Finding the Sweet Spot

Determining the right entry point to the new wealt

Serving 6,000 investment advisors with $243 billion in assets under management, Charles Schwab & Co.'s institutional channel is the cornerstone of the firm's efforts to reach beyond its traditional client base of do-it-yourself investors. Now, Schwab Institutional is angling to upscale the advisor business. The key to that strategy is Schwab's $2.7 billion acquisition of U.S. Trust Corp. this year. The purchase was a direct move into a business where the average account is worth $7 million - more than 25 times the size of the average advisor-directed Schwab account. But Schwab executives also see U.S. Trust as a deep source of products and resources for advisors. For example, U.S. Trust is marketing its Excelsior Venture Partners III to advisors. The $600 million fund will invest in venture capital-backed companies as well as other venture and private-equity funds. Schwab Institutional is also making trust services available via advisors. During a break in its Impact 2000 conference in Denver, Schwab Institutional's president, John Philip Coghlan, and its COO, Gerald Graves, chatted about the wealth market with Investment Advisor Editorial Director William Glasgall.

Why is Schwab so focused on the new wealth market?

Graves: A huge boom in the growth of the affluent marketplace is going to take place over the next 10 years. Growth over the next five years will be $10 trillion - entirely in investable assets. The fastest growing of that is in the $1 million-$5 million [investor net worth] category. That's the sweet spot investment advisors must focus on.

Coghlan: You're talking about baby boomers wanting to remain in control and find experts to help them. People who define their practice very broadly - helping clients find comprehensive solutions - are perfectly suited to perform the role of aggregator.

Who makes up the new wealth market?

Graves: You've got a mix of the millionaire next door, proprietors, entrepreneurs. Emerging wealth from publicly traded corporations. The mature segment.

Coghlan: And they're not just on the [East and West] coasts.

How does Schwab fit in?

Coghlan: That's exactly how the acquisition of U.S. Trust falls into this. Asset management, tax planning, insurance, helping people with charitable contributions. U.S. Trust, in a holistic way, has provided some of these services to clients for years. The challenge for Schwab is to unbundle these services.

Should advisors worry about competition from U.S. Trust or other Schwab units?

Coghlan: U.S. Trust has been competing with investment advisors already. If you take all of Schwab together, it has a 5% market share among households with $1 million in investable assets. All investment advisors, taken separately, have 7% to 10%. Let's say Schwab has 15% of all investment advisors' business. All advisors at Schwab have, maybe, 2% of that market. You've got 92% elsewhere. It's the combined power of going after the 92% - most of which is at full-service brokerage firms.

Graves: With U.S. Trust, we are allowing investment advisors to compete for the emerging affluent investor using tools that are unique.

What kinds of tools?

Graves: We look to our clients to tell us. We have an advisory board that meets with us. With U.S. Trust, we are looking to unbundle more pieces, like tax and estate planning. We are looking to help advisors manage multiple pieces of research.

Coghlan: What we can do with U.S. Trust, which has some good shared family office software and knowledge tools, is to make them available to investment advisors and create Web sites to serve their needs. We can make experts on estate or tax planning available to advisors.

With the addition of U.S. Trust, are you becoming a virtual wirehouse? Coghlan: Wirehouses adopted the independent, fee model. What is not working is the proprietary nature of their architecture. You need to put financial consultants on the same side of the table as the client. Nonetheless, there is a tremendous amount of money going into these asset-based accounts. But there still is a tremendous amount of proprietary product showing up in these broker-managed portfolios. I am tremendously impressed with the market share brokerage houses have been able to retain.

There's been talk about Schwab doing another merger.

Coghlan: We're not buying anyone else at the moment.

But what do all the mergers in financial services mean for advisors?

Coghlan: In some cases, do you get the feeling this is going to serve the clients any better? Are these things being done with the client's interest in mind or for profit? If I were an investment advisor, I'd be happy every time one of these things happens. The reason people choose me [as an advisor] is that I have personal relationships, I am involved in the community.

But is the same consolidation going to happen in the investment advisor area itself? For 40 or 50 firms that want to develop a larger presence there are opportunities to build scale and develop a brand.

Is technology the answer for advisors who want to compete effectively?

Coghlan: While technology helps them compete, other technologies are commoditizing what investment advisors have to offer. Some of the better stuff is being provided for free, like Financial Engines, and asset allocation.

How much are you spending on technology for advisors?

Coghlan: For advisors, we are spending $50 million this year out of a total $400 million. In the field of technology, who's going to do that for them? It's our role. Whether it's technology or another area, we're spending almost $200 million a year in our business with investment advisors.

Tell us about your separate account business.

Graves: The separate account offering at Schwab is approaching $7 billion. It's a fast-growing part of our business. We are hearing from investment advisors that it's something they are interested in. We recently hired a senior vice president, Jeff Cusack, from Salomon Smith Barney, where he spent years working with separate accounts as a senior official. It's a way for investment advisors to provide an alternative to mutual funds. There are a lot of components to a wrap account fee. Our strategy is to unbundle that and charge the fee investment advisors want.

How about alternative investments? Graves: This market is relatively new for investment advisors. It's going to be increasingly important for them to compete with wirehouses.

It is another reason why we are very pleased with what we can provide through U.S. Trust to become more competitive. We also offer access to private equity markets through Offroad Capital. We are going to provide our clients with choice and opportunity.

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