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Tim Sargisson: Adviser profits up – but not for everyone

FCA figures suggest smaller advice firms are a good deal more profitable than their larger counterparts but, wonders Tim Sargisson, does this suggest not enough resource is allocated to risk management and oversight?

Earlier this month, the Financial Conduct Authority (FCA) provided its latest analysis of the intermediary sector based on data from the Retail Mediation Activities Return.

The regulator’s key findings show that revenue earned by intermediary firms increased in 2018 compared with 2017, continuing a trend seen in recent years. Reported annual revenue from retail investment business increased by 12% between 2017 and 2018 – from £3.95bn to £4.42bn. Revenue for 2018 is up by 58% on 2014.

Despite all the talk about consolidation, the number of intermediary firms increased over the corresponding period. The number of firms rose from 5,048 to 5,131 and, while this is an increase of less than 1%, it is an increase nevertheless. The total number of advisers in 2018 also increased at just under 1% to 26,677. Small firms remain a significant part of the intermediary sector. Nearly 90% of firms have five or fewer adviser staff – a figure comparable to last year.

Some 96% of financial adviser firms made a profit with total pre-tax profits up to £872m from £698m in 2017.

To focus on profits for a moment highlights an anomaly. This is because 97% of firms with between one and five advisers are profitable, with profits of between 35% and 43% as a percentage of revenue.

This compares with 73% of firms with 50-plus advisers, which are profitable, but where overall profits are negative by 1% as a percentage of turnover. This appears counterintuitive – in that ‘big’ should imply firms better make use of economies of scale and critical mass to deliver their service. Scale is about adding revenue at a rapid rate while adding resources at an incremental rate. All of which is designed to drive profits.

So what are we seeing here?

In terms of profitability, vertical integration will distort the picture among the bigger firms. To take two firms as an example, St James’s Place’s losses in 2017 were £35.3m while Intrinsic’s were £15m. Indeed losses widened compared with the previous year – at £24.7m and £8.9m respectively.

The beef among advisers is that vertically integrated models can support these losses with the cross-subsidy available from the investment arm. Nevertheless, the lack of profit in the 50-plus group gives the impression that the larger the firm, the less likely it is to be profitable.

Yet maybe there is something else at work here. Maybe profit alone is too one-dimensional and takes too myopic a view? Could it be argued that smaller firms do not spend a large enough proportion of turnover on what might be loosely described as ‘hygiene factors’?

Let’s suppose the larger firms understand the necessary requirement to apply a greater level of resource to areas such as risk management, compliance, technology, paraplanning, governance and oversight – all that added resource takes a larger chunk of income.

It is not so much that larger firms set the bar higher in addressing these needs, but maybe they set it at the correct level because they better understand this is a necessary requirement for a regulated business of any size and scale?

Talking to Professional Adviser last year, LEBC chairman and CEO Jack McVitie offered the excellent suggestion that networks should take care of the smaller firms, which would, in turn, enable the FCA to focus on the bigger fish.

Exceptional Resource 

Jack’s point reinforces the concern that perhaps not enough resource in smaller firms is allocated to risk management and oversight. Firms such SimplyBiz provide an exceptional resource for adviser firms to outsource these requirements and to better ensure they remain the right side of the line. Yet how many firms employ outside experts in this way?

Perhaps another way to make this point is to look at the size and number of advice firms that go bust and dump their liabilities on the Financial Services Compensation Scheme. If we see a large proportion of small, toxic firms, perhaps this implies that profits in these firms when things are going well are inflated at the expense of managing investment risk? Managing investment risk matters because it is ever present and, when it goes wrong, it has the potential to bring down the whole enterprise.

Profitability can quickly unravel following complaints over investments, as well as increasing costs such as regulatory levies and professional indemnity insurance premiums. There is a constant need to balance the management of risk, particularly investment risk, as well as governance and oversight, with the resources available to the business.

It is great to see our profession growing in terms of income, profit and numbers – but not if firms continue to give short shrift to including the essential components necessary to run a regulated business with a genuine client-centric proposition at its heart.

Published 25th June 2019

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