Breeding Great Wealth Advisors - Interview With Jamie McLaughlin

Joe Reilly May 24, 2021

Breeding Great Wealth Advisors - Interview With Jamie McLaughlin

Jamie McLaughlin - honored by this news service's awards program, runs a management consulting firm focusing on strategy and practice management for wealth management and investment advisory firms, private banks, trust companies, single and multi-family offices. He sits down with FWR to share views on where the industry needs to be headed.

In this article, Joe Reilly interviews Jamie McLaughlin, whom Family Wealth Report has honored with a lifetime achievement award at this publication's annual awards program. McLaughlin has been a prominent figure in the North American wealth sector and his advice and commentary has been invaluable to the FWR editorial team. We are delighted to publish this interview, carried out by a fellow member of our editorial advisory board.

Reilly: Great advisors - bred or bought? 
I’m convinced that every firm has the same so-called “talent” issues; they don’t have enough skilled senior client-facing talent, arguably the principal determinant of the client experience and the underlying driver of a firm’s enterprise value. The only way they can find these elusive people is to breed or grow them. 

The Medieval European merchant guilds come to mind as a model for wealth management. In this pre-mercantilist era, tradesmen banded together to sustain their common interests and respective crafts (i.e. masonry, glassworks, millinery, etc.). The quality of what they stood for was inviolate and, transcending their crafts, bound their villages and regions together. Notwithstanding their anti-competitive economics, the products of these guilds were widely accepted as providing artisanal quality and, therefore, a perceived value and demand.

As it is today, the pathway to becoming a counselor to families of great wealth and complexity is misaligned. Too often, firms react to whatever the market presents to them; they cannibalize their neighbor’s talent or have a passive response to whatever the market bubbles up, largely products of a higher education system focused on the theoretical. That is, individuals largely focused on degrees or vocational paths heavily tilted to finance and the capital markets where mathematics, analysis, and empiricism is predominant - not the study of the human dimension. 

The academy and industry have responded to a degree with programs and credentials (CFA, CFP, CPA-PFS, CIMA, etc.), but these formal training programs are “pulled” by market participants not “pushed” and do not train anyone in the advanced and peculiar needs of families of great wealth and complexity. Without oversimplifying the challenge, most financial firms, including wealth management firms, are populated by “left-brained” rational, logical, analytical types and not often enough by “right-brained” “feelers” or intuitive types who possess empathy and to whom others are comfortable revealing themselves. 

Most importantly, there is no early identification process. The industry does not effectively identify individuals with the intrinsic talents necessary for a consultative role and, on the professional development continuum, firms have not invested in their people to optimally train and acculturate them into client-facing roles. Ultimately, there is no substitute for applied training where the advisor learns to recognize complexity, can identify and unfurl client issues that are often unstated, and can facilitate an integrated dialogue across various client needs and solutions - no small task. 

The wealth management industry could emulate the guild or an artisanal model with improved advisor identification, by committing resources to training and development of advisors through an apprenticeship to a journeyman stage and onto a final master stage. Those who are masters and grand-masters will understand their duty to mentor the next generation to sustain their "craft.”

Fifteen years ago, when I was a partner at Lydian Wealth Management, our senior team was trained in using a personality assessment tool and our syndicated interviewing process was rigorous and unified - we were looking for certain intrinsic attributes, not simply the acquired or learned competencies that were listed on candidates’ resumes. We identified, hired, and trained scores of young people who I’m proud to say are now sprinkled all around the UHNW industry in mid-career client-facing roles and next gen leadership roles.  

Reilly: How important is culture in an MFO? Does it differ qualitatively from a private bank or brokerage firm? 
Culture is the single most differentiating characteristic of any firm in any industry, even more so in the wealth advisory business where very few firms can differentiate themselves by what they do, but, where every firm can differentiate themselves by who they are. Clients are yearning for a relationship and will naturally select firms with whom they are compatible and where they share common values. Firms are wise to build their brands around these markers – whether using subliminal or overt messaging. 

The so-called MFO is nearly always a closely-held partnership organized as a registered investment advisor or independent non-depository trust company. Most private banks and broker-dealers are public companies. The introduction of shareholders as “stakeholders” tends to have a dilutive effect on firm culture as return on equity becomes a driver of behavior and skews the client experience, too often placing the firm and client at odds. Further, while scale implies an opportunity for operating leverage, it tends to further dilute the culture and client experience with firms looking for opportunities to replicate processes and clients preferring customized solutions. 

Reilly: What are the essential skills for MFO leadership? Can you contrast those skills with the skill sets of traditional and alternative asset managers? 
The essential skills include a combination of leadership and management skills, but far too often MFO leaders lack the critical management skills and experience needed to operate a business. As founder principals their intrinsic talents and interests tend to be either sales and relationship management or an expertise in investment management and capital markets. Few have had previous operating business experience in investment management or any other industry. Firms have been slow to bridge this gap, but this pattern is changing. In the largely undercapitalized MFO model, hiring senior talent for non-revenue bearing operating roles has often been financed through cash flow, dampening margins and/or paid for out of the founder principals’ pockets. 

Asset management businesses, by contrast, enjoy much stronger capital structures and, until very recently, had much better margins. The asset management business, essentially a product manufacturing and distribution model, is also more mature where a full generation of founder principals has exited and been replaced by a generation of C-level business managers. 

