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.