Why investors should care about who owns their advisor’s firm

Getting financial advice online is easier than ever before. Even so, many investors are likely to discover that there is no substitute for a human financial advisor.

The problem, however, is selecting the right one.

One thing an investor should consider is the advisor’s investing acumen. Low-cost funds that track various indexes are widely available. So, if part of an advisors’ value proposition is managing individual portfolios, how does their performance stack up?

Another is the availability of services and products. Most investors even if they don’t realize it — have needs that transcend investment management, including help with saving for a child’s college education, picking the proper insurance, creating an estate plan and navigating taxes efficiently.

More from Personal Finance:
Here’s what every taxpayer needs to know this season
IRS unveils Taxpayer Experience Office to improve customer service
Here’s why your tax return may be flagged by the IRS

Whether an advisor is a fiduciary and puts their clients’ interests ahead of their own is also important. Incredibly, some advisors — subject only to a suitability standard, which offers investors far fewer protections — are not legally required to do that.

Moreover, no one should discount the importance of personal chemistry. Few people want to have a long-term business relationship with someone they do not like, regardless of how competent they may be.

Another huge consideration is who owns the advisor’s firm. Though this isn’t a concern that immediately comes to mind for a lot of investors, it’s just as important as the others listed above.

In the rare event that investors do raise this point during the vetting process, some advisors will respond by touting their “independence.” The implication is that this makes them more objective since they don’t have sales quotas, sell proprietary products or have to confront other types of conflicts that are often associated with large, publicly traded firms.

To be clear, good advisors come in all shapes and sizes. That includes those in business for themselves, employees of the biggest firms on Wall Street and everyone in between. Still, it’s important to note that just because someone is independent doesn’t mean they work in a conflict-free environment.

At issue is not only the amount of money that has flooded the wealth management industry in recent years, but where it has come from. According to a report by Echelon Partners, there were a record number of merger and acquisition deals last year involving registered investment advisory (RIA) firms. Of the 307 total transactions — which encompassed more than $575 billion in assets — private equity played a role in more than 66% of them.

While private equity firms are often led by sophisticated investors, the mandate is simple: acquire assets, hold them for a short period (usually between two and seven years) and then sell for a considerable profit to reward themselves and their shareholders. More so than any other business, therefore, the emphasis is on expanding margins — and if an acquired firm must slash costs and charge higher fees to achieve that, then so be it.

Naturally, it’s easy to see why this approach could lead to a decline in client service. After all, no one likes to pay more for less. Yet almost every time a private equity-backed deal gets announced, all the participants paint a rosy picture, claiming that the extra capital will create “scale” and greater efficiencies. The result, they invariably say, is better client service.

Whether things play out like that is a fair question. Some firms may be able to pull it off. But for most, it doesn’t seem possible when their service model is, in part, rooted in how much money the business can bleed out of clients.

In the meantime, a recent academic paper suggests that issues related to private equity may run deeper still. In December 2021, researchers at the University of Oregon released a report examining whether the model impacts the way advisors interact with their clients, given the dynamics described above. Their conclusion? Private equity creates a conflict between “advisory firms’ profit motive and ethical business practices.”

Specifically, the report’s authors found, based on a sample of 275 RIA firms, that once a private equity takeover gets completed, the number of advisors within an acquired firm who commit misconduct jumps by 147%. And while it’s important to point out that the misconduct rate of those advisors remained below the overall industry average, the trend is undeniable: When private equity invests in a wealth management firm, its advisors are more likely to act out.

And while it’s important to point out that the misconduct rate of those advisors remained below the overall industry average, the trend is undeniable: When private equity invests in a wealth management firm, its advisors are more likely to act out.

None of this is to say that private equity firms are inherently evil. Like any other business, they have every right to make money. But when customers feel valued and supported, they tend to have higher levels of satisfaction. When that happens, profitability usually follows.

Conversely, when businesses focus solely on hitting numbers, day after day, quarter after quarter and year after year, service can suffer — which is why every investor should be mindful of who owns their advisor’s firm.

— By Detlef Schrempf, director of business development at Coldstream Wealth Management. Schrempf played 16 seasons in the National Basketball Association.