Registered investment advisory firm aggregators are growing fast. But they face significant risks from debt, post-M&A integration, and financial advisor and client retention, according to an analysts’ note.
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With record deal volumes and valuations booming amid continuing stock rallies that have fueled wealth management firms’ profits, any gathering storms seem distant. But a tempest could be brewing, analysts from Morningstar’s credit rating arm, Morningstar DBRS, wrote earlier this month. The clouds could come in the form of elevated debt for the financing of those transactions, the complexity of managing previously disparate teams of small business owners who became the aggregators’ employees after an M&A deal, and the long-term threat of advisors and clients departing the firms.
The June 1 note didn’t include a full list of the RIA aggregators it analyzed. But it mentioned Hightower, Mercer Advisors and Corient (formerly CI Financial’s CI Private Wealth) as examples of “our rated RIAs,” where the combined assets under management have surged at an average 32% clip over the past three years, reflecting how “M&A is accelerating scale-building and platform relevance over a relatively short period.” Industry fee compression, higher operating leverage from the debt and any moves by advisors or clients to rivals could reduce the advantages from that scale. And the possible vulnerability in the event of an economic downturn for large RIAs or other wealth management firms that have expanded rapidly with M&A deals has turned into something of an open secret across the industry.
“The risk is, what kind of a company are you building? Are you building a company that has a purpose, that has a mission? Or are you building something that is purely financial engineering?” said Eric Amar, a former chief growth officer with RIA aggregator firm Focus Financial Partners who is now founder and CEO of Accelerated Wealth, a private equity-backed minority investor in wealth management businesses.
Since the strength of the economy has been “hiding a lot of potential issues,” the combination of a down cycle, high debts and unhappy advisors who want to leave means that “things can get pretty dicey very quickly” for aggregators that haven’t successfully integrated incoming teams and systems, Amar said.
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High stakes for successful RIA stakes
And that’s why “deleveraging must occur” and “execution matters” for those firms, as the Morningstar DBRS note put it. Their current average leverage of 8.1 times earnings before interest, taxes, depreciation and amortization (EBITDA) represents a four-year low among the rated RIAs. However, that level remains “elevated compared with traditional investment management companies,” according to the note, which was written by Shaima Ahmadi, an assistant vice president for North American financial institution ratings with Morningstar DBRS, and Timothy O’Brien, the managing director of North American financial institution ratings.
“The operating model described by some of the acquirers generally points to higher advisor productivity and better operating leverage over time, even though compensation remains the largest variable expense and may limit the pace of margin expansion,” the note said. “Stronger earnings conversion depends on whether larger platforms can improve advisor productivity; absorb centralized costs more efficiently; and realize synergies after transaction, integration, and retention costs are incurred. Near-term profitability can still be held back by continued platform investment before synergies are fully reflected in EBITDA or net income.”
The “sponsor-backed acquirers” in particular could face risks from carrying so much debt, since their “future capital structures may compete with deleveraging efforts,” the note continued, referring to the private equity firms that eventually sell their stake in firms to another investor. “As a result, leverage can remain elevated even when EBITDA is growing because debt is incurred upfront, while deleveraging depends on the pace of earnings realization and management’s willingness to moderate acquisition activity.”
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Many factors at play
At least three episodes demonstrated those points over the past few years: a 2022 ratings downgrade for CI Financial; litigation between Mercer and the founders of a firm it acquired in 2021; and the “strategic realignment” at Hightower in 2023 and its subsequent “greater focus on centralized onboarding, operations, technology, investment management support, billing and performance reporting” through Hightower Signature Wealth, according to the note.
“This suggests that management bandwidth, systems readiness, and integration sequencing can become constraints if acquisition activity outpaces operating capacity,” Ahmadi and O’Brien wrote. “Public transaction announcements repeatedly emphasize cultural alignment, continuity of service and leadership retention, suggesting these are core integration priorities and potential sources of downside risks if handled poorly. … Advisor departures can quickly become AUM and client-retention risk if acquired teams do not integrate well into the broader platform or if compensation and culture expectations diverge after closing. We therefore place meaningful weight on evidence of successful acquisition execution, including stable leadership, limited client disruption and steady post-close asset retention.”
In an interview, Ahmadi and O’Brien referred questions about the specific nature of the firms’ risks to the Morningstar DBRS methodology for its ratings of investment management firms. The RIAs discussed in the note are at sizes ranging from about $20 billion in assets under management to several hundreds of billions of dollars, Ahmadi noted.
Alongside tracking the level of debt leverage, the agency is examining the degree that the RIAs engaging in M&A are ramping up “specialized services that meet the needs of their high net worth and ultrahigh net worth clients,” and the extent to which the dealmaking “adds to their advisor productivity and also increases their operating margin,” Ahmadi said. The various factors make discussions about how an incoming RIA firm will operate under a new parent company even more important to both parties trying to find the right fit in a deal.
“The challenges that we are concerned about are definitely integration and execution,” Ahmadi said. “As long as the pace of acquisitions is in line with the operating capacity of the platform, that is good. But that is a challenge that surfaces over time.”
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Accelerated Wealth Partners
A crowded recruiting trail
In other words, if RIA aggregators don’t successfully integrate incoming teams, the legal restrictions against departures in the terms of their M&A deals may only be somewhat more effective than those of wirehouses trying to block advisor breakaway moves in court. And the firms will also have to fend off more competition from newer entrants to the industry that aren’t trying to roll up a dozen firms or more under a new majority owner each year.
For example, Accelerated has received $200 million in capital to deploy from a fund managed by J.C. Flowers & Company, but Amar said that it is operating as a holding company that “takes stakes into a handful of wealth management businesses.” So far, the company has acquired minority stakes in two firms. Accelerated won’t have any specific timeline for exiting from the investments, and Amar’s team selected J.C. Flowers from other bidders with the mutual goal of supporting a small number of firms rather than dozens at once, he said.
“We are going to be exclusively dedicated to their success,” Amar said. “They understand financial services very well. They understand wealth management very well. We are effectively their only platform for U.S. wealth management right now.”
