Contingency Plan

The hot Dow and more competition are creating some

Illustrations by Barry Blitt

Blame index funds or online trading, but the competitive landscape for financial advisors is getting scarier. After all, why should someone come to you when they can get an index fund for 10 basis points and have great diversification? Who needs you, anyway, when online trading is so cheap?

In an effort to bolster his raison d'?tre argument, Portland, Oregon-based investment manager John Lekas has borrowed an idea from the lawyers whose stern visage dominates the back cover of your phone book - "NO FEES UNTIL WE WIN!" - and offered money management on a contingency basis. Clients pay 20% of what Lekas earns for them in a given year, or nothing if their accounts break even or drop.

To many advisors, this probably sounds like a good way to drive your practice headfirst into the ground: How could you stay in business in a bear market? But that doesn't change the fact that to the average consumer, it may sound logical and pretty attractive: Pay when you get the goods, don't pay when you don't. At least 200 clients have taken Lekas up on his offer, and he now has $40 million under management.

Lest you ignore the apparently suicidal tendencies of this strategy and seize upon it as marketing potential, however, consider the potholes. "The implied notion is that the advisor controls the world - if the advisor is skilled and tries hard, they'll always make a lot of money," says Milwaukee planner and NAPFA standards chair Paula Hogan. "But if the market goes down, the market goes down."

In addition, the "pay when you get the goods" logic encourages clients to think of what you provide in terms of returns rather than in comprehensive financial security. And the strategy could easily encourage risky investing on the part of the advisor. "The advisor's reward for good performance is high, and her penalty for poor performance is: 'hey, I lose some clients and go on to the next one,'" says Hogan. And if advisors stand to gain a lot by taking risks and the worst they can do is break even, clients had better put on their seatbelts and prepare for the ride. - Karen Hansen


Out, but Not Down?

Just because John S. McCain has "suspended" his campaign for president doesn't mean his crusade to reshape the Republican party is over. Apart from luring to his camp hordes of Independents and conservative Democrats, what this self-professed "loyal Reagan Republican" has done, as noted by The New York Times, is to open an "historically significant debate among other Republicans over the fundamental purpose and direction of their party." In fact, he's alienated himself from some GOP stalwarts by being critical of its stance on tax cutting and campaign finance law, and by calling for a more inclusive, reform-minded party. His bitter struggle with GOP front-man George W. Bush has most assuming McCain will snub any VP offer. Barring some unforseen disaster for Al Gore and George W. Bush Jr., we now know who the major party candidates for president will be.

What would President McCain have done, and what could transpire if his ideas take root?

McCain says taxes are stratospheric, the tax code mind-bendingly complex. He would increase the number of taxpayers eligible for the lowest 15% tax bracket, and he would eliminate what he calls the "obscene" tax penalty levied on married couples.

While he's at it, McCain would like to chainsaw the present gift and estate tax that, in his words, "penalizes people from passing on the fruits of their labor to their children." Towards this end he has called for raising to $5 million over five years the amount of an estate that is not subject to taxation.

McCain would like to see Family Security Accounts established, giving families a tax incentive for "future priorities," such as college education. He'd also bolster IRA tax benefits, increasing by 50% the limits on employee contributions to employer-sponsored plans.

While his bid for the nomination fizzled, McCain arguably changed the tenor of the political argument in his party. In the months ahead, as the political jockeying over party platforms, running mates, and general election strategizing plays out, we'll know if McCain's ideas have had a lasting impact. - Cort Smith


Bait & Schwab

Will Schwab's new initiative to provide direct investment advice alienate independent financial advisors?

Charles Schwab's 1,100 Registered Investment Specialists have begun giving fee-based investment management advice in the firm's branches.

Yes, this is the April issue of the magazine, but this is no April Fool's joke.

While Charles Schwab & Co. remains well in command of a dominant market share of the independent advisor back-office business and handles the sensitive job of clearing and custody of securities for advisors' clients, the discount brokerage has once again inched closer to directly competing with independent advisors.

Unlike previous announcements by Schwab about services that bring it into closer competition with advisors, this time more of the advisors we polled said they regard Schwab's action as a direct threat to their businesses. In an unscientific sampling of opinion, about half of the 25 advisors we contacted reacted negatively to Schwab's latest advice offering. Compared with the reaction of advisors to Schwab's purchase of U.S. Trust two months ago, more of the advisors we polled said Schwab has irreparably damaged its relationship with them.

"We met with Waterhouse just yesterday and were about to start putting new clients there," said one advisor. "With this news, we're mapping out plans to move some or all of our current clients."

"It is ominous, especially with the U.S. Trust merger in the works," said another advisor, referring to Schwab's plans to buy the nation's second-largest trust company and deliver advice to clients with a net worth of $5 million and up. "Schwab now can take care of the upper tier of clients through U.S. Trust and the lower tier through this new offering. For now, the bread-and-butter middle-tier client still belongs to the independent planner, but for how much longer?"

