The independent advisory market is changing, perhaps in some surprising ways.
All too often, this emerging profession's
conferences, like those of most other industry and professional groups,
resemble a poor man's version of the Academy Awards. Endless
self-congratulation leavened with pompous platitudes about the noble
public service provided by their businesses, culminating with a bunch
of guys presenting awards to each other and telling each other how
great they are.
Small is often beautiful, and it is the rare
conference that challenges its attendees and the conventional wisdom
they hold to be self-evident. For a previous attendee, it was hardly
surprising that the collegial atmosphere at Tiburon Strategic Advisors'
11th annual CEO Summit in San Francisco on October 18 and 19, limited
to 75 attendees, did exactly that, while generating numerous insights
into the fast-changing world of financial services delivery.
Chip Roame, the host of the conference, began by
outlining five recent developments that have made headlines in the
financial services business and another five findings that Tiburon's
research has uncovered.
1. The asset management business is playing a widely
divergent role at the nation's largest brokerage firms. Acting partly
out of the belief that proprietary asset management represents a
conflict of interest for brokers in the post-Eliot Spitzer era, Smith
Barney and Merrill Lynch are jettisoning asset management units. But at
the same time, Morgan Stanley, Wachovia and UBS are enhancing their
asset management arms and are trying to implement new safeguards to
prevent conflicts from arising.
2. Two of the nation's largest load fund families,
MFS and Putnam, were placed on the sales block recently. Roame posed
the question of whether this signals the decline of a major mutual fund
sales channel-load fund growth had outpaced no-load fund sales for much
of the last decade-or simply reveals that the market is "penalizing
poor investment performance." Another possibility behind the strategic
move could simply be a refocused strategic direction at their parent
companies, Sun Life of Canada and Marsh & McLennan. Asset
management businesses still sport hefty price tags, but Sun Life took
MFS off the block after failing to find a suitable buyer.
3. The financial services business continues to
witness the continual proliferation of a stream of new products. At the
start of 2006, there were about 8,000 mutual funds, more than 350
exchange-traded funds and 9,000 hedge funds. That hedge fund figure
doesn't include about 8,000 offshore hedge funds. But the fact that so
many of these vehicles were targeted at a mere 2.6% of America's
population helps explain why more than 1,000 of them folded their tents
in 2006.
According to one conference attendee who consults
hedge-fund investors, the sad truth about hedge funds is that many
failed funds actually enjoy better investment performers than
survivors. He cited a recent study that found many small hedge funds
fold because they don't reach critical mass, about $100 million in
assets, even though they outperform the average hedge fund by 400 basis
points. In contrast, mid-sized and large hedge funds fail because of
poor performance, not insufficient scale.
Meanwhile, the exchange-traded fund business
continues to boom, with one company, Barclay's, garnering a 65% share
of all asset flows. Speaking to attendees later in the conference, Lee
Kranefuss, CEO of Barclay's intermediary business, declared that the
question isn't if actively managed ETFs will start appearing, but when.
4. Venture capital is back in a big way, and much of
it is going into private equity. The size of several funds is "truly
ludicrous," Roame said, and some funds already are returning money to
investors. But when Google pays $1.8 billion for YouTube, which has yet
to turn a profit, the money keeps flowing. VC and private equity have
barely penetrated the financial services business, but as the $2.4
billion purchase of LPL Financial Services demonstrated, that doesn't
mean it won't.
5. Depending on what day you look, Bank of America
may have surpassed Citigroup in market capitalization. While Citigroup
is buying banks around the globe in places from Turkey to southeast
Asia, Bank of America is building branches in the United States. The
relatively superior performance of Bank of America's shares partially
reflects the long-term staying power of retail banking and investments
over the more cyclical corporate banking, underwriting and merger
businesses.
6. In a sign of the shifting balance of power,
Fidelity has overtaken Merrill Lynch as the largest retail financial
services firm, when measured by assets in custody. With $1.6 trillion
in assets, Fidelity surpassed Merrill, which had taken the top spot
from several banks 20 years ago. Schwab also is poised to surpass
Merrill by the end of 2006, Roame predicted.
7. The data for fee-based accounts continues to be
miscalculated, Most measures peg it at $1.2 trillion, with two-thirds
of that amount in separately managed accounts, But with some
calculations, it's unclear whether they factor in RIA self-wraps, bank
trust departments and money managers. Independent RIAs only made it
onto the Investment Company Institute's radar screen a few years ago.
8. The number of independent broker-dealer reps, now
80,000, has surpassed the 70,000 brokers who work in wirehouses.
