Establishing a managed account service can substantially increase the value of a financial planning practice, but establishing one isn’t for the faint-hearted, and going about it the wrong way can backfire severely, according to Tony McDonald, a director of T&C Consulting.
McDonald told an Institute of Managed Account Providers (IMAP) seminar and webinar in Sydney this week that before a financial planning practice even embarks on offering managed accounts to clients, its managers and principals need to be familiar with the terrain and terminology, and there are are six key questions that they need to answer.
While implementing a managed account offering effectively could improve performance for clients and the business and also reduce risk, if it’s not implemented correctly it could significantly increase business risk and put the practice on a direct collision course with its licensee.
An increasing number of financial planning practices are turning to managed accounts to streamline their investment offering, and to improve business performance. Some view managed accounts as signalling the end of financial planners’ days as quasi-investment managers; others see them as enabling financial planners to take greater control of their clients’ investment portfolios.
And others have seized upon the potential of managed accounts to reduce investment-related business costs, and to help advisers spend more productive time face-to-face with clients. But irrespective of the end game, identifying the key decision criteria is considered to be critical.
McDonald said the successful implementation of a managed account offering can also help improve a firm’s compliance score. It creates a more sound financial footing for a business while weaning it off platform rebates and other forms of conflicted remuneration.
The hypothetical business
McDonald said that in the hypothetical case of a financial planning practice with $100 million of client funds under advice (FUA), the impact on the bottom line, and hence on valuation, could be substantial. The assumptions and figures used by McDonald appear in Tables 1, 2 and 3, below.
“This is illustrative only,” McDonald said.
“These aren’t the actual numbers from someone as a practice owner who’s moved from effectively traditional platform with managed funds, into a managed account world. But it is drawn from some of the research that’s been done into managed accounts as to the consequences and the value accretion that you can achieve through managed accounts.”
McDonald said the economics of a business change considerable from a “pre-managed-account” (pre-MA) environment to the post-managed-account (post-MA) environment.
“The assumption in the pre-managed-account world is that the client’s advice fee was 70 basis points. Why was that a little bit low compared to the 90 to 100 that’s bandied around the industry? Because…the platform rebate to the firm was 20 basis points, so that took their advice fee, effectively, up to 90 basis points.
“We assume that 90 basis points is your advice fee going forward, post-managed-accounts.
“Let’s assume the managed account fee you charge as a practice owner for packaging up and running a managed account, with one of the service providers, is 35 basis points. If that’s the assumption, you’re gig to have to give up some of that 35 basis points to those service providers who are helping you with portfolio construction, portfolio management and administration.”
Direct-ownership world
McDonald said that assuming an investment offer incorporated direct equities and exchange-traded funds (ETFs) or index funds, the client indirect cost ratio (ICR) for investments could fall from 80 basis points to 30 basis points.
“Let’s assume the platform has done the right thing and gone to naked pricing, and taken off the 20 basis points that they were giving as a grubby rebate before, and it’s now a naked price of 40 basis points for the platform,” McDonald said.
“So the total cost to the client pre-the-managed-account was 210 basis points. Post-managed-account it’s 195 basis points, so the client is better off. A large part of that has come from a change to a discretionary world with direct equities or ETFs in the portfolio getting that ICR down from 80 to 30. But also as a consequence, you’ve got rid of your dreaded platform rebate, not only under FoFA, so your compliance…has gone up.”
McDonald said more efficient portfolio reviews and rebalancing meant the business’s operating cost ratio could improve – in his scenario from 68 per cent in the pre-MA world to 60 per cent i the post-MA environment.
“At 60 per cent you’re starting to get up to a reasonably efficient practice,” McDonald said.
Huge effects on valuation
And that, McDonald said, could have “huge effects for the value of your practice”.
“The bottom line starts to change,” he said.
“Let’s assume the upfront fees for strategic advice are $120,000 in both cases; the advice fee has gone from $700,000 to $900,000 – because we’ve gone from 70 basis points to 90 basis points – but don’t forget you’ve got to add the platform rebate of $200,000 under the pre-MA [arrangement].
“Let’s assume your managed account fee is $350,000, so your total revenue has moved from around $1 million to $1.4 million, as a result of introducing managed accounts the right way.”
“Your operating costs have improved, from $694,000 down to $612,000 because of those efficiencies introduced thought managed accounts.”
McDonald said the calculations have to take account of the assumed $250,000 that the practice pays to the provider of its managed account service.
“That means your EBIT, when you add all of that up, has gone from $326,000 to $508,000,” he said.
“That’s an increase of $182,000 or 56 per cent.
“Done properly, and done the way that suits you from the plethora of service providers out there, you’ve increased your EBIT from $326,000 to $508,000 – happy days.”
McDonald said a stronger EBIT, based on more robust factors, would directly affect that valuation of the practice.
EBIT stronger
“Your EBIT is a lot stronger,” he said.
“It means your EBIT margin has gone from 32 per cent to 37 per cent – you’re getting towards the magic 40 per cent – and as a consequence of that you would be entitled to a higher intrinsic value for your practice.
“Why? Because the free cash flow the business is throwing off has increased; it’s of a higher quality. You’re a more efficient business and you’re more FoFA compliant as long as you’ve done it properly in relation to the interplay between the managed account provider and your licensee, in a post-FoFA world.
“Therefore you would expect to look a purchaser in the eye and say mine is a better business from a compliance point of view and from a financial point of view and therefore I should get a higher multiple for my business, being six times EBIT rather than 5.5 times.
“My business value goes from about $1.8 million to just over $3 million – that’s a massive 70 per cent increase in the value of my business, which equates to a times-recurring-revenue [figure] of three times rather than two times.”
| Table 1: Demystifying managed accounts – an example | ||
| $100m FUA advice firm | Pre-MA | Post-MA |
| Client ongoing advice fee | 0.70% | 0.90% |
| Client managed account fee | 0.00% | 0.35% |
| Client indirect cost ratio (ICR) | 0.80% | 0.30% |
| Client platform | 0.60% | 0.40% |
| Total cost to client | 2.10% | 1.95% |
| Platform rebate to firm | 0.20% | 0.00% |
| Operating cost ratio | 68% | 60% |
| Source: T&C Consulting/IMAP | ||
| Table 2: The bottom line – an example | ||
| $100m FUA firm | Pre-MA | Post-MA |
| Upfront fees | $120k | $120k |
| Advice fee | $700k | $900k |
| Managed account fee | – | $350k |
| Platform rebate | $200k | – |
| Total revenue | $1020k | $1370k |
| Operating costs | ($694k) | ($612k) |
| Managed account costs | – | ($250k) |
| EBIT | $326k | $508k |
| Source: T&C Consulting/IMAP | ||
| Table 3: Creating value – an example | ||
| $100m FUA advice firm | Pre-MA | Post-MA |
| EBIT | $326k | $508k |
| EBIT margin | 32% | 37% |
| Valuation multiple | 5.5 | 6.0 |
| Business value | $1793k | $3048k |
| Times recurring value | 2.0 | 3.0 |
| Source: T&C Consulting/IMAP | ||
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