Casting a Wide Net

Times may be tough for big brokers, but that isn't

The events of September 11 further shook the foundations of the nation's wirehouses and brokerage firms. Already struggling under weak markets and sluggish trading volumes brought on by shaky consumer confidence, the attacks on the World Trade Center and the Pentagon exacerbated these firms' declining revenue streams, spurring layoffs in divisions bearing the brunt of the economic blow. But despite these setbacks, both the wirehouses' and major brokerage firms' fee-based services are continuing to thrive.

Indeed, even as Wall Street firms slash staffing in such divisions as investment banking, they are instituting new services for advisors. In so doing, it's getting harder to separate the Merrills and Morgan Stanleys of the world from the Schwabs and Fidelitys. In October alone, Fidelity Investments Institutional Brokerage Group and Frank Russell Company joined forces to offer a separate accounts program for advisors.

TD Waterhouse Institutional and Charles Schwab unveiled similar versions of new services for fee-based advisors, including equity research from Goldman Sachs. CSFBdirect Institutional will soon introduce new software for advisors that offers block trading capabilities. And GE Financial Assurance recently acquired Centurion Capital Group to help the investment company accelerate its foray into the third-party mutual fund and separate account wrap market for independent fee-based advisors.

But some advisors say this latest round of new services is a self-serving attempt by wirehouses and brokerage firms to drum up new business in a down market, and the attention being lavished on them will do little to appease advisors' strained marriages with these firms. "They have seen volumes drop, and they are soliciting us for business," says Tom Gryzmala, a planner with Alexandria Financial Associates in Alexandria, Virginia. "Going forward, the [advisor/wirehouse relationship] is going to be a mixed situation at best."

Sam Hull, a planner with Northstar Financial Planning in Bedford, New Hampshire, doubts the new wirehouse and brokerage services will receive a warm welcome from advisors. "Everybody wants to be in our shoes, even Morningstar, for gosh sakes." Hull says he's irked by these firms' service offerings that consistently compete with advisors. "Vanguard is aggressively offering financial planning services, and they have made their retail Web site much more friendly than their advisor site. To me, that's just another example of the fact that Vanguard is really a retail house, and we are kind of along for the ride, although at the far end of the train."

It remains to be seen if the wirehouses and brokerage firms will suffer any long-term repercussions from the terrorist attacks. The outlook is both sanguine and grim, depending on who's talking. Chip Roame, managing principal of Tiburon Strategic Advisors, a research firm in Tiburon, California, says the terrorist event "is going to be a blip in the business of investing." He's optimistic the nation's stockpile of baby boomers will keep investment firms of all types busy for the next couple of decades. The investing business will do "exceptionally well for the next 20 years because people will earn a lot of money, they will retire, and this money will flow into the investing market."

But Martin Weiss, chairman of Weiss Ratings Inc., which issues safety ratings on financial institutions, including brokerage firms, worries that some brokers lack the capital to withstand a prolonged bear market. He says well-capitalized firms like Charles Schwab, Prudential Securities, and Morgan Stanley will be more apt to stomach the multiple hits that the industry has taken this year in falling commission and IPO revenues, the World Trade Center disaster, and the bear market.

Also troubling, Weiss says, are the extra costs associated with the attacks. Some firms will have to absorb the expense of relocating, hiring, and setup costs not covered under their insurance policies. While well capitalized, Morgan Stanley, the World Trade Center's largest tenant, estimates it will suffer $150 million in damage and relocation expenses. Weiss says the brokerage firm's property damage is fully insured, but it may be hard for the firm to recoup the losses it suffered when business was interrupted.

Even before the World Trade Center attacks, Weiss says, CSFB, Goldman Sachs, and Merrill Lynch were downgraded because of drops in their capital ratios. "Therefore, there's a good chance we'll see further downgrades once we put a reliable dollar figure on the recent financial damage to these and other firms."

