This software is the heart of an advisory practice-so why are there so few options? (Hint: look in the mirror.)
Here I am at a Greek diner near my office in
Westbury, N.Y., sitting in a booth across from Bob Yacobucci, a
42-year-old programmer, who started his own portfolio management
software (PMS) company in 1999. In an instant, ten years of covering
PMS systems for RIAs crystallizes to form a clear picture of the
gridlock paralyzing this part of the RIA world. Before you can say
"cheeseburger, cheeseburger," I realize while talking with Yacobucci
why the PMS market for registered investment advisors (RIAs) is
paralyzed. I realize why so many advisors dislike Advent Software, and
why financial services technology giants like SunGard Data Systems and
The Thomson Corporation have not entered the RIA market with a PMS
product.
Before going any further, I want to say that my
epiphany at the Greek diner should not be construed as a knock at
Yacobucci or his PMS product. Portfolio Director sounds like an
innovative application. Its interface is programmed in Java, and the
application uses the Microsoft SQL Server database back end, which
makes it different from any other PMS application being marketed to
independent advisors. In addition, Yacobucci says he has made it easy
for advisors to publish portfolio reports to their Web sites. So please
understand. I could have been talking with any of the tiny PMS vendors
when I had my epiphany and realized why the market for providing the
mission-critical lifeblood application of an RIA is frozen in gridlock.
Yacobucci had been asking me for more than two years
to review his PMS software, but I'd been reluctant. By the time
Yacobucci's software came to my attention three years ago, I had
already been covering the advisor technology beat for seven years. I
had already covered the meteoric rise of Techfi, which lit up the RIA
world in 1999 with the first SQL-based PMS product, only to become so
consumed by its growth that it failed to provide good service or
support to its clients. I had by then already covered Techfi's purchase
by Advent Software in June 2002 and Advent's subsequent decision to
stop offering Techfi's products from the market. In short, experience
had taught me to pause before covering tiny startups like Yacobucci's,
to look at all the angles, and to be skeptical. So I've been slow to
give Yacobucci's company any coverage in this column. But now Yacobucci
had traveled all the way from Holidaysburg, Pa., and wanted to see me.
We settled into the booth at the diner after making some small talk and
I asked him some questions.
Yacobucci said he had 250 clients. Earlier, he had
told me that the cost of the software was $150 a month, $1,800 a year.
I started making the calculation out loud.
"Okay, so you have 250 clients each paying you $150 a month," I said. "Right?"
"No," said Yacobucci. "We only raised prices on the new customers and not on the existing clients."
"So you have 250 clients and each on average is paying you $1,000, right?"
"Yes," he said.
"See, that's why I am such a pain in the neck," I
said. "You have a business with six employees and revenues of $250,000.
That's not a serious business."
In this brief exchange, I saw the truth about the
providers of PMS software to RIAs: The market mechanism for providing
PMS software to RIAs is broken, stuck in gridlock. Advisors choose
small technology companies to serve them because they can save money by
doing so. Small companies like Yacobucci's offer their products at
incredibly low prices. But small companies often cannot provide the
solutions advisors say they want. Consequently, RIAs bemoan the fact
that there are only two industrial-strength portfolio management
software companies, Advent and Schwab, when in fact RIAs themselves
have made it unattractive for qualified new entrants to try to serve
them.
In light of two recent developments of significance,
it's time for RIAs to critically examine why viable technology
companies are not trying to provide them with the central application
they use to run their business. The two developments are Advent's
decision to market its new SQL-based PMS product to RIAs with at least
$1 billion under management, and the decision by technology giant
Intuit, makers of QuickBooks and Quicken, to pull the plug on a
one-year effort to enter the advisor PMS market. The strategic business
decisions made by these two large technology companies indicate that
something is wrong in the RIA world. Why aren't large financial service
technology companies clamoring to provide RIAs-a growing market-their
core application?
The PMS Challenge
To understand the dynamics at work here, let's start
by examining what RIAs expect of a PMS software application. RIAs want
interfaces allowing them to download transactions from an array of
custodians-Schwab, Fidelity, TD Ameritrade, Raymond James, Bear
Stearns, Pershing, just to name a few. They want to be able to
reconcile their data easily and clean it up when a stock split,
dividend or other corporate action occurs that requires data scrubbing.
They want elegant-looking reports and the ability to customize reports
to show the data and graphics they want their customers to see.
