More firms are looking for custody relationships with RIAs.

More custody players have been clamoring for the business of registered investment advisors, and that trend will continue this year, say two well-known research firms for financial institutions and investment managers.

Tiburon Strategic Advisors of Tiburon, Calif., and Cerulli Associates of Boston both expect more firms to go after the business of fee-only advisors in 2004. As much as $2 trillion in assets are custodied throughout the country at all financial institutions, including wirehouses, brokers, banks and others, some industry observers say. Cerulli says about $1.2 trillion in client assets from RIAs is held at various custodians, while Tiburon estimates about $400 billion is controlled by traditional RIA service agents (primarily discount brokers and some trust companies) such as Schwab Institutional, Fidelity Investments, TD Waterhouse and Datalynx. Take your pick, but it's still a lot of money.

Matt McGinness, Cerulli's associate director, says more players are competing for RIA custody business because they see a growing opportunity. "We think the RIA market will continue to experience healthy growth, but for the most part that will not be in the number of firms but in assets under management," he says. In fact, he expects the number of firms, now at about 12,000, to decline gradually for many reasons. Among them: Increasing regulation is making it less attractive to start an RIA firm and advisors as a group are getting older, which will lead to more consolidations.

Jeff Gyomber, research manager/consultant for Tiburon, says the flood of new entrants into the custody business is concentrated in two different market segments. On one hand, a number of firms are looking to carve a niche between the upper crust of the traditional world (the largest Schwab advisors) and the lower end of the institutional world. Examples of these new custodians would be Bear Stearns, Merrill Lynch, State Street, and Northern Trust, which are appealing to the more sophisticated fee-only financial advisors who primarily use individual securities, he says.

On the other hand, a number of firms are coming in at the low end of the traditional custody market, appealing to smaller fee-only financial advisors who are being underserved (or in some cases, turned away) by the big firms, Gyomber says. "Players like Ameritrade, NATCO, Shareholders Services Group, Rydex, and Raymond James are banking on the fact that they can effectively serve smaller advisors (who primarily use mutual funds) while still maintaining a profitable custody model. In this segment, the appeal is not assets per advisor, but the sheer number of smaller advisors that need to custody somewhere," Gyomber says.

The winners in the custody business will be those firms that successfully serve a segment of the market and then build a platform around the needs of that group, he believes. "Good examples of this strategy can be found on the high- and low-end segments: Bear Stearns is focusing specifically on the 1,500 SEC-registered advisors with $100 million to $5 billion in AUM, which would be the high-end Schwab advisor or the advisor who would traditionally custody at a bank. Bear Stearns already has 70-plus advisors on board, but the real key is the fact that they already have over $30 billion in assets, which is significantly more than three of the five traditional custodians," Gyomber says. "On the low end, Rydex has pinpointed the smaller, more active financial advisor as their segment. They've created some interesting products such as leverage funds and inverse funds that appeal to the intellectual, active advisor; because of their unique custody offer, Rydex is also heading in the direction of success."

Advisors seem aware of the changes in the marketplace and certainly have been considering whether it makes sense for their firms to make a switch. Dee Balliett, chief operations officer and partner in Balliett Financial Services Inc. in Winter Park, Fla., says her firm, which has four planners and about $80 million under management, moved all its assets to Rydex Financial Services last spring. "We liked their products, we liked the people and the systems. They have been a delight to work with," she says. The firm had custodied assets at many of the larger firms, but now has everything in one spot, she says.

Scott Leonard, president of Leonard Wealth Management in Redondo Beach, Calif., is using Schwab, but is looking at Fidelity and also is evaluating Raymond James. Leonard says the most important thing he wants from his custodian is what he calls "blocking and tackling," help with daily operations, opening new accounts, sending brokerage statements, and so forth. The second is tools to make his job easier such as electronic downloads, good interfaces with the software his firm uses and an effective Web site to look at client information. Third is marketing assistance. "Most RIAs are small independent firms. We don't have the power of a wirehouse behind us selling our message," he says.

Marketing assistance is where he's unhappy with Schwab. "They don't spend enough money promoting independent financial advisors. They are direct competitors with us," Leonard says. Other advisors have made the same complaint about Schwab, the dominant player in the RIA custody marketplace, with $260 billion in assets from RIAs at the end of the third quarter.

In many quarters, complaints about Schwab's retail strategy are fading, and many advisors are pleased with Schwab's level of service. Jerry Spitzberg, principal and portfolio manager at Noesis Capital Management, in Boca Raton, Fla., and Fremont, Calif., whose firm has $250 million under management, says they've looked at other custody firms, but are sticking with Schwab. Noesis also participates in Schwab's advisor network. Spitzberg says he particularly likes that Schwab's services are transparent to his clients. He's also pleased with Schwab's technology and its integrity, and he doesn't view Schwab as a competitor. "We're just one solution for one part of their client base. We're not right for all of their clients. We're looking for someone who wants to delegate, who wants professional help. That's not everyone at Schwab," Spitzberg says.

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