But in these times of instability for the wirehouses and brokerage firms, their fee-based services show no signs of faltering. Since entering the fee-based asset management business some four years ago, the wirehouses and brokerage firms haven't tired in their efforts to build and hone their fee-based skills. "The growth in fee programs in wirehouses is substantial," says Tiburon's Roame. "What they are building are their separate account wraps and their fee-based brokerage accounts."

In a new research report, "Fee Accounts and the Booming Turnkey Asset Management Program (TAMP) Market," to be released this month, Tiburon examines the growth of fee-based investing programs by the wirehouses and regional brokerage firms, as well as the emergence of separate-account turnkey asset management programs. "We think the TAMP market is booming and will continue to boom," Roame says. Tiburon estimates that there are now 57 TAMPs with $64 billion in assets, and the research firm expects these assets to hit $200 billion by 2005. Tiburon says the frontrunners in the TAMP market are SEI, Lockwood, Envestnet PMC, AdvisorPort, RunMoney, London Pacific Advisors, Centurion, AssetMark, Assante, Buckingham, Brinker, and Morningstar.

TAMPs have become an invaluable resource, particularly for independent reps. These programs provide five crucial services to those working in a fee-based environment: client profiling software; assistance with investment selection (for instance, Lockwood screens separate account managers, while SEI helps you choose the right mutual fund); ongoing monitoring of accounts; the shipping of quarterly client performance reports; and handling of client billing.

Tiburon's report also asserts that fee accounts continue to comprise a larger percentage of clients' assets at wirehouses. At year-end 2000, 12.9% of wirehouse and regional brokers' assets were in fee-based programs, up from 5.4% in 1995. "This isn't 12.9% of their flows, this is 12.9% of their assets, which means fees have to be way outgrowing commissions," Roame says.

And according to the report, consumers appear to prefer advisors who use fee-based models to ones based on commissions. Tiburon asked a group of consumers to rate their fee-based advisors and commission advisors on a 10-point scale. The fee advisors got an 8.7, while commission advisors registered only a 6.3.

As Jay Lanigan, executive VP and head of the RIA business at Fidelity Investments Institutional Brokerage Group, puts it, "More and more end consumers seem to find a fee-based relationship to be more consistent with the type of relationship they are looking to have with a financial services representative, whether it be an advisor, broker, or insurance agent." On the other hand, John Bachmann, managing partner of the St. Louis-based brokerage firm Edward D. Jones & Co., says his commission-only firm is thriving, and his customers couldn't be more satisfied. (See sidebar, page 56)

In the world of wrap programs, separately managed wrap accounts dominate, accounting for nearly $300 billion of the $600 billion in total assets, according to Tiburon's report. Mutual fund wraps rank second, holding about $127 billion; fee-based accounts total $103 billion; and broker wraps account for $54 billion. Wirehouses dominate in separate accounts offerings, with Solomon Smith Barney taking the lead with 27% of the market. Merrill Lynch runs a close second with 22% of the market, while the other three wirehouses--Morgan Stanley, Paine Webber, and Prudential--each account for about 10% or less in market share.

As investment firms of all types vie for high-net-worth clients, separate accounts have become the golden chalice because they're customizable and tax efficient. Fidelity Investments is getting in on the separate accounts game--albeit belatedly--by aligning with Frank Russell. The two firms' separate accounts offering, called Russell Managed Portfolios, will combine Frank Russell's multi-manager investment style with Fidelity's technology platform and services. The relationship allows Frank Russell to deliver its traditionally institutional investment expertise to RIAs and their high-net-worth clients.

Fidelity's Lanigan says as "RIAs have focused more on the financial planning aspect of client relationships, and they continue to add value in their wealth management capacity, clearly separate accounts have been an area of interest for some time."