Indeed, the captive advisor channel is not growing at all in the number
of reps, and some firms are looking to continue cutting unproductive
reps aggressively. While the number of independent B-D reps continues
to grow, their average account size remains very modest at about
$140,000, indicating that it's very much a platform for Main Street,
not Wall Street.
However some firms, like LPL Financial Services and
Raymond James Financial Services, have managed to move up-market.
Incidentally, LPL offers certain advisors a 98% payout rate on
commissions and fees and still earns "the best customer service scores,
so it's not an either/or proposition," Roame argued. Banks and other
firms, like H&R Block, have taken notice and now are recruiting big
Smith Barney brokers with million-dollar books of business.
Independent RIAs represent the fastest-growing
sector serving individual investors, and many have larger average
account balances-in the $500,000 area or higher. Independent advisors
often target the millionaires next door. Roame indicated that RIAs'
assets are growing at rates of three to five times brokerages and
banks, even though they don't market. "The number of independent reps
is growing very fast and the number of RIA firms is not," he explained.
"But the amount of RIA assets is growing much faster."
Amazingly, the biggest RIAs have no real marketing
strategy, but their business is booming from passive referral
strategies. Roame offered a mixed perspective on the arguments about
firms with size and scale garnering the lion's share of business. The
biggest firms tend to have very simple strategies and do one or two
things very well. "But we can't prove that there's any evidence that
big firms have synergies and have more assets per partner," he
contended. "I'm not saying it's wrong; I just haven't seen the
evidence."
9. Online brokers are once again enjoying strong
growth. While independent advisors continue to gain market share,
online brokerages that spent the 2001-2003 era dead in the water are
seeing substantial online account growth. So the competitive playing
field that existed earlier in this decade, when wirehouses were
floundering in scandals and do-it-yourself (DIY) investors either had
burned their wallets or couldn't bear to look at their portfolios is a
thing of the past.
Virtually every study of affluent investors says 75%
of them use an advisor. "I don't believe it," Roame declared. However,
other studies show that many well-heeled investors use several advisors
and also have self-directed accounts. Karl Mills, president of Juricka,
Mills & Kiefer in Oakland, Calif., produced the best line at the
meeting when he noted that there's never been a cheaper way and easier
time to hurt oneself.
Later in the conference, the room full of at least 50 top financial
services executives was asked if they used an advisor, and fewer than
ten hands went up, hardly a ringing endorsement. When asked how many
attendees planned to use an advisor after they retired, about half the
hands in the room were raised.
10. Many top financial companies remain obsessed
with international expansion. But right now they either may be thinking
really long term or deluding themselves. In point of fact, Roame
explained, that measured by wealth Canada equals Pennsylvania and the
United Kingdom equals California, which has 855,000 households with $1
million in investable assets, compared to Chile with 4,000.
Why Are RIAs Booming?
Shortly after Roame's presentation, the meeting
moved on to a panel discussion asking several custodians why the
independent RIA model is working so well when most RIAs don't know
how-or don't try-to market their way out of a paper bag. One obvious
answer is that the baby boom generation hates to be sold anything, so
the independents' non-existent marketing strategy may be just what the
doctor ordered.
But the RIA market also is one that is misunderstood
and difficult to measure. While most industry consultants believe
Schwab Institutional is the largest RIA custodian with $468 million in
assets and a market share over 60%, Randy Merk, president of Schwab's
financial products division, estimated that firm's market share is
really about 23%. Translation: This market's a whole lot bigger than
consultants like Cerulli & Co. think. While there are about 10,000
SEC-registered RIA firms and about 9,000 state-registered firms, they
employ about 65,000 people, many of them professionals.
About "57% of the industry is not services by
single-purpose platforms like we have today," Merk continued. "Half of
all [custodial assets] are all over creation." To put this in
perspective, John Iachello, chief operating officer of Pershing Advisor
Solutions, cited one RIA client who used 140 different custodians.
Iachello went on to describe a pattern that Pershing
often sees in the evolution from broker to advisor. The wirehouses
often serve as a training ground, performing a similar function to the
minor leagues. Many brokers hunger to go independent but they "won't
walk away from 40% to 50% of their business," which is commissions,
immediately. After a few years as an independent, some can convince
most of their clients to work on a fee-only basis and so they decide to
drop their license and go fee-only.
One trait that differentiates the advisor business
from do-it-yourself investing and day trading is that it manages to
flourish in good times and bad, explained Tom Bradley, president of TD
Ameritrade. "Research shows that between 2001 and 2005, the wirehouses'
market share fell 20% while advisors' market share increased 71%," he
said. "The business has the potential to get a lot larger than $1.2
trillion."
