Track 1: The new role of the custodian – as a value-driven wealth management partner

We are entering a post pure custody environment where advisors are compelled to deliver more and custodians need to adapt to offer more. It can't just be custody. Advisors need to be better business owners and run more efficient businesses to compete. Staffing, real estate and technology have a huge, and costly, impact on managing business efficiencies. We will discuss alternative business solutions and resources that can help solve what are some of the most important and the highest cost areas of running a practice so advisors can more strategically compete and deliver long-lasting value that drives client loyalty and profitable results.

Transcript :

Nathan Place (00:07):

We are just about ready to get started. Welcome to the panel. Our topic is the new role of the Custodian as a wealth management partner. I am Nathan Place, Retirement Reporter for Financial Planning, and our speaker is Gary Carrai. Gary is the Executive Vice President of Advisor Business Strategy at LPL Financial. So ladies and gentlemen, please welcome Gary Carrai.

Gary Carrai (00:32):

Thank you Nathan. Everyone hear me okay? It is a cozy little group here. Hey, just background on LPL. Just so folks know what the company does, it is a big diversified financial services firm that I think can be confusing. And the way that I break down the four different capabilities of LPL one, we are a wealth management platform and we'll get into what that means in terms of investments and technology. Two, we are a broker dealer. That's how most of the industry thinks of LPL's largest independent broker dealer in the country. Three we are an RIA custodian. And then four, increasingly we are a professional services firm and we are going to spend a fair amount of time on those last two pieces, what it means to be a custodian and how professional services help supplement that. Now my background, I oversee advisor business lines and think of that as how advisors affiliate with LPL.

(01:24)

They could be a W2 based advisor, we call it Linsco. And we help with everything from HR to real estate compliance and so forth. It is our ADV, it could be a shared ADV where they are an advisor, most LPL advisors, that is how they affiliate or it could be an RIA custodian where it is their ADV. Those are the different ways that folks affiliate. On RIA custody, we believe that the competitive landscape is at a pivot point. It is changing historically. You think of a custodian as safeguarding assets and bookkeeping of client accounts. Increasingly with fees coming down a commoditized service. Where we believe that the industry is going and where we are investing is how do we think of the custodial marketplace differently? How do we transform pure custody because we think that we are entering a post pure custody world and be more of a wealth management partner.

(02:22)

There is tremendous alignment between a custodian and the advisor and the RIA. As they grow, the custodian grows and that alignment creates really good incentive to help each other, help each other grow. So what services can we offer as a custodian to help solve problems for the advisor? So what I'll talk about next 25 minutes or so, one just the macro opportunity that advisors have. Spoiler alert, it is big and it is growing. More people are paying for advice than doing it themselves. And we'll go through what that macro opportunity looks like and then what are the challenges or opportunities that advisors face? And then we'll go through how custodians in the modern era can support them. So I'll go through these at a high level, enhancing organic growth and profitability through professional services. Organic growth is the number one factor that drives firm valuation for RIAs.

(03:20)

It is can you sustain a growth rate that creates that level of value? And again, what can the custodian do to be able to support it and end-to-end technology platform? And I'll tell you, it is not all about technology. As we have come to learn, giving advisors access to technology does not optimize their use of that technology. And what services, human services have we wrapped around there that ultimately to greater scale and efficiency for their practice. Number three is the wealth management platform to win and retain high net worth clients. It is the fastest growing segment in the wealth marketplace. So what role can we play to help them win that type of client? The next 10 years will be a fascinating time in this industry. Roughly a little more than a third of the industry of advisors are going to retire. That creates tremendous opportunity for inorganic growth, ability to acquire other practices.

(04:16)

And then lastly, managing increasing regulatory climate. It is the RIA industry, I think in the next 10 years to really predicts will be the largest channel of advisors in the market. And with that comes a microscope from the regulators of how you think of that and what are the risks that you are managing to. So we'll go through these in a little bit more detail. But first, let's start at a high level of the size of the market for investment advisors. And it is a 27 trillion market today, and the wealth market is much bigger than this, but 27 trillion of investors that trust advisors to manage their wealth professional advice. So really predicts over the next 10 years that'll grow to 37 trillion. So if you think of the overall wealth landscape, more investors are choosing to pay for financial advice. And most people think, well, but the younger investors ultimately want to do it themselves.

