lots of fragmentation with 66% of the market managing less than $100 million.
“The consolidation trend is parallel and resonates with the breakaway trend in that the larger firms have more resources to offer advisors and clients,” says TA Associates Burns.
Burns anticipates even more consolidation going forward because of a fragmented market and aging advisor demographic but also because the larger firms will continue to grow resources to better dedicate to clients. Vendors in the space, such as TA Associates-backed Orion, which provides technology and turnkey asset management capabilities, will also lower the barrier of entry for independents and attract more breakaway advisors to aggregating firms, according to Burns.
“As with any fragmented market there is opportunity for M&A and interest from PE and investors who can inject capital, management and strategy,” Shtyrkov said. “Essentially, they’re investing in what we call major consolidators who are able to couple the flexibility, autonomy and fiduciary appeal of the RIA model with the power of a national firm.”
The final driver of consolidation is the growth challenges facing existing RIAs that differ depending on size and where they are in their life cycle. Small RIAs face operational challenges and, in a pursuit of more efficiency and agility, will look to transition into an enterprise. Going on their own comes with headaches and costs around margin compression, balancing processes, technology and operations which often drives these sub-scale RIAs to larger entities to use their infrastructure to alleviate challenges and costs. Additionally, when larger firms merge or are acquired by a larger consolidator they can help them grow inorganically and geographically through roll ups, often funded by the PE backers.
As PE increases the scope of these firms they are able to achieve economies of scale through technology, marketing, back-office support and enterprise pricing and in turn able to attract advisors who normally wouldn’t take the jump to independent channels, Shtyrkov said.
Ultimately it is an abundance of dry powder that is driving the wealth management firm buyout boom. In December 2000, private equity had $253 billion in dry powder according to Preqin. In December 2019, it was a staggering $1.43 trillion (see chart).
Read original article here