Mindset ‘shift’ key to unlocking value in financial advice practices
A mindset transition from ‘practice manager’ to ‘business manager’ could be just the ticket for financial, risk and wealth advisers seeking to extract full value from their financial advising endeavours. This fresh perspective emerged during a succession-focused presentation by Kevin Hinton, founder of The Collaborative Exchange, who confesses to being passionate about the financial services industry, and especially the role performed by financial and wealth advisers.
M&A themes and trends
Hinton was the keynote speaker at an event held to introduce independent financial advisers (IFAs) to a pioneering evaluation tool developed by GrowthHouse, and branded GrowthX; but his presentation centred on succession and the themes and trends dominating international merger and acquisition (M&A) activity in the investment and wealth management disciplines. “The world has awakened to the opportunity that exists in acquiring wealth management business,” he said, before devoting around 30-minutes to compare developments in the United Kingdom (UK) and United States (US) with local happenings.
The first ‘tip’ offered to the attentive audience was the need to understand why private equity was so keen on investment and wealth advice businesses in the first place. According to Hinton, investors are snapping up smaller advice businesses to create scale and benefit from the resulting higher valuation. He pointed out that small practices usually changed hands at significantly lower price-to-earnings (PE) multiples than could be obtained for large, listed entities. The GBP5.4 billion takeover of UK investment platforms, Hargreaves Lansdown, by CVC Capital Partners, Nordic Capital and the Abu Dhabi Investment Authority is the pinnacle of this process.
SA follows the developed market
At the top end of the ‘game’, acquisitive asset managers like Japanese-based Nomura Asset Management are making big ‘plays’ in the investment and wealth advice segments as part of their growth-seeking vertical integration strategies. The presenter offered four key reasons for this trend, describing the first as investment management headwinds. “The shift from active to passive; and the growing role of discretionary fund managers (DFMs) are putting pricing pressure on asset managers, and forcing margin compression,” Hinton explained, sharing charts of net flows to active and passive strategies since the early 1990s.
The impact of shrinking net flows to active managers has been compounded by high levels of concentration in the asset management industry. “The top 10 funds in the global passive space control 95% of the assets, and in the active asset management space, 67% of net flows went to just 10 asset management groups,” Hinton said. “There is a high concentration of deal flow going into a handful of firms.” South Africa faces a slightly different problem in that there are arguably too many asset management firms for the size of the domestic market; and in this context, the presenter was confident that significant mergers would take place in the next couple of years.
A second driver for M&A activity, relevant to both the asset management and financial advice segments, stems from that perennial bugbear of complex regulation and the cost of compliance. Citing a report by Deloitte, the presenter noted that regulation in the UK had added around 1% in annual costs to financial services consumers, and that this ‘cost’ was being recovered from the fund management part of the value chain. In South Africa, the implementation of the two-pot retirement solution coupled with auto enrolment (default annuities) in the retirement fund industry could further reduce assets under management (AUM) industrywide, and steer flows from active to passive management.
Demographics, technology to shape the future
At this point, technology was introduced as a third motivation for advice-focused businesses to consider their scale. “Every financial adviser we talk to battles with their technology stack … and you now have artificial intelligence (AI) coming into the picture as well,” Hinton said. And finally: demographics. The average age of financial advisers in South Africa is around 58, with many practicing at age-70 and beyond. He mentioned that an Investment Think Tank roadshow, held countrywide mid-2024, revealed “high evidence of advisers wanting to exit their businesses” as well as signs of many up-and-comers looking to buy books.
Domestically, the trend of life offices ‘buying up’ distribution has been adopted by investment managers who are desperate to grow AUM. “Net flows are dying,” observed Hinton. “Whereas life offices historically played in the distribution area, buying advice firms, you are now seeing investment management firms starting to play that role as well, [with many] springing up from asset managers.” The catchphrase, both domestically and offshore, is that everybody is grappling for distribution. This comment was supported by data from Bain and Co., which shows that despite a drop in M&A deal value since 2021, the number of transactions has soared.
“Transactions have shifted to acquiring wealth management practices; a bigger proportion of deals are now being done in the wealth management space … and there is evidence of this coming to South Africa as well,” Hinton said. The presenter then used a bell curve of M&A valuations ex-UK to illustrate the valuation arbitrage or leverage on offer from building scale in the investment and wealth management space. “Getting scale right presents a significant opportunity for shareholders,” he said. From an IFA perspective, the motivation to sell a portion of the practice is clear, including lower operating costs; improved liquidity; and a lump sum for retirement.
Chasing a valuation ‘bump’
Aside from the aforementioned valuation ‘bump’, acquirers benefit from growing their client base and financial adviser talent pool. According to Hinton, the growing acquisition appetite is based around the realisation that the person who ‘owns’ the client effectively controls the value chain now: “Advisers who control the client can put much more pressure on the value chain.” From an investment and wealth management perspective, an obvious way to capture more of the value chain is to expand the product offering, and perhaps extend into short-term insurance. Expanding geographic footprints, investing in technology or considering M&A also drive growth.
M&A stands out as a common sense way to go from a sole proprietor type arrangement with a R250 million book to an advice business with scale, managing R5 billion or more. In the latter business, you have enough cash flows to employ specialists in non-advice roles; hire strong technology resources; and introduce a managing director, among other value-adds. “When you start building to a higher asset base, you can afford to pay fixed salaries, and not lose talented individuals to the banks,” Hinton said. But the real ‘meat’ of the discussion focused on the all-important succession and valuation twin.
Hinton lamented that many of the advisers he interacted with were struggling to put the necessary succession mechanisms in place. One of the common concerns is that the eventual acquirer has the seller’s clients’ best interest at heart; another is with price. In fact, valuation, and the valuing of advice practices, is held up as a major stumbling block in the succession paradigm. And unfortunately, the underlying reason for this valuation hiccup often derives from the selling adviser having paid scant attention to funding his or her retirement.
Due diligence or bust
Whatever the case, selling your practice demands proper due diligence. “If you are thinking about partnering with an adviser organisation of some sort, you have to take the time to understand what is on the tin,” Hinton concluded. “You have to manage the expectation of what you think you are buying with what you are actually getting from the transaction; and remember, once you make this journey, it is very difficult to reverse the transaction.”
Writer’s thoughts:
Today’s newsletter hints at the value you can add to your financial or risk advice practice by treating it like a business, and growing it to the scale that makes this thinking possible. Are you considering growing your practice value by building scale via acquisition or merger? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