Schwab announced the launch of its Portfolio Consultation service in a March 15 press release, after taking out an eight-page spread in the Wall Street Journal a day before and launching an expensive media blitz. According to Schwab's Glenn Mathison, a Schwab investment specialist will meet with a client in a branch office for $400 to evaluate a client's goals, risk tolerance level, and tax situation, and go over investment statements for accounts held at Schwab and elsewhere. The current portfolio is analyzed, an asset allocation plan is designed, and rebalancing opportunities are suggested. In a second meeting, specific mutual funds or individual securities are recommended, Mathison says, making this the first time Schwab has offered specific securities advice. The Schwab investment specialist also trains the client to rebalance his portfolio on an ongoing basis using Schwab's Portfolio Checkup online tool, which is free. Mathison says the service is "generally targeted at people with more than $100,000" to invest.

"We are for the first time offering interaction that is structured enough to charge a fee, but we have for some time been guiding people through asset allocation and picking investments," says Mathison. "In conversations with advisors, we have made no secret of the fact that Schwab has been headed in this direction."

Mathison says that in the pilot program to test the advice service, 15% to 20% of the conversations resulted in a referral to an advisor. He stressed that Schwab branch personnel, referred to in Schwab ads as "Schwab Registered Investment Specialists," have no incentive to promote the branch service rather than make the referral to an advisor. But Schwab is known to have greater profit margins on retail clients than on Schwab Institutional's advisor clients.

Mathison says existing retail clients as well as new customers will be solicited to use the service. Therefore, an advisor client who also owns a retail account at Schwab is likely to be solicited to use the service.

Schwab Institutional is by far the largest back-office provider for independent RIAs. Schwab is recognized as a revolutionary firm because it morphed itself from a discount broker into an online broker and is now becoming a new kind of full-service broker. But Schwab cannibalized its discount brokerage business to become the online brokerage leader, and some advisors now worry that it is willing to cannibalize its advisor business to create the new full-service brokerage firm.


Mile-High TechFi

TechFi's Matt Abar had nifty software. Now he's got a partner - Morningstar

You can make good money playing organ in a church on weekends," says Matt Abar, founder and CEO of TechFi, the Denver-based company that makes the Portfolio 2000 reporting and accounting system.

Yes, Matt, playing church organ is a pretty good gig. But getting several million bucks from Morningstar Inc. for a 20% interest in your company is not so bad, either. And that's exactly what this 28-year-old whiz kid has done.

Morningstar, flush with cash since a $91 million infusion from Internet giant Softbank Corp. in September 1999, has sunk several million dollars into TechFi as part of a broad plan to create an Internet portal for advisors.

TechFi captured the independent advisor industry's attention shortly after its Portfolio 2000 reporting software was reviewed favorably here just over a year ago.

While some advisors say Portfolio 2000 still has some weaknesses in tax accounting and fixed-income reporting, the only negative comments I've heard about the software are from people comparing it to its much more expensive package rival, Advent Axys. But advisors who have switched say it does pretty much whatever tasks they need to accomplish, and it's still only Version 1.0.7.

Abar's made some incredibly prescient moves. He priced P2000 on par with Centerpiece. He wrote P2000 using the latest Microsoft database platform, Sequel Server 7.0, which has an open architecture that independent advisors feel comfortable with because it allows them to easily export their client data into another portfolio management system if they ever want to drop P2000. Abar also made P2000 user-friendly by making it a true Windows application, and he created a seamless import from dbCAMS.

And in a stunning move, he made it Internet-friendly, which is what undoubtedly attracted Morningstar's money. TechFi's Internet version, P2000 Enterprise, allows you to serve reports to clients if you run a Web server from your office, and of course, serve reports to branch offices. Satellite offices can see all your client reports using Web browsers.

P2000-Enterprise was easy to use--I was able to get it running in my office in just a few hours. And it's cheap, about $12,000 versus about three times as much for similar functionality from Axys, which is widely regarded by independent RIAs as the premier portfolio reporting and accounting package.

Abar saw a powerful opportunity in making P2000 Web-enabled. He plans to roll out a service bureau that downloads all your portfolio data nightly from your B/D or custodian. Advisors use their browsers to see client reports via the Web, and clients can also view a limited number of reports online. It's using the Internet to let financial advisors focus on clients and investing instead of technology.

The service bureau, AdvisorMart, is being beta-tested now by three users and will be launched in June, Abar says. Cost: $50 per account (not per client) per year for Web reporting, and $100 per account for the full-blown package, which includes mailing out hard copy quarterlies to your clients as well as Web access for you and you clients.

And Morningstar's plan? It's hard to say. Abar wouldn't comment on how Morningstar might use P2000's Web capabilities. The same week it bought its stake in P2000, the Chicago firm hired Bob Clark, this magazine's editorial director and publisher, to lead its charge into the advisor world.

