byline: Paul Bergeron

Talk of a looming recession has seemed endless for the past few years. However, with their eyes on long-term retirement investments, many wealth management advisers’ clients have avoided dramatic, emotion-driven decisions.

Educated and guided by advisers, they understand the cyclical nature of investing and therefore are considering varying options on where to put their money.

Meanwhile, keeping up with changing times, some advisers are adjusting their business operations. Others are considering mergers and acquisitions, wanting to expand their resource capabilities. And for the large population of baby boomers aging out of their careers, retirement has become an option for both wealth advisers and their clients. These converging trends all make for an interesting and transitional time for the wealth management industry.

When it comes to those suggesting a recession is on the horizon, Michael Joyce, president of Richmond-based independent fiduciary firm Agili, says he’s been a skeptic for the past two years.

“Inflation is slowly retreating. Supply chain issues have largely been resolved and that is bringing down goods inflation,” Joyce says. “Indeed, many who had predicted an imminent recession have now thrown in the towel and are predicting a ‘soft landing.’”

It’s comforting to know that history shows the average recession is much shorter (14 months) than the average expansion (48 months), setting up greater hope for investing in equities.

But for those maintaining a more cautious approach, Aashish Matani, managing director and private wealth manager with Merrill Private Wealth Management in Norfolk, says many investors have been adding to their bond and alternative investment allocations and that most other asset classes are seeing outflows this year. In particular, more investors are putting cash into U.S. Treasurys, he says.

Matani’s clients also are seeking opportunities to rebalance their portfolios amid current market volatility. In addition to fixed income and equity investments, clients continue to consider alternative investments in areas such as private equity, debt and select real estate sectors.

Nevertheless, wealth management clients and consumers overall have some potential economic headwinds to navigate, Joyce says.

Pent-up goods-and-services demand from the pandemic could begin to wane, he says, adding that higher interest rates are already impacting consumers with variable rate debts such as credit cards. Borrowers with low fixed-rate debts are starting to see some debts mature and are facing higher rates to refinance, Joyce says.

“We do expect to start to see more credit stress,” he says. “While defaults are still not far off all-time lows, we do expect these to start to increase — albeit not to worrisome levels.”

Long-term optimism

Joyce is pleased with available yields in short-term bonds, including very short-term 4-week to 3-month Treasury bills. “There’s very little risk to those investments,” he says. “It is important to remember that most financial goals are long-term. For the most part, we are not investing for a 6- to 12-month time horizon. And it pays to be optimistic over the long term.”

Nevertheless, this year has been a challenging one for conservative investors, says Simon Hamilton, managing director and portfolio manager for Reston-based The Wise Investor Group of Raymond James.

Fixed-income investors “were ‘penalized’ while other asset classes performed better,” Hamilton says. “This year has been all about a handful of stocks doing well. Traditionally, defensive cash flow-oriented investments like bonds and dividend-paying blue-chip stocks have in aggregate been the worst performers. Even gold has significantly underperformed the S&P 500.”

Hamilton says he sees 2024 as a year for “revenge” for these conservative investors who are seeing some recovery in fixed-income investments lately after they underperformed over the past year or so.

“What we’re seeing now with interest rates has historically resulted in strong future returns for the next six or seven years,” Hamilton says. “There is a strong historical correlation between starting yields and future returns going out seven years or so. If rates are 5% to 6% today, then there’s a good chance that’s what bond allocations will perform on an annualized basis.

“If inflation moderates, then real returns adjusted for inflation could be positive for years to come. There’s a decent chance the Fed will cut rates in 2024, which would be helpful to dividend stock investors and bondholders.”

For 2024, he says, “simpler will be better.”

In the recent past, some investors, looking at basically 0% interest rates, experimented with investing in and/or managing rental properties, which is generally outside their skill set, and getting mild returns, according to Hamilton.

“They also in many cases dipped their credit standards, extended duration by
going into long-term investments, and pursued in some cases more sophisticated, less-transparent and less-liquid strategies. Now, you can get 5% on cash,” he says.

Joyce says clients not wanting to rely as much on the stock market and fixed-income investments are showing renewed interest in nontraditional investments such as private credit and private real estate — investments that are illiquid but have the potential for premium returns.

“These investments require a lot of research and specialized knowledge,” Joyce says. “These are not investments that you can look up in The Wall Street Journal or Yahoo Finance. You have to work hard to do your due diligence on their outlook, and make sure your clients understand the potential opportunities and the potential drawbacks of the investment.”

Generational changes

Some older, long-term holders of real estate assets are seeking advantageous ways to sell their properties or transfer them to younger generations.

Dwight Dunton, founder and CEO of Bonaventure, an Alexandria-based integrated alternative asset management firm specializing in multifamily development, investment and property management, says he has seen many property owners look for tax-advantaged ways to exit active ownership in the case of retirement or estate planning. The firm has conducted many such transactions in Virginia in the last two years.

“Experts and economists are all aligned that a large transfer of wealth from baby boomers to Gen X and millennials is underway,” Dunton says. “Of the $84 trillion projected to be passed down to younger generations, the Federal Reserve estimates that $18.9 trillion is tied up in real estate assets. We’ve seen family offices and high net-worth individuals, many here in Virginia, look for unique, tax-advantaged solutions, like the 1031 or UPREIT transaction, to offset the capital gains risks associated with property transfers.”

Similarly, just like their clients, as baby boomer wealth advisers age out of working, the industry is seeing an uptick in mergers and acquisitions, also driven by firms seeking opportunities for greater efficiencies by combining assets with larger groups.

“I’ve been in the industry for 40 years,” Joyce says. “This is an aging industry, and everyone’s thinking about a succession plan.”

The wealth management industry, he says, is a fragmented one in which companies tend to have good cash flow, and “this has attracted a lot of private equity-backed funds looking to consolidate.”

Hamilton expects the number of mergers and acquisitions “to explode” in the coming years. “Right now, the cost of capital is too high, so it won’t happen short-term,” he says. “Wealth management companies will look to sell when it becomes too expensive for them to pay for all the regulations our industry faces.”

Additionally, with fast-changing technologies, including artificial intelligence, to grapple with, firms look to consolidation to scale up infrastructure for departments ranging from IT to regulatory compliance and marketing.

“Investing in technology isn’t cheap,” Hamilton says. “If you can’t be both compliant and a state-of-the-art firm and just can’t make the numbers work, you sell. It’s also very expensive and time-consuming to train young or new advisers. Firms in many cases would rather buy a business than start from scratch.”

One of the most common reasons a registered investment adviser (RIA) firm would agree to a merger or to be acquired, Joyce says, would be if the offer was 1 plus 1 equaling more than 2 — a deal too good to pass up, in other words. However, the most common reasons why an RIA firm would not agree to a merger or to be acquired include the freedom for the firm’s principals/owners to be their own bosses.

“You see many deal structures that are not ‘seller-friendly,’ that put too much risk on the seller,” Joyce says. “There’s also an advantage for an RIA firm to tell prospects that you are an independent firm.”

Also, in a time when many industries are grappling with staffing shortages, he adds, “a lot of acquisitions are done so the buyer can acquire talent.”

“It’s a handshake, face-to-face business,” Hamilton says, “and most young professionals want to work remotely.”

Like a lot of other industries, wealth management offices are also seeking a more diverse workforce.

“Right now, there’s never been a better time to get into our industry if you are a person of color or a woman,” Hamilton says. “Firms are making a strong push to be more diverse — something our industry really needs, given the advancing age and homogeneity of much of the financial adviser workforce.”