Private equity chasing healthy returns at RIAs and broker-dealers

Why are private-equity investors swarming over the wealth management industry?

As Willie Sutton supposedly said when asked why he robbed banks, “That’s where the money is.”

Looking to buy businesses with annual rates of return of 20% to 25% in order to double their cash and flip an investment in five years, private-equity investors are scouring registered investment advisers and broker-dealers because they fit that profit profile. The median profit margin at an RIA was 20% last year, according to a new survey by TD Ameritrade Institutional, which was down from a 24% a year earlier.

Independent broker-dealers typically see much smaller profit margins, typically in the mid to high single digits, but have room to boost those levels and be more attractive to a potential private-equity buyer if they can move assets to platforms that charge an annual fee rather than commissions.

“The RIA space is also evolving quickly, and that’s when private equity likes to get involved,” said David Devoe, managing director at the investment bank DeVoe & Co. “Private equity wants and expects a return on investment that is above their cost of capital. They are looking to invest in mega RIAs and wealth managers, which have a higher and faster return and lower risk profile than an independent broker-dealer.”

The market for private equity funds buying both IBDs and RIAs is humming.

Most notably, private-equity shop Genstar Capital last month said it had reached an agreement to buy Cetera Financial Group, a network of six independent broker-dealers with about 8,000 brokers and advisers.

Terms of the deal were not disclosed, but earlier speculation had stamped a $1.5 billion valuation on the Cetera network.

“For the Cetera broker-dealers, there is still a lot of commission revenue there, and if advisers convert that to fees it helps Cetera’s bottom line,” said John Rooney, managing principal at Commonwealth Financial Network, a competitor of Cetera’s. “And the political winds are continuing to blow in a less regulated direction,” which could continue to help the profitability of brokerage firms, he added.

In a closely watched transaction for private-equity investors in the RIA industry, Focus Financial Partners last week raised $535 million in an initial public offering. Focus Financial’s initial price of $33 per share fell short of its expectations of a range of $35 to $39 per share, but shares have rallied since then and were trading at $39 a share on Thursday, an increase of 18.2% in a week.

Focus Financial has been partially owned by P-E investors for 12 years, and in April 2017, a 70% ownership stake in the company was acquired by Stone Point Capital and KKR.

In fact, it was KKR’s entrance into the wealth management space that captured private equity’s attention.

“The interest by private equity seems like it’s heightened over the past 12 to 18 months,” said Peter Nesvold, managing director and chief operating officer at Silver Lane Advisors, an investment bank focused on RIAs and the financial services industry. “The real inflection point was last year when KKR invested in Focus. Once you had the blue chip sponsors and funds making a sizable investment it felt like the industry had arrived, at least from the P-E side. Plenty of managers and funds invested well in this space for many years but that really was the big one.”