Reilly: Where do you feel the leading wealth managers demonstrate strength? 
: First and foremost, culture where the client experience is shaped more by who a firm is than what a firm does as previously noted. These high-performing firms have an allegiance to a cause. Their people and clients feel they’re part of something greater than any one person creating a cultural anthropology that is unified and collaborative. Clients can feel an esprit de corps when they walk into an office or toggle to a firm’s landing page.

Further, from a business dimension, the most successful firms have four interdependent components in descending order of importance:

--   Capital – MFO capital structures are weak and concentrated. Capital sources are limited and often incompatible with the long-term requirements of the business and the principals’ objectives; 
--   Leadership – a strong and deep leadership team with operating skills; 
--   Strategy – firms must decide what is a core capability and what is an “adjacency” and then “stick to their knitting.” They need to decide what they will deliver and what they won’t deliver, and in the latter case, how or through whom they’ll deliver certain non-core solutions; and  
--   Execution – execution requires discipline and discipline requires management. 

Few firms have demonstrated success on all four of these dimensions, but the model is evolving.

Reilly: Do you feel the MFO space will consolidate over the next few years or continue to expand? Or do you feel that the paradigm of family office services will shift? 
The nascent wealth management industry broadly is immature – the business economics, particularly in the UHNW segment are extremely challenging, and demand is shifting, all at the same time. It’s very dynamic. 

For firms that serve the mass affluent and high net worth segments, pre-tax margins can exceed 40 per cent. Margins for firms that focus on the UHNW segment are often in the range of 20-25 per cent. But the velocity of wealth creation has reached an unprecedented level. While all wealth levels are expected to grow at compelling rates, the rate of growth of the super-wealthy (more than $100 million) is expected to grow twice as fast. While this newly-minted wealth presents a huge opportunity, the challenge for the industry will be to win mandates from this new cohort of super-wealthy. Too often, these families chose to do-it-themselves or chose multiple investment advisors and shop “a la carte” for various non-investment needs bypassing the bundled, commercial MFO offerings. In this setting, it’s easy to conclude that the industry has not made a case for its value proposition.

Further, while many firms aspire to capture this demographic opportunity, most are inappropriately staffed and configured to profitably deliver the idiosyncratic solutions needed or, worse, insufficiently wary of the challenging economics.

The list of economic challenges for MFOs is long:  

--  As partnerships they have no capital per se other than their free cash flow.  Partners can choose to compensate themselves or reinvest their annual distributions in the business; 
--  Few have achieved “scale” as measured simply by operating leverage; 
--  The aging of key principals and their clients, who tend to be their contemporaries, implies a further diminution of firm valuations; 
--  Due to the idiosyncratic nature of their clients’ needs, it has proven very hard to replicate work processes and/or leverage technology; and 
--  Organic growth has also proven to be longer-cycle so firms' cost-of-acquisition tends to be higher.  

Consequently, MFOs are less attractive to capital sponsors than “plain vanilla” RIAs. 

While there’s been a lot of press about consolidation (much of it coming from various transactors and bankers trumpeting their prowess) in a period of unprecedented multiple expansion that has motivated sellers in the industry at-large, there have been woefully few transactions in the UHNW segment. Tiedemann (Presidio, Threshold), Pathstone (Federal Street, Convergent, Cornerstone) and Fiduciary Trust International (Athena Capital Advisors) are among a handful of exceptions.  

As I predicted nine years ago in this same Q&A format, a non-investment management “family office services” model has become increasingly in demand as UHNW clients and sub-scale family offices conclude that they cannot rationalize certain internal capabilities such as household financial management and IT/systems development. Firms that can deliver these services are capturing this market share and will do so at reasonable margins using a professional service firm (PSF) revenue model and flat, negotiated, non-asset-based fees. 

Reilly: Staff compensation is a substantial part of an MFO's costs. Are there ways to increase the operational efficiencies of MFO staffing while offering a full suite of services? 
The best long-term strategy is to build a true middle office: one where the senior client-facing personnel are leveraged by next-generation professionals. This can increase capacity utilization (i.e. load management) and provides next-generation personnel a clear professional development track. All non-strategic duties (tactical and administrative) can be cascaded down to middle- and back-office personnel. Two key performance metrics are a firm’s cost/income ratio and cost of (client) acquisition. As costs are often 65-80 per cent staff related, the middle office needs to be seen as a high return on capital as increased client-facing activities drive client satisfaction, increase income from existing and new clients, and lower unit staff costs. It also has a salutary effect on firm morale. 

Secondly, pricing methods and discipline can be improved. As noted above, clients are increasingly demanding non-investment services but have been socialized to expect these services are offered “for free” or as part of a bundled fee where the firm’s pricing power is principally related to the investment delivery. An alternative pricing delivery system, one that avoids this “trap” and does not jeopardize a firm or advisor’s “primacy” with a client, is for firms to either systematically outsource or joint venture the delivery of non-core capabilities or categorically enumerate these discrete services in their annual engagement agreements passing through their true costs. Firms need to stop tiptoeing around their fees and provide regular communication, expectation management, and transparency on their service delivery and value proposition. And, finally, as part of their client acceptance, they need to limit fee exceptions and discounts and below minimum relationships.  


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