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Advisory Biz Shakeout Set in Motion: JPMorgan Warns of Major Consolidation


NEW YORK - The financial advisory business has reached a tipping point. Gone are the days of low barriers to entry, robust markets and a seemingly endless source of new clients.

That was the message delivered by JPMorgan Asset Management here last week, when it predicted that rising compensation levels, higher operating costs, compressed margins and overall distressed market conditions will force a significant shakeout among advisors.

Vast Disparity

Speaking at a press briefing in Midtown Manhattan, the J.P. Morgan Chase & Co. unit unveiled its latest study of the advisory landscape, warning of a "mini-rationalization" on the horizon. The report highlights the great disparity that exists in the marketplace between the "haves" and the "have-nots," with a shocking 94% of the industry falling into the latter category. Breaking down the numbers, the "haves" contingency represents 1,102 advisors who generate more than $1 million a year.

This is not to say that the rest of the pack is not making money, but they have "unsound business models" that serve too many unprofitable clients and don't generate enough revenue to re-invest in the firm, according to Mark Hurley, senior adviser at Headwaters MB and co-author of the report. "They have very little enterprise value at the end of the day," he said.

Sharon Weinberg, a managing director at JPMorgan Asset Management and co-author of the report, told reporters that stock market volatility and soaring operating costs have ruined the profitability of these firms, leaving them in a cloud of dust.

The backdrop for this consolidation scenario has been a flood of new entrants to the business, increased competition from the wirehouses and regional broker/dealers, advances in technology and shrinking profit margins.

One-Two Punch

The one-two punch of new entrants and the re-invention of traditional competitors has stymied growth efforts among smaller advisory firms. In a telling example of this environment, Wall Street behemoth Merrill Lynch spent more than twice as much on advertising as iPod manufacturer Apple last year, illustrating the intimidating force of these few large participants.

On top of this already difficult terrain, Hurley sees five additional negative catalysts that will alter the structure of the advisory business over the next five to seven years.

Chief among them is a growing demand for professionals that will significantly drive up salaries. Large financial services firms can offer experienced professionals much more attractive compensation packages than most advisory firms. As more entrants break into the wealth management space, the competition for talent will heat up considerably, leading to skyrocketing labor costs and further downward pressure on profit margins.

Operating Costs Up 60%

A sharp spike in operating costs will also help shape the business in the next five to 10 years. In the last four years, operating costs have risen more than 60% on a cumulative basis, the study showed. Further underpinning that trend in the years ahead will be normal inflationary pressures, fatter pay deals for non-professional staff members and more stringent regulatory and compliance requirements.

"Growth is the only way out of this dilemma," Hurley said. But getting there is a lot easier said than done. The "have-nots" have very few options available to them and none are very appealing. "Work harder and earn less" is one option, he said. Admitting defeat and going to work for a larger firm is another. A third option is the advisor selling the book of business and getting out altogether.

Indeed, merger and acquisition activity will get underway but not in full force any time soon. "[Right now,] there aren't that many firms that are worth buying." He noted that there are probably two or three out there right now and once they go there won't be any to replace them.

"It's probably not a good idea to sell your firm right now," Hurley advised. "I'd wait. The market isn't there yet."

150-200 Big Deals

But when the market is ripe, he said, strategic acquirers like banks and insurance companies will make 150 to 200 deals during the next five to seven years. Many of these companies will have tried to build their own advisory businesses and failed and will turn to buying large financial advisers.

The report is the second installment of a "1999 Undiscovered Managers" study that predicted a few key players would dominate by 2009 and many niche advisory firms would survive while most firms would be marginalized.

In November 2003, JPMorgan bought the assets of Undiscovered Managers.

JPMorgan analysts spent 12 months researching the competitive landscape, which ultimately confirmed that the 10-year period of consolidation has been wrought.

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