This isn't the first time Frank Russell has hooked up with Fidelity to service advisors. Last year, the Tacoma, Washington-based investment firm abandoned its trading custody platform, Russell Advantage, and transferred its 100 advisors onto the Fidelity IBG platform. At the time, "We recognized that advisors going forward wanted open architecture and efficiencies in trading administrative platforms so they could become more efficient at their business," says Len Brennan, managing director, Russell Investment Group. "It was a logical extension for us to create a product line of segregated accounts based on Russell's objective research of money managers and manager of managers approach," he says. Russell Managed Portfolios will be available on November 5 through RIAs who custody their assets on Fidelity's institutional brokerage platform.

Brennan says with the Russell Managed Portfolios, customers' individual accounts will include individual money managers that have been researched and selected by Russell. "It's not just a list of recommended managers," he says; "Russell will also be responsible for combining these managers into a mix so that a customer that goes into an asset class, like U.S. equities, will get multiple managers" unlike the one manager option offered by other separate account programs. "That mix of managers will bring a greater level of diversity to the portfolio, and there will be more due diligence in the ongoing monitoring based on our manager research function."

The platform is also Web-based, Brennan says, allowing advisors to control the entire client experience in one place. The advisor will have a Web-based tool allowing for prospect profiling, access to a risk tolerance questionnaire, asset allocation capabilities, the ability to generate proposals on her desktop, comprehensive performance reporting and, if an advisor chooses, she can allow clients to access their accounts online.

CSFBdirect Institutional, a division of CSFBdirect, the online brokerage arm of Credit Suisse First Boston, aligned with London Pacific Advisors in July to provide advisors with a Web-based solution that streamlines their separate account manager business.

And in October, CSFBdirect upgraded its software, CSFBdirect Institutional 2.0. The software now includes a block trading tool, which allows advisors to trade in three new ways. The software's new Quick Trade option allows you to place an order in your average price account and allocate it across multiple accounts upon execution. The Aggregate Order allows you to construct and allocate orders for equities and mutual funds. And advisors can use the Import tool to import individual orders and combine them into block trades. And CSFB equity research is now available online.

At TDWaterhouse Institutional, advisors now get online access to proprietary research from Goldman Sachs PrimeAccess, offering access to real-time news and proprietary research, IPOs, and alternative investments. And the company is furthering its existing relationship with Nexstar Financial Corp. by allowing advisors using the TD Waterhouse Mortgage Program to access residential home financing. Through an alliance with Total Personal Services Administrative Group, a leading provider of family office solutions, advisors can now provide wealthy clients with an Administrative Family Office, which allows the client to control his personal business affairs, without having to handle administrative duties. And, through AdvisorSites, the Web development arm of Advisor Products, (owned and operated by IA columnist Andy Gluck), advisors can access customized Web site development at discounted rates.

New enhancements are afoot, too, for TD Waterhouse's year-old separate account program, Managed Asset Network, according to Tom Bradley, president of TD Waterhouse Institutional Services. In 2002, the firm will be adding more managers to the program, but Bradley declined to detail further enhancements, noting that more specifics would be announced at TD Waterhouse's annual meeting in February.

And Schwab is now offering its 6,000 advisors new trading technology services, including a managed accounts solution called Fund Rebalancer, as well as a trading platform called CyBerTrader, which combines custody services with cutting- edge trading technology. CyBerTrader allows advisors to route orders directly to market makers or electronic communications networks (ECNs). Schwab also added account management tools like electronic account submissions and electronic alerts. And, like, Waterhouse, Schwab will offer advisors branded and customized Web site solutions.

While planner Hull with Northstar Financial admits that the wirehouses' and brokerage firms' deep pockets allow them to offer top-notch services, like other advisors, he'll continue his love-hate affair with these firms. "It's like being married: After a while you're so deeply in bed it takes a real act of dedication to get a divorce. When you switch custodians, it's a real job."


T+1 May Have To Wait

Will Wall Street meet the Securities and Exchange Commission's deadline of June 2004, to shift settlement from the current three days to T+1? A new report by Meridien Research of Newton, Massachussetts (www.meridien-research.com) says that is unlikely because the September 11 attacks exposed vulnerabilities in the U.S. securities markets.