(05:17)

That's not what the metrics have proved out. In fact, that millennials are three times as likely to hire a financial advisor and pay for advice than their parents. Now, the robo movement 12, 13 years ago or so ushered in wonderful investment innovation and technology. One of the other things that it proved for us is that investors still want human advice. Technology is a good enabler to make things better. Open an account faster, go through a process a little bit easier, the output looks better. But ultimately you want that EQ to go along with IQ. You want some level of emotional attachment. When there is a problem, you are not going to go online, you are going to go to an advisor. No different than if you had a serious medical issue. You are not going to go to WebMD, you are going to go to your doctor and get that real advice. And there is sustained momentum in the business. Again, it is 60% is where the marketplace of hiring financial advice versus doing it yourself. And then the far right column is just where the advisor market is shaking out. Increasingly more advisors are independent versus part of large organizations and the fact that they are independent, those are the type of advisors that need a little bit more support. So it is what support can a custodian provide?

(06:41)

We'll talk about organic growth, but a high level, this is a study done earlier this year by a firm called Advisor Growth Strategies, an investment banking firm on the number of transactions done during the year there over the last five years. And you can tell that it is increasing. The number of M&A transactions in the RIA industry is continuing to expand. With that comes tremendous information. When you have that many transactions, you get really tight on what are the drivers of value for a business. And there are three main drivers of value. One is financial and think organic growth and profitability, organic growth, the ability to sustainably grow your business. If you are a buyer of a practice, you want to know that it is, there is some element of growth. Two is target market. What does their client mix look like? What's their client base? What niche do they have?

(07:34)

What is their right to win in the marketplace that will drive organic growth? And then the last is the quality of the team. Most advisory practices, 70% of their costs are payroll. People drive the value of the business. Now again, organic growth by far is the number one factor that we have learned in all of these transactions and some of the traps that we have seen advisors fall into. One, they are not investing enough in their business. They may have been a producer at a larger firm, they went independent. They think of themselves as a producer, not a business owner, but they are as much of the business owner as they are a financial advisor. And investing more into the business ultimately drives greater long, long-term value. And it is a tough thing to do to give up some of your current income with the prospect of future growth if you invest the right way.

(08:24)

And one of the ways you invest is you leverage support services that help strengthen your practice over and above the skillset that you have. So on the right, here's some of the ways that LPL is providing support services to advises to help them grow. One is something we launched earlier this year called partial book sales. If you think an advisory's practice like any business, you have got clients that are driving large portions of the revenue of your business and your profitability and you have got others that may be on a smaller end or ones that may not be strategic to your business. We have played a role in buying those non-strategic clients. Now we have no designs of running a retail business. Ultimately we will be a bridge to hand that off to other advisors that would find those clients more valuable. But if you think about the advisory practice that sells some of the clients, they've now created more capacity.

(09:17)

Those are clients that were spending time and money and focus on that allow them to focus on the more strategic clients and help grow their practice. The second one is on growth financing. We will provide financing in the form of a repayable loan. This is not equity in the business that allow advisors to be able to invest in things like marketing or staffing or headcount for the prospect of growth. Business owner services, I'll talk about two administrative assistance support, there is a war on talent everywhere, including on the administrative assistant side. We have created a solution where you could buy hours of an administrative assistant rather than the entire administrative assistant. And that may be fine for smaller practices and advisors that run smaller practices. It is just a more efficient, more affordable way to gain support. So you can operate lean, focus the right way and save on expenses.

(10:13)

The other business services is what we call CFO, the ability to what if you had a professional CFO into your business that you could talk about, talk with once a month of where you should focus, how do you align your strategy or sales? And we play that role for advisors as a service. And then the last item is support services that supplement technology. And it is where me, what I mentioned earlier, that it is not just giving the keys to technology to an advisor because it, it is almost not fair to an advisor to say, well here, you have got access to the planning system or CRM, go to it. Go figure out how to connect your tech stack. They most, some are good, most are not. Don't. They did not get into the business because they were technologists or they are operationally savvy. They got them.

(11:03)

They are a great financial advisors. So the ability to provide support services around that is significant. Now on technology, I think of where we are in the landscape is three different waves. Wave one, pre 2010, and I was an advisor earlier in my career, so I was in that pre 2010 category. You think of technology in for big firms, big firms had end-to-end technology. It was connected. You had a level of integration, it just wasn't very good. But advisors that were part of those larger firms felt trapped. There was no real place to go. They would complain, but they really couldn't leave. There were no good alternatives that were out there. There was no performance tension. If you were a large firm and you had your own operating system on the RIA pre 2010 technology, and this is what I used, it was Excel, it was Outlook and it was a yellow legal pad.