With just a few clicks, advisors want to be able to
upload their reports daily in a batch process that encrypts and stores
client performance report data on their Web sites, so that clients can
pull from personal folders whenever they wish. Advisors also want their
PMS data stored on an SQL database, which would allow them to
inexpensively write custom software programs integrating their PMS
application with customer relationship management software and other
applications, and allowing them to drill down in their PMS database
from the portfolio level to the transaction level.
Most importantly, advisors demand that this
application be 100% accurate. Whether calculating time-weighted returns
on stocks, a variety of types of bonds, mutual funds and other
securities, reinvesting dividends or not, RIAs absolutely, positively
cannot stand for any calculation errors. And the most sophisticated
advisors want to be able to manage tax lots using multiple
methodologies-first in-first out, last in-first out, average cost,
highest cost, lowest cost and actual cost.
To round things out, advisors want these features
delivered through an easy-to-use interface that junior-level employees
in their firms can use to generate reports, download data and perform
day-to-day chores needed to run their businesses. They also want the
PMS vendor to provide a toll-free support hotline 12 hours a day
(between 8 a.m. Eastern time and 5 p.m. Pacific) five days a week, with
the help desk manned by qualified experts.
Advent And Schwab
Now let's assess the competitive stance of the two
dominant firms providing PMS software to RIA firms, Advent and Schwab.
Schwab almost single-handedly invented the RIA
business in the early 1990s by creating the first mutual fund
supermarket and establishing a division to serve independent RIAs. To
provide better service to its advisor clients, Schwab built technology
systems for them and in the early '90s acquired a then-tiny PMS vendor
called Performance Technologies Inc., which made an application called
Centerpiece. By the end of the millennium, Schwab had attracted about
70% of all the assets of independent RIAs using mutual funds to serve
the high-net-worth investor market.
For Schwab, its foray into the PMS market has been a
blessing and a curse. It's been a blessing because it gives Schwab a
competitive advantage. No other custodian can boast of offering an RIA
the technological guts it needs to run its business-a portfolio
management and reporting system as well as a back-office trading system
and portfolio accounting system. Schwab truly understands RIA
technology challenges because it lives and breathes it daily. It's in
the trenches with RIAs, selling them PMS systems. And by the way, that
just happens to also be a great sales pitch when Schwab is selling RIAs
on custody services. Plus, Schwab can give away its PMS software for
free to big advisors who are good custodial clients.
However, offering its PortfolioCenter PMS system has
also been a curse because it costs Schwab a lot of money to support and
upgrade its software. Schwab now has about 5,300 RIA firms using its
custodial service and 3,300 using Schwab PortfolioCenter. Schwab says
900 of its 3,300 PMS customers are not Schwab custodial clients.
The economics of supporting RIAs that are not Schwab
custodial services clients came to a head in February 2002, when Schwab
announced that it would stop selling its PMS system to advisors that
were not Schwab custodial service clients. This sent a chill through
the RIA market because Schwab, which had long been accused of being
heavy-handed with advisors, seemed to be pulling a major power play.
RIAs that had trusted Schwab for both PMS and custody services suddenly
became uneasy. If Schwab could impose conditions on Centerpiece users
not using Schwab's custody services, what conditions might Schwab
impose on Centerpiece users relying on its custody services?
It was a PR nightmare for Schwab. Schwab eventually
reversed its decision because the distrust it engendered threatened to
harm its highly successful custody business. To this day, however,
Schwab is looked on warily by many advisors who fear Schwab might use
its tremendous clout to somehow strong-arm them.
But what's been forgotten is that Schwab was simply
trying to protect itself from a bad investment-providing a PMS
application to hundreds of advisors who were not its custody clients.
Schwab has a strategic reason for supporting the PMS needs of RIAs that
are not its custody clients: It hopes to convert them to Schwab custody
services. However, 900 advisors who now pay Schwab $1,650 a year for a
single-user license to PortfolioCenter and another $600 for each
additional user are probably not adding much, if anything, to Schwab's
bottom line. That's why, when the bull market ended and Schwab was
laying off thousands in early 2002, it no longer wanted to support PMS
users who were not Schwab custody clients.
When Schwab rolled out PortfolioCenter two years
ago, it raised prices sharply. For advisors who did not custody assets
at Schwab, the first-year license fee more than doubled, to $8,000 from
$3,450. Schwab says it does not subsidize its PMS subsidiary and that
its PMS unit must stand on its own financially. But the licensing fees
Schwab makes on PortfolioCenter don't add too much to the financial
services giant's bottom line. Just eyeball the economics of running
Schwab Performance Technologies.