"In examining the trading environment in the U.S. following the September 11 attacks, we uncovered a glaring weakness in the technological infrastructure that supports the trading and settlement systems throughout the U.S.," says Damon Kovelsky, a Meridien analyst. He says there are too few telecommunication conduits and insufficient bandwidth to support the huge volume of data that must be exchanged between trading partners in a T+1 environment. Kovelsky says that new money must be plowed into the securities infrastructure if the T+1 effort is to succeed.

The report, "The Dawn of a New Market Reality," also details how the New York Stock Exchange failed to have a contingency plan in place to cover major disasters. The NYSE depends almost solely on its 18 Broad Street office, and doesn't have a backup trading floor. A major cause of the four-day suspension of trading on the NYSE was that traders were prevented from entering the exchange, Kovelsky says.

Two weeks after the September 11 event, Kovelsky says, the NYSE has begun forming a disaster plan. Building a backup trading floor alone will cost $150 million. "The NYSE is also in discussions with Nasdaq on how it could trade NYSE securities if access to the NYSE floor should again be disrupted," Meridien says, adding that the rivalry between the two firms will likely stymie this plan.--Melanie Waddell


At Edward D. Jones, It's Buy, Hold, and Prosper

While other Wall Street firms are moving gung-ho toward fee-based services to appeal to new clients, Edward D. Jones & Co. refuses to budge from its commission-only style, and wouldn't think of trying the latest product fads.

As one brokerage firm after another reduces its head count in these volatile market times, Edward Jones is adding 200 new brokers per month. "We've been growing rapidly this year, just as we've done in the past," says John Bachmann, managing partner of the St. Louis-based firm. "We've added about 900 people so far this year."

Edward Jones has about 8,000 offices, of which 7,400 are in the U.S., 100 are in the United Kingdom, and about 500 are in Canada. Brokers operate in one-man offices, which are placed primarily in small towns. The brokerage firm caters to clients "who see themselves as serious long-term investors, and who are not trying to play the market," Bachmann says. Clients generally have a net worth of $400,000 or higher, and hold mutual funds an average of 20 years.

The brokerage firm is far from cutting edge in its technology offerings. But Bachmann says the firm will go to the ends of the earth to keep up with new technology when its services become outdated. The brokerage firm is now overhauling its computer network by making "a generational switch to broadband. We've got the largest non-military satellite network in the world today--it's incredibly efficient but it does not offer the broadband capability we will need so we see ourselves transitioning to a terrestrial system," Bachmann says. "We're moving to a whole new approach to our database architecture because when we designed our database, it never occurred to us that the investor was going to need direct access to it." Another new twist for the firm will be storing documents and other information digitally, he says.

But new products aren't considered unless they fit into the firm's one investing style, "which is serious long-term buy and keep," Bachmann says. So that cancels out two of the hottest product trends, separate accounts and wrap programs. "We are not in the wrap fee business, and we don't plan to offer them," he proclaims. "The way we look at it, the average holding period for a mutual fund is four years. The average holding period for a no-load mutual fund is less than 18 months. The average holding period itself is 20 years. So we just start with a different set of facts, and if you did the math on it, you'd say if we charged a wrap fee it probably wouldn't be as good for the customer as to do it the way we are doing it." He adds: "If you're going to buy a security and keep it a long time, the broker ends up with an awful lot of the money. So for the long-term buy-and-hold investors, the initial service charge is less, and the longer they hold it the service charge becomes dramatically less."

How about alternative investments? "We are not big on alternative investments. That has all of the earmarks of a fad," Bachmann asserts. "How do you know what you are buying when you get an alternative investment? You are often handing money to a boy genius with a secret plan. Well, that's not a consistently successful approach."

Shunning fees will never make Edward Jones feel like the odd man out. Says Bachmann, "We've got a long record of going our own way."--Melanie Waddell

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