(12:00)

That was how you was your mechanism for managing clients. Thankfully, and I would say the robo firms sort of ushered this wave in. We have had the FinTech boom that we are still in over the last 12, 13 years. It is massive private equity investment, massive innovation inside of our industry. It is been wonderful and a number of things have happened as a result of that. Custodians could either had two choices. One, you can abdicate your technology to third parties that were emerging or you could double down and invest in your operating system. We have invested in our operating system. The other dynamic that is interesting in the last X number of years is increasingly technology firms are thinking of themselves broader than technology firms. They've morphing into tamps, they are offering custody now, partnering with custody. So you see a sort of convergence happening in the industry, which is interesting and it is just that the FinTech boom is an enabler of that.

(13:04)

But the challenge created by the FinTech boom is that you have got wonderful technology that just isn't connected. The integration is not great and it is dependent on the user, the advisor or their practice to figure out how to integrate it, who to select how to maximize the effectiveness and the efficiency of it. And that is that. That's where we are today. And it is leading to what I believe is wave three, which is it is not just the technology, it is services, human services around it, professional services that help accelerate that. I'll go through examples of the services, but a couple of statistics that are relevant. There is a capacity crisis with advisors today. The growth of professional advice is wonderful, creates opportunity. The ability to inorganically grow through acquisition is great, but they need time in their day. 52% say maximizing their current tech is the most important to their growth.

(14:01)

These are the release statistics. And then 57% say the lack of integration is their biggest pain point. Now what we have done is we have created an end-to-end operating system that is fully connected. We have invested in it with the optionality of incorporating third party technology and integrating that for advisors. They can customize it or we have an ability to create a sort of an easy path or glide path either with our system or in partnership with third party systems to be able to do that. Now, some of the professional services that wrap around the technology that help optimize that technology, one is paraplanning, something we launched last year. Think of a planning system and all the work that you have to do to enter information into a planning system before then you could start offering advice. One of the things that we realized is like what if we took that from advisors?

(14:51)

What if we were, we did all the grunt work, we put all the detail and the data inside of the system and all the advisor had to do was just interpret it and offer advice. So that is the service that we are providing. And here's the opportunity that creates, let's say you are an advisor, you have got 150 clients, you have 20 that you have done a financial plan for. It is just too painful to do the financial plan for the other 130. And you may not want to. There may be some that you just don't need to, but what if that 20 went to 120? What does that mean in terms of your ability to grow through greater wallet share of the client household wealth that you may not have had access to? Those are the benefits. They're clear ROI statistics that the more planning you do, the greater the wealth of a client you tend to be able to attract.

(15:41)

So that was strategically important for us to create that service to eliminate an obstacle in the planning system. Same thing with marketing. These wonderful marketing systems that are out there, they tend not to get as much adoption as you would think because it is advisors just don't have the skill and capability. We have wrapped a whole service structure around that to help with things like website development, collateral material, and lead generation in partnership with the technology to optimize it. Taking some of the pain away from the advisor to supplement with human services outsource billing and trading. No, no client ever said to an advisor, I love the way you send me your bill or man, you really executed that trade nicely. You just never get credit for that. And if you don't get value from your client, then that is an opportunity to outsource. And it with trading in particular is more and more the industry is shifting to individual securities away from pooled investments.

(16:35)

The value of trading I think will become more strategic than commoditized, which I think the perception is that is where it is today. So those are examples of how services wrap around technology. The third element of value that a custodian can provide in this modern era of value driven wealth services rather than just custody is in high net worth. It is the fastest growing segment. You look at the just that top line of 10 million clients and greater, it almost doubled in the last three years. Now the market's been great and that is a component of that, but it is a meaningful component of the industry and it is, it also helps with firm value for the advisor. The more high net worth clients, it is a better client mix that leads to a higher valuation. So there are many ways that you can help advisors outside of a platform on high net worth.

(17:28)

It could be complex planning support, it could be trust services. But I wanted to focus on two things from a platform standpoint that a custodian can provide. One is on alternative investments and it is not just providing access. And I think what most people think about is you partner with the firms that are out there that allow a feeder structure into alternative investments, and that is part of it. But how do you think of access maybe a little bit more broadly? And then what level of diligence can you provide as the custodian? Alternative investments is, it is costly to due diligence. It is not just the normal due diligence of a typical long only manager. It is operational diligence that takes time and there is an expense to that and what role can we play as a large diversified firm in being able to offer that. And then also the economies of scale that can afford a level of access beyond what a normal custodian would have access to. How do you get direct access to an investment rather than through a feeder where you have an ability to eliminate an element of cost that an advisor may want to do for a certain size of their client. And as a large firm, you have an ability to lever the leverage those economies of scale to be able to provide that level of access.