It seems likely that Morningstar will somehow use P2000's Web capabilities to offer a service bureau to advisors from its portal. The service bureau concept is revolutionary because P2000 will have interfaces with all B/Ds and custodians. So an advisor will suddenly be able to custody assets anywhere - Schwab, Waterhouse, and any other low-cost custodian that comes on the scene. This could turn the industry upside down and will pose a threat to Schwab Institutional.

Success couldn't have come to a nicer guy, or his partner. Abar is lovable nerd, who looks and acts much older than his age. In At age 21, he did an eight-month stint at dbCAMS, where he befriended a marketing staffer, Rob Major. Major is now the marketing and sales director at TechFi and owns an 18% stake in the company.

The two left dbCAMS and went their separate ways, but in September 1998, Abar called Major and told him he had written a new portfolio reporting package. Abar wanted Major to look at his software. Major got in his car and drove from Texas. He was so impressed with Abar's project that he immediately quit his job in Texas and moved his family to Denver.

Portfolio 2000 has about 250 licensed users, eight of which are using its Enterprise version.


Study Hall Revisited

Despite predictions of cutthroat competition, study groups are flourishing

Fear swept through the independent advisor community last fall after a mutual fund company targeting RIAs issued a 91-page report predicting that, "a small group of 40 to 50 organizations will emerge as dominant competitors."

"Most financial advisory businesses that are unable to become dominant competitors will find life increasingly more challenging," predicted Mark Hurley, of Undiscovered Managers Funds, who authored the report. "They will be paid less and have to do more for their clients."

Hurley also predicted the industry would become "far less collegial and far more competitive." "While advisory firms today regularly share data and ideas with other organizations, future advisory businesses will become much more Darwinian," his report said.

Should you believe predictions about consolidation and Darwinian competition? There is evidence that consolidation of independent RIAs is likely, but that doesn't mean small firms won't continue to flourish. But predictions of Darwinian competition seem to be plain wrong. In fact, advisory firms may cooperate more in the future.

Advisory firms are certainly sharing more information. Private virtual networks are springing up to foster idea sharing, planners are consolidating back offices while preserving their independence, and virtual partnerships among independent planners are growing. The "coopetition" spreading through American business, where companies like Intel and Microsoft compete while cooperating in strategic alliances is infecting the planning business.

I stumbled into this while researching a story about study groups. After speaking with 10 advisors involved in seven study groups, I realized this wasn't a story about study groups. Evidence suggests advisors across the country are sharing more information and cooperating more with each other, and most are considering strategic partnerships. Sure, they talk about investment ideas and planning, but they also talk about practice management issues.

"These groups are not about studying, they're about critical mass," says Tom Connelly of Keats, Connelly in Phoenix. "This is a way a firm can keep its individuality. Whereas, if you're sucked up by a larger entity, you'll have to conform and people that get into this business aren't usually the type that like to conform."

The Council of Independent Financial Advisors seems most energized. While it now has 15 members and is focused on idea sharing among members firms, it is establishing a national brand and getting the critical mass to negotiate with service providers and vendors. CIFA plans to grow to 50 members or more, and some members may try to consolidate back offices.

CIFA started as a study group in 1993 when Ron Yolles of Yolles Investment Management in Southfield, Michigan, met Larry Waschka, an advisor from Little Rock, Arkansas and Stewart Welch, an advisor from Birmingham, Alabama, at a Schwab Institutional conference in New York. "We have two rules: total candor and we encourage diversity," says Yolles.

In a pointed example of the benefits, Yolles says Keller, Collins, Hakopian & Leisure Investment Counsel, Inc, an advisory in Irvine, California recently helped his firm establish the platform to offer a quantitative style of stock management. Instead of taking a projected 36 months, Yolles says he was able to get the service running in under 30 days.

Some advisors feel they benefit most when members have diverse practices, others believe a common focus is best. Some feel being in one section of the country is advantageous because it permits frequent meetings, while others feel being too close is a negative because you might have a competitor in your study group and be less than candid about your embarrassments and successes. The study groups usually set an agenda for each meeting and name a chairperson, and some create subcommittees to focus on specialties.

Advisors affiliated with B/Ds are also moving in this direction. About a year ago, says Gregg Fisher of Gerstein Fisher in New York, 12 planners in the New York area who are affiliated with Nathan & Lewis Securities started a study group. Fisher says it's a way for a group of successful planners in the same B/D to trade ideas, but says the group may explore enlarging its scope to advisors affiliated with other B/Ds.

The granddaddy of study groups is the Alpha Group, which began in 1989. "We've talked about creating a common back office or negotiating as a group with vendors, but it's not happened," says one member. Recently, it added three new members who are not advisors: fund company president Hurley was one of them.

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