Financial income may have been flat or down in 2001, but broker-dealers report that the psychic income of their reps has rarely been higher. At first glance, this sounds like a paradox, if not an outright contradiction.
An outsider would expect that broker-dealers and their reps would be longing for a return of the greatest bull market of all time, which ended 22 months ago. But what outsiders wouldn't understand is that broker-dealers were being taxed by constantly rising volume, and many advisors and planners increasingly were frustrated by performance-obsessed clients who questioned their failure to produce 30% plus annual returns.
Take Ric Edelman of Edelman Financial Services, one of Royal Alliance's largest offices, in Fairfax, Va. "Many clients we lost in 1998 and 1999 are coming back with their tail between their legs," Edelman says.
Like many advisory businesses, the firm refused to alter its asset-allocation or investment-management style, despite the powerful undertow from the tech craze of the late 1990s. "A lot of our clients are now seeing people who are down 60% to 70%," Edelman notes. "Since September 11, our firm has been very busy."
Advisors often express fears about losing clients to all the recent financial planning converts, such as the advice arms of Merrill Lynch, Schwab and Fidelity. But the reality is that in the late 1990s, they lost more clients to CNBC and online brokerages than they gave up to these giants. "It was substantial," says Jay Lewis, CEO of Nathan & Lewis in New York. "Clients who left for the Internet are coming back. The value of a person giving advice is going up."
That may explain why Anthony Greene, chairman and CEO of Raymond James Financial Services in Atlanta, came away from a regional meeting in mid-November with reps in California amazed at their upbeat attitude. "Revenues are down and expenses are up at many of these firms, but I've rarely seen people more optimistic," he says.
It's not hard to see why advisors, broker-dealers and other service providers are feeling upbeat. The list of mutual fund companies that have either downgraded or completely jettisoned their direct-marketing operations seems to grow daily. And direct-marketing financial giants wouldn't be entering the advice game if the outlook for do-it-yourself investing weren't grim.
Broker-dealers didn't shoot the lights out in 2001 by any means. An informal survey of seven independent brokerages by Financial Advisor finds that firms' revenues through November were down by between 4% and 20%. Some product lines, most notably variable annuities, experienced declines of as much as 30% or 40% last year, as many firms cracked down on 1035 exchanges and sales of variable annuities to qualified plan rollovers. But mutual fund sales and other key product lines suffered only minimal declines, while fee-based programs, including separate accounts, showed gains at many firms.
"This past year was right at the level of 1999, which was a great year, even if volume was higher in 2000," reports Art Grant, CEO of Cadaret, Grant & Co. in Syracuse, N.Y. "UITs (unit investment trusts) did well, and mutual fund sales held up."
Still, Grant is cautious about 2002. "I think next year will be flat," he says. "It's perverse, but layoffs can be good for our business because the rollover business goes up. But what really affects us is people's proclivity to invest, and that tends to lag the economy. People still have to come to grips with what are likely to be 7% or 8% returns in the stock market for the next few years."
Some firms already are seeing signs of a modest improvement. "November was even with the same month last year, and December looks pretty good," says Scott Sherwood, chief operating officer of Investacorp in Miami Lakes, Fla.
"July and August of this year weren't pretty," says Vince Cloud, chief marketing officer of Mutual Service Corp. (MSC) in North Palm Beach, Fla. "But business in October was better than it's been for six or seven months, and the flows in November look just as good. Our people are saying clients are more receptive to new ideas."
Like many brokerages, MSC and SunAmerica's sprawling broker-dealer network are placing more emphasis on fee programs. The industry's two largest independent firms, LPL Financial Services and Raymond James Financial Services, have grown at superior rates over the last decade. And with nearly 50% of both firms' revenues coming from fees, their business has weathered the downturn remarkably well. In the case of LPL, which has talked openly in recent years of going public, the greater the percentage of revenue it derives from far more predictable fee income, the higher the multiple it presumably could obtain.
The slowdown in business over the last 15 months allowed many firms that for years had been scrambling just to keep up with rising volume to shift gears and focus on strengthening their infrastructures. Investacorp spent much of the past year helping reps create Web sites so clients can look up their accounts. "It saves the rep time and lets them talk about serious matters with clients," Sherwood says.
For LPL, last year was time to take advantage of its move to self-clearing, which was a multiyear process. "We went paperless, and that helped control costs at both the corporate and the rep level," Jim Putnam, LPL's managing director, explains. "That's a big benefit for small firms."
In October, LPL's reps opened a record number of new accounts, and the firm collectively has 15% more accounts that it did one year ago, Putnam says. "People are positioning themselves for the next bull market, whenever that starts," he says.
There is a reason why more firms are telling their reps to look closely at fee programs. Putnam says that 90% of LPL reps with $50 million in assets or more will have 2001 revenues that will be even or ahead of the prior year's. "When clients needed advice the most, they were there to provide it, and frankly, they also got paid to provide it," he notes.
At Commonwealth Financial Network in Waltham, Mass., CEO Joe Deitsch made a conscious decision to invest heavily in infrastructure and marketing more than a year ago and didn't flinch when business softened. "We didn't see 2001 coming; you never get hit by the bus you are watching," Deitsch says.
Commonwealth's decision to maintain its spending levels appears to have paid off-through November, its revenues were down less than 4%, the strongest 2001 performance of any independent brokerage surveyed by Financial Advisor. "An interesting trend is that margins are getting tighter," Deitsch notes.
That margin squeeze is affecting many smaller brokerages, and all is not as rosy as the larger firms might lead you to believe. Several executives at larger firms report talking with reps at smaller shops that are suffering noticeably during the downturn. One executive reports he's heard of firms that haven't paid reps commissions for nearly two months because they don't have the capital to get through a tough market. "If you don't see an upturn in business in January and February, you will see an increase in consolidation because of capital problems," predicts Miles Gordon, CEO of ING's Broker-Dealer Network.
Another development broker-dealers are watching closely is the yet-to-surface stance of the new chairman of the Securities and Exchange Commission, Harvey Pitt, who succeeded the SEC's longest reigning chief, Arthur Levitt. Most brokerage executives expect Pitt to be less confrontational than Levitt. Beyond that, Pitt remains an unknown quantity.
At least one broker-dealer thinks Pitt should step back and re-examine the existing regulatory structure. "The securities laws need a total overhaul," declares Grant of Cadaret, Grant. "It's like a house in a prime location that is cobbled together piece by piece. That house should be knocked down. Look at the Merrill Lynch rule [a proposal to exempt wirehouse reps from registering as investment advisors]. People cite ancient securities laws to justify their positions on both sides. The idea of using commissions versus fees to distinguish between agents and fiduciaries is archaic."
A total rewrite of the securities laws may not be as far-fetched as it sounds, according to ING's Gordon, who worked at the SEC decades ago at the same time as Pitt. "I've heard faint rumors about a rewrite, and I would not be shocked, though it would take years," Gordon continues. "Harvey Pitt knows the securities laws as well as anyone in America, and he won't be an accommodator. The 1934 act and the 1940 act need to be brought into some kind of conformity." Pitt, he adds, is a skilled lawyer who just might be up to this daunting task.
Gordon also wouldn't be surprised to see changes in the laws regarding mutual funds' capital gains distributions. If that happens, mutual funds could advance their competitive position versus separate accounts, which have been taking market share from funds in recent years, Gordon adds.
One thing independent firms acknowledge is that the securities business never sits still. Although 2001 may have been a tough year, many brokerage executives have reason to feel good. "Our part of the industry has given a lot more than lip service to long-term investing, and that's paying off now," Investacorp's Sherwood says.