(18:50)

Next is on the retirement side of it. This is interesting. This is a massive opportunity for the advisors. Advisors will be retiring within the next 10 years, 8.2 trillion in assets, and 25% of them don't have a succession plan. There is the reason that you see so much financial investment, so much private equity investment, a tremendous amount of consolidation. It is just the beginning that is happening. But it also creates an interesting opportunity of a custodian supporting other advisors separate from private equity that allow them to attract and grow and buy other practices. And the statistic in the middle. More advisors increasingly over the last year are interested now in acquiring other practices because the access is there. There is more opportunity to do that. LPL, we have 22,000 advisors. We are the largest in the industry in terms of supporting advisors. That creates a fair number of introductions that we can make within our community that allow advisors to be able to grow to inorganically.

(20:00)

And there are three ways as we think about how we can support advisors. Again, thinking of the role of custodian differently as a wealth management partner rather than as providing pure custody services. One is around growth capital, talking a little bit about that before just growth capital to help an advisor market without having to sacrifice equity in their business. Two is around M&A services and it is matchmaking the ability to advisors that are looking to sell with advisors that are looking to buy and helping with the economics of that transaction. And then the last is what we call liquidity and succession. And if you think about it with a number of advisors retiring, there are problems that are created in that dynamic. Let's say you have got generation one that is ready to retire and wants a liquidity event. And you have got generation two doesn't have to be parent child.

(20:56)

It could just be the next generation of the business that wants to take it over. But they have no financial means to be able to do that. And the generation one wants to make sure that the legacy that they've built in their business continues and maintained. And there is risk if you sell that your business to a private equity investor that they are, who knows what will happen to the team, who knows what will happen to the business. There is more threat of that legacy. So the role that we wanted to provide is how do we provide liquidity to the generation one and with our capital base, we are able to do that. And then how do we create a pathway for generation two to effectively buy the business back over time through the earnings of the business. And we just started doing this about two years ago, and we have had tremendous success of helping advisors in that pathway of moving from generation one to generation two in a way that the generation two ultimately wants to, well ultimately have a capture of the business.

(21:58)

We don't have, don't have a retail business. We only support advisors. It is the only business that we are in. And we believe that the advice should be delivered by an entrepreneur, not by a large firm like LPL. And so our model is how do we make sure that we create that right pathway and that right bridge from one to the next? And that is what liquidity and succession represents. And then the last area on regulation, and as I mentioned, this has become more of a micro sip. The top chart is just fines, fin refines, and think of hybrid advisors that have some brokerage, some fee-based advice. And those firms that they may affiliate with that don't have the proper infrastructure in this increasingly regulatory world, fines are on the increase. And then the SEC is absolutely focused on this. Last year there were 32 roles.

(22:49)

Think of things like the SEC marketing role or the diligence requirements of third party vendors or how to think of consolidated reporting with illiquid assets. Those are very real, very new rules that advisors not only have to be able to comply with, but they have to interpret. And it is not easy. I mean the SEC marketing role is an example is not easy. It is not just sort of a recipe that you follow and it is very clear. It requires some level of interpretation. And who do you feel comfortable talking to about that and making those decisions? And I say that in the context LPL, in addition to being a broker dealer and a custodian, we play RIA for a number of advisors. And I think there has been this wave, and I, I am a former RIA and I love the model, but there is been this wave that almost pendulum swung too far of advisors creating their own RIA where they probably shouldn't, they should be under a shared ADV model where they are working with a larger firm that can provide the level of support and compliance and diligence where they may not have the resources to do it internally.

(23:56)

And the way that always say is that independence isn't defined by how an advisor registers themselves. It is the freedom, flexibility, and control to operate their business. So whether it is their ADV or a shared ADV shouldn't matter. It doesn't matter in terms of business value that is been proven out. So what is the right structure that allow them to operate more efficiently? And so just in conclusion, no, you don't care about that. I think the market for custody services with price reductions and consolidation in the industry has increasingly become more commoditized at a time when more advisors are independent. The growth of hiring professional advisors is increasing. And it is at a time when advisors need more and more support. And the custodian, we believe, play a role in offering that level of support beyond just the normal custody services with some combination of technology, wealth, platform, and professional services. Thank you very much.