From the October 2008 issue of Investment Advisor • Subscribe!

When Big Is Better

Larry Roth believes that in these troubled times, being big is quite an advantage

When we last conducted a personal interview with Larry Roth two years ago at the FSI conference in San Diego, he had just joined the AIG broker/dealer network as the new president and CEO of Royal Alliance, and he was rightly hesitant in expressing his judgments on prospects for the AIG B/D stable and on the industry in general. Two years later and now CEO of the AIG Advisor Group, Roth was disarmingly candid in a telephone interview in early September as he spoke of how in a time of market complexity the best advisors--and clients--are more comfortable casting their fortunes with a big, well-run firm like, well, like AIG.

There's been some consolidation in the independent broker/dealer space--most recently Securities America buying Brecek & Young, Ameriprise buying H&R Block's advisor unit [and soon after the interview, Securian Financial forging a deal to buy Capital Financial Group/H. Beck]. Does a broker/dealer have to be big these days to thrive?

There are advantages to being big, but to your broader point on industry consolidation, I think it's a great time to be in the independent architecture space, the best time ever, in fact. I do believe that financial advisors who are already independent, or are with a regional or wirehouse firm, the smarter business people out there are seeing more and more success than they've ever had. We see this directly with our biggest financial advisor relationships. Our biggest and best clients, even this year, are seeing increased revenue and profitability. As the markets have become more complex, those clients who have built up significant amounts even in a defined contribution plan realize they can't do it alone and are seeking out financial advice. Long story short: Smart independent financial advisors and smart advisors with the big firms--when they do decide to go out on their own--they're only going to look at the biggest and best firms. That plays to our benefit, and whether you're talking about AIG or one of the handful of other big firms, we're going to be the net winners in the space.

You said the "smarter businesspeople" are having more success than ever. I assume you used that term advisedly. Do you mean the bigger firms that run their practices more efficiently so that even in tougher times market-wise they can still grow revenue and profits?

That's exactly what I'm trying to say. Independent financial advisors who have a defined market niche within a community are doing better than ever, in general, in 2008. Not in every case, but in general. So if you have a good service model and you're operating within a community, this kind of market allows you to attract more and more clients than ever. It also allows you to hang onto your best clients, because if you provide good service, even if their accounts are down, they're going to be more interested in what you have to say. Many of our advisors are doing more meetings with clients: They're showing up for their quarterly meetings; they're dialing into conference calls. Those are the people you want as an advisor--people that are engaged and focused on what they have to do to continue to grow their portfolio.

It is a little scary right now because of the markets, but I think the smartest advisors and the smartest clients will continue to align themselves with the biggest and best firms out there, and we're one of them. So we'll be a net beneficiary of all this.

I think clients are better served now than at any other time. I've been in the business for 25 years, and so we are definitely encouraging them to communicate. On the broader industry issue, I think some of the smaller broker/dealers are going to say, "This is a little too exciting. Maybe we should find somebody to partner with."

You say that folks need advice more than ever, and that perhaps things aren't as bad as when the tech bubble crashed, but their portfolios will be down.

Most of the people that I work with, the financial advisors that I serve at the AIG Advisor Group, have been in the business a long time--15, 20, 25 years. The tech bubble was a lesson we all took to heart. Many of our clients were not as well diversified then as they are now. In fact, I'd argue that it would be hard to find a portfolio today that isn't highly diversified. This time around, financials have been hit, and hard, but not as hard as the tech companies [were then]. Our advisors are much more involved in the fee business and having quarterly meetings and communicating with their clients more now than in the past. So clients today are not panicking at all. Clients are calling with questions and may be concerned, and for the most part our advisors have diversified their positions much better. So for me, that's all good stuff. If you look at our product mix today, the fee-based clients are protected by diversification, the clients invested in variable annuities and other insurance-based products are better diversified but more important are invested in products that have a lot more guarantees--of principal, of income for a long period of time. So this time around, we're in much better shape.

People in the business seem to be more concerned today with risk. Isn't that the most important thing you offer clients?

Absolutely. I can't think of one successful financial advisor we work with that promotes their returns. They're selling safety, predictability, and service, and that may be something that's changed the last 10 years.

To your point on how portfolios are diversified. It's in tough times like these that advisors' true value to their clients shines forth, right?

Think of this. In my opinion, 10 years ago, from a broader industry perspective, the independent contractor B/D business rode the market along with their clients--if the markets were doing well, the advisors did well. If the markets softened, like in the tech bubble--if the markets were down 30%, you'd see the revenue of firms like ours down 30% or 40% or even 50%. Today, investors and advisors have redesigned their portfolios and their businesses so that they're more diversified, more fee-based, they're safer. The individual investor is much better off than they were 10 years ago. The independent broker/dealer entrepreneur is much better off than 10 years ago. If you look at the broker/dealer business model, the big firms, including AIG, are much better off--we have much larger budgets, more technology, and we're managing risk better in our business than we used to. So we're going to feel the lumps much less than a small firm. A third of our assets are in fee-based accounts, but over half the revenue we have is recurring. So when the markets get difficult, it doesn't have as much effect on me as it would on smaller firms. So everybody is better off than those small firms, because they don't have the revenue sources that the advisors have and I have, so they're less protected. That's why there will be more consolidation, because those guys are naked. If the regulators come in and hold us to the same standard as they're doing to some of the manufacturers, guys like me will be able to deal with that. Small firms can't. A lot of the firms wouldn't be able to buy back securities into inventory if it was required. The bigger firms wouldn't have that problem.

Looking ahead, how do you see things changing in the business from the broker/dealer's perspective.

One thing that has changed already, but you may not see until the markets become more difficult, is that in order to remain in this business, you're going to need great technology, great fee platforms, and diversified sources of revenue that are not all correlated with the markets--as markets fluctuate, we have to be in a position where our income doesn't fluctuate with those markets. You have to be a really good businessperson and you have to have scale on your platform, or you'll suffer at a minimum with wild fluctuations in income, or worse. We're going to have to have better systems than we've ever had. For example, when the banks started going through the credit problems that you alluded to, when there is a bank failure, or more importantly a bank on a watch list, I need to run a report that tells me whether I have clients that hold CDs at those banks, and where I am relative to FDIC insurance, and I need to be able to identify and reach out to those advisors, and maybe those clients, and tell them they you might have a potential problem. We do that now, and on a daily basis. Other firms are hopefully doing that as well. When the auction rate securities issue became apparent, we needed to look that day at everything in our portfolio and design a program that if they have a hardship or liquidity program we can address it. From a systems standpoint, we have to read the tea leaves a little better and get in front of potential problems. We do that ourselves, but we also work closely with our clearing firms, especially Pershing, to take a look at all this stuff. It's not just a pure distribution business any more like it was years ago.


Communicate with Editorial Director James J. Green via e-mail at jgreen@investmentadvisor.com.

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