If you assume that the average firm licensing the
software has three licenses and is paying Schwab about $1,650 for the
first seat and another $1,200 for two more seats, Schwab is getting
about $9.4 million in revenue a year on its PMS business. If Schwab
signs up 50 new clients a year, it's another few hundred thousand in
revenue. The company has about 90 employees. If you assume each one is
making $50,000 a year, its payroll alone is $4.5 million. Add in the
cost of employee benefits ($1.5 million), rent ($250,000) and all the
other expenses that goes with running a company with 3,300 customers
and 90 employees-utilities, travel, lawyers and all the rest-you have
to assume Schwab is not doing much better than breaking even on its PMS
business.
PortfolioCenter is a strategic investment for
Schwab, not a financial one. Advisors who are Schwab clients and who
use Schwab's PMS system are paying a low price for their PMS
application because PTI is not a division Schwab is trying to make
money on. Schwab can afford to keep the price of PortfolioCenter
software low because it gives Schwab a competitive edge in the custody
business. That's one of the reasons why the market mechanism for
providing better PMS solutions to RIAs is broken.
Meanwhile, about a year ago Advent Software, a
company advisors love to hate, rolled out a new, SQL-based PMS system
called PortfolioExchange. Two months ago in this space, I noted that
Advent was not interested in selling its very sophisticated new PMS
application to the RIA market. That's because Advent is targeting large
RIAs with at least $1 billion in assets under management to buy this
software. For users of Axys, Advent's reliable but technologically
ancient PMS system for small RIAs, Advent is charging tens of thousands
of dollars to convert to PortfolioExchange. One advisor managing about
$300 million with a long history of transactions was told it would cost
$125,000 to convert to PortfolioExchange, for instance. Even a "small"
RIA firm with just $100 million under management should expect to pay
tens of thousands of dollars to convert to PortfolioExchange.
Incidentally, if you contrast Advent's launch of its
SQL product, PortfolioExchange, with Schwab's launch of
PortfolioCenter, you see major difference in approach. When Schwab
rolled out its SQL-based PMS system, it made upgrading free. Schwab
rolled out the new software over a one-year period to limit disruption
inherent in converting hundreds of transaction-history databases
maintained in each of the RIAs using its PMS, but conversion was
free-zero, zilch.
Why? Because Schwab is not really in the advisor
software business. It's in the RIA custodian business. Its PMS
subsidiary need not make any money on the software conversions. Advent,
meanwhile, a publicly held company, must make money on its software and
services and charges tens of thousands for a conversion. No wonder
Advent is not rolling out its new SQL-based desktop product for small
RIAs serving high-net-worth individuals. No wonder Intuit concluded
there was no money to be made in offering RIAs a PMS application and
killed its offering after a year. Please understand that Schwab is not
to blame for this. It's doing what's best for its business and, many
would argue, what's best for its customers. Schwab is not evil or even
devious. It's running its business wisely.
The Challenge To New Competitors
Every once in a while, you open up one of the
industry magazines and read about some new PMS application that is
going to reinvent the industry. Four years ago, the buzz was around
Interactive Advisory Software. Eighteen months ago, Intuit hit the
market with PortfolioMinder. IAS is a good application that might yet
succeed, but so far it has done little to effect RIA technology and it
remains a secret to most advisory firms. Intuit pulled the plug on
PortfolioMinder after it apparently figured out that this market
offered little hope for the financial technology behemoth that makes
Quicken and QuickBooks.
We in the press need to be taken to task for being
such suckers and telling advisors that almost every new application
that comes along is good. And let's not even talk about those stories
that talk about a start-up with the promise of transforming the
industry. Attaining the age of 51, running my own technology business
serving advisors for a decade and seeing so many promising technology
companies descend into mediocrity or, worse still, come apart in
tatters, has taught me that serving RIAs with technology is no mean
feat.
When magazines give glowing reviews of professional
software, and most of the reviews in the trade press are favorable, it
often generates a lot of buzz for these companies. But these are tiny
start-ups we're writing about. Some have just a few employees. Such
tiny companies usually cannot, overnight, create good service models
that can deal with complicated issues like those inherent in PMS
software support, and providing good service when you're doubling or
tripling your business every year is a huge challenge.
When start-up businesses grow rapidly, they are
usually confronted with challenges that must be resolved by applying
skills different from the founders' core competency. A programmer who
was able to create great portfolio management software may not have the
skills to market the company or manage its staff. A small PMS
company-or any company for that matter-that has six or eight employees
can often provide good software and good service to 100, 200 or maybe
even 300 clients. But when a start-up grows beyond ten or 15 employees,
the business can't be run the same way as when it had six or ten
employees.