Indeed, some think it already is. Folks at Schwab,
who have been pounding the pavement in this business for about two
decades, peg it at $1.8 trillion.
Though the number of RIA firms has been relatively
stable for several years, it is likely to see a spike upwards this year
as more brokers decide to go independent and/or become an RIA. The
disclosures resulting from the broker exemption rule about their
potential conflicts of interest that brokers must make to clients is
making many of them uncomfortable, Bradley explained. Whether or not
the Financial Planning Association wins its lawsuit asking the
Securities and Exchange Commission to vacate the broker exemption rule,
"brokers will do what they have to do to provide advice," Bradley
continued. "RIAs may be surprised."
Indeed, the balance of power has shifted so
dramatically from wirehouses to independents that some might wonder if
this shift is producing the same type of overconfidence that once led
wirehouses to dismiss independents as the bush leagues. Recalling his
early days at Merrill Lynch, one attendee said that "we used to say it
cost Merrill $20,000 to train a broker and it cost our clients
$100,000."
Over the last decade RIAs have led a charmed life,
which may explain why they measure success so differently from big
public financial services concerns. As Kurt Brouwer, CEO of Brouwer
& Janachowski, an advisory firm managing $650 million in Tiburon,
Calif., put it: "Success [to me] is working the hours I want to and
working some of the time in Hawaii on California time."
Roame recalled visiting an advisor in Iowa when he
worked at Schwab in the 1990s and hearing a Schwab executive tell an
advisor with $50 million under management and "half an employee" that
he really needed to jumpstart his practice and start to grow it. "In
reality, he was earning a very good living and didn't need to change
anything," he says.
Independent advisors may no longer be the best-kept
secret in the financial services business, but millions of Americans
aren't using them or are failing to connect with any advisor. Andrew
Rudd, the former co-founder and CEO of BARRA, which was sold to Morgan
Stanley for $900 million, probed this question and shared some of his
own experiences.
"Why did I fail?" asked Rudd, discussing his
experience with a private bank. "Clearly, I chose the wrong advisor."
He cited a "lack of control, a lack of access, arrogance, and appalling
support" as reasons why he dumped the private bank.
Despite a doctorate in operations research and the
fact he knows more about finance and risk analytics than all but a few
advisors, Rudd wanted to delegate his financial affairs to an advisor
and certainly would have made a desirable client. "Too many times I
would find an advisor who would try to put a collar around my BARRA for
only 2% of its value," he continued. "They only addressed a miniscule
part of the whole picture."
And as a consumer panel would reveal later on the
second day, the experience of many investors was similar to Rudd's in
both its randomness and ultimate disappointment. One bad experience can
sour many an investor.
One investor, a pharmacist called Jack, sold his
store in 1983 and went to a planner who put him in limited partnerships
and Florida apartments. Jack admitted to making a lot of mistakes on
his own before finding an advisor, Tif Joyce, who put him in stocks in
1987. Nonetheless, their relationship has survived, and Jack was
impressed by how much Joyce cared and that he called him on vacation.
Jack still works one day a week, a factor that Joyce said helped
provide a cushion over all thee years.
Another consumer, Brad, complained that he still
"gets calls from people on Long Island in a boiler room." That's not
the infamous Boom Boom room. "You can hear all the other brokers
yapping away," he remarked. "It might be time to look at financial
advisors again, but I put up a shield because of the way the industry
presented itself a few decades ago."
Another investor, Larry, was what you would have to
call a serious player. An accountant and lawyer by training, Larry had
owned his own commodity firm in the late 1970s, only to have his
partner flee the country with $3.5 million, forcing him to sell all his
assets at 20 cents on the dollar.
He managed to recover by moving to Alberta, Canada, and doing a
leveraged buyout of a sizeable company. Still, he knew he was
vulnerable. "I realize when I'm 70 someone's going to call me up, tell
me I hit the Lotto and take my money," he quipped. Having a brother who
got a $3 million liver transplant also left Larry acutely aware that
most of us will finance on our own longevity.
Another panel with several product and service
sponsors generated a provocative discussion on what baby boom investors
really want. Of course, it's what they don't have, a defined benefit
plan.
"People want guarantees," said Ron Cordes, CEO of
Assetmark, now a Genworth subsidiary. "No one has cracked that code. To
some extent variable annuities have, but they have a lot of baggage."
Everyone agreed that a product that looked like a
defined benefit plan and worked like an annuity would be a tremendous
success if someone could find a new name for it.