When a business has ten employees, all the details
about a company's product and processes for dealing with clients can be
stored in human brains. The CEO and a few key employees know everything
about the company and its processes, and can communicate on the fly
with the entire staff and clients to keep the business running. But
when a start-up grows to have 15 employees and hundreds of clients,
communication becomes complex. Storing processes in people's heads no
longer works. When you lose one or two key employees, important
institutional knowledge about your business processes goes out the door
with them.
Tiny businesses, in order to succeed and become big
companies, must get over this hump. Their processes for conducting
business must be systematized, and cannot remain totally reliant on a
few key employees. That's a big hurdle that most small companies never
get past. In fact, few of them ever get to the point where their growth
forces them to confront these challenges.
In more than ten years of covering technology for
advisors, I can count on one hand the number of software start-ups
serving advisors that navigated successfully through this phase of
growth. Albridge and EISI come to mind, and a few others are on the
cusp of getting on this short list, such as Investigo and PIE
Technologies. And this is when you examine the entire field of
companies serving advisors with all types of professional software-CRM,
financial planning, analytics and PMS. When you look at just PMS
vendors who have moved from the start-up phase to become sizable
companies, only Albridge clearly makes the list, with the possible
addition of Investigo, and both of these companies are focused on
providing an enterprise-wide PMS solution to B-Ds and their reps and
not serving RIAs.
Until a start-up surmounts these hurdles, relying on
it for your mission-critical task, like portfolio reporting, seems
chancy. Yet that is exactly what many advisors are doing when choosing
a small vendor for a PMS system. Many are expecting tiny PMS start-ups
to deliver great service and sophisticated technology at a low price.
It's unrealistic.
Breaking The Gridlock
So where does this leave RIAs seeking a PMS vendor?
The great majority of RIAs choose the two big vendors, Advent or
Schwab. A small minority, maybe 20%, choose one of the small vendors,
such as Cornerstone Revolutions' PowerAdvisor, CapTools, Interactive
Advisory Software, AssetBook from Major Technology, Financial Computer
Support, Inc. or Portfolio Director. None of these vendors seem poised
to break out of the pack and become the dominant new solution.
Meanwhile, some advisors continue to pray for viable alternatives to
Schwab and Advent.
Breaking the gridlock may take a concerted effort.
RIAs could organize a technology co-op. Much the same way as a group of
about 50 advisors banded together about five years ago to form a trust
company, National Advisor Trust Company, that could serve their niche,
RIAs could band together and marshal their resources. They could choose
one start-up vendor that holds promise and come up with a list of
features they want and a schedule for getting them, and agree to move
their PMS business to the vendor if it meets specified goals on time.
Another possibility is that advisors will be forced
to spend more on PMS by Advent and Schwab. Most RIAs are paying $3,000
or less annually for their PMS software, which is pretty low when you
consider it is the core application they run their business on. A study
by Moss Adams, a prominent consultant to advisors, recently found that
firms with $250,000 or less in revenue had budgeted $1,000 in 2005 for
software expenditures, while firms with $250,000 to $1 million in
revenue had budgeted $5,000 for software expenditures. Those with
revenue of $1 million to $5 million had budgeted $22,000 for software
expenses. Advisors I know who are managing $300 million are paying
about $3,000 annually for their PMS system-the lifeblood application of
their business. This does not make sense and does not work in other
industries.
When you compare what advisors spend to run their
practice's core technology to what a doctor spends, the strange
economics of advisor PMS systems is obvious. A physician friend of mine
is in a group practice with six doctors and they recently priced a new
recordkeeping system, which included scanners and tablets as well as
software. Price: $100,000-half of which would be for software and the
other half for hardware. The software costs amount to about twice the
entry price of Advent or PortfolioCenter for an office with six
professionals.
To put it all together, RIAs have high expectations
of their PMS vendor, are incredibly cheap about spending on technology,
and the competitive framework among vendors is not allowing
capitalism's great strengths to serve up new solutions from larger
vendors. There is no money in it for them. The RIA PMS market is stuck
in gridlock, with no signs of it breaking up anytime soon. Sorry, but
that's what I'm seeing.
Andrew Gluck, a longtime writer and
journalist, is CEO of Advisor Products Inc., a Westbury, N.Y.,
marketing company serving 1,500 advisory firms.