From the November 2011 issue of Research Magazine • Subscribe!

A Lost Decade for Advisors?

Poor performing stocks and erratic investor behavior are squeezing many advisors — but also bringing benefits to some.

It has been called the “Lost Decade” for stocks, the period from January 2000 to December 2009 that saw the stock market decline for the first time since the decade that started in the 1930s.

Indeed, $100,000 invested in an S&P 500 index fund in January 2000 would have been worth $89,072 by mid-December of 2009. Adjusted for inflation, the returns are even worse. That initial $100,000 becomes $69,114 at the end of the decade known as the “aughts.”

Previously scorned investments, such as gold and silver, performed spectacularly, while blue chips faltered. Investing overseas was one way to beat the market. Another was to stick your money in bonds, where the gains far outpaced those of the largest U.S. companies.

But as painful as the decade was for investors, financial advisors suffered as well. For every market dip that saw investors sell their holdings and for every customer who waited on the sidelines until the market stabilized, advisors who earn a paycheck based on asset-based fees on assets under management lost out.

In conversations with advisors and industry professionals, the decade that just passed was described as one in which hard work did not necessarily pay off. For all the media spin about the long-term profitability of the market, the aught decade saw advisors struggling to build their businesses and keep customers satisfied.

“The bottom line is that people were not willing to do business in traditional products,” says Lou Harvey, president of Dalbar Inc., a financial services market research firm based in Boston. “If the S & P just dropped 40 percent, it’s really difficult to explain why [clients] should be buying a stock-based mutual fund.”

According to data supplied by the Securities Industry and Financial Markets Association (SIFMA), a securities industry trade group, market gyrations and pressure on advisors to perform led by decade’s end to fewer advisors in the industry. Utilizing data generated by the Financial Industry Regulation Authority (FINRA), the largest independent regulator for all securities firms doing business in the United States, SIFMA says that total personnel in the industry declined from 423,345 in 2000 to 378,946 in 2010, a dip of 10 percent.

Dalbar’s Harvey says the failure of Lehman Brothers and other financial services firms like Washington Mutual and Wachovia has forced many advisors to leave the industry or go independent, where they can keep 98 percent of the fees they generate instead of splitting them down the middle with the firm.

Unhappy Advisors

With all the various factors nagging at advisors — from the down market, to worried clients, to firms pushing them to work harder for more profitability — it’s no wonder that the average advisor is unhappy.

“This summer has been horrific,” Harvey says. “The ups and downs in the market have advisors tearing their hair out trying to give comfort to clients who are being whipsawed on a daily basis. The advisors we talk to are down in the dumps about it.”

But it’s not the markets alone that are solely to blame for advisors’ difficulties. According to Joe Duran, chief executive officer and founding partner of United Capital, a private wealth counseling firm, there has been a “colossal” shift in the landscape.

Duran says that advisors and clients alike had become accustomed to a steadily rising market that protected everyone from temporary downturns. But now, he says, the “buy and hold” strategy of yesteryear no longer works. Second, the variable costs both for brokers working in the largest wirehouse firms and on their own have increased. Ten years ago, for example, buying a piece of software represented a fixed cost. Nowadays, software and other services come with annual fees and maintenance charges that take 30 to 40 basis points off the bottom line. Lastly, Duran says, there has been a “massive reduction” in pricing. Whereas 10 years ago a broker could charge 2 percent to manage assets, now that fee has been slashed in half and even quartered at large consumer firms like Schwab, where customers can have their money managed for 50 basis points per year.

Advisors, Duran says, are “squeezed from all sides and working harder than they ever have.” What’s more, he says, they are “not even sure what they are doing is helping clients.”

An upbeat market would cheer clients and give advisors a break, but according to Don Schreiber, CEO and co-founder of WBI Investments, an investment management firm, things are not looking rosy. Schreiber foresees a market downturn for “at least” the next 10 years, until 2021. He says our current market stalemate resembles the one that lasted from 1924 until 1952. In that period, the Dow Jones Industrial Average started and ended at around 300 points.

“The way the market is behaving, it’s tough for getting clients to invest,” Schreiber says, and that means less money in the pockets of fee-based advisors. Schreiber suggests that advisors will have to look for novel approaches to investing to keep their fee-based paychecks coming. “The precepts that we’ve been using, like passive asset allocation, have underperformed expectations,” he says. “We’ve got to find a better solution.”

Stock price appreciation, for instance, is obviously not a winning strategy for advisors or clients in a down market. So Schreiber recommends strategies that focus on cash flow and not return, in particular dividend-paying stocks. “I think there’s a great portion of the investor community that is in denial about the current form of the product that we are giving to investors,” adds Schreiber, whose firm manages more than $900 million. “There are people in the industry who know this isn’t working and it hasn’t been working since the market break in 2000.”

One of the reasons investors — and thus the advisors who collect fees on their money — lose out is that they don’t fully embrace the “buy and hold” strategy. Instead, spooked by a down market, investors will sell low, stay on the sidelines until market gains boost their confidence, then buy once more. The problem is that investors lose twice employing this strategy. First, they sell stocks at a low and not a high. Second, by staying on the sidelines, they miss out on the biggest gains of the recovery.

Happy Ones

All the more reason that investors should rely on the advice of their financial advisors, argues Mark Elzweig, a New York-based recruiter for money managers. In fact, Elzweig argues against the idea that the aughts were a “lost decade” for advisors. While it’s true that there are fewer advisors in the industry than 10 years ago, he says, and that those advisors are earning less in asset management fees, the ones who remain are earning more for their firms and bringing in wealthier clients.

In fact, data provided by SIFMA confirms Elzweig’s supposition. In 2000, revenue per employee at FINRA’s 4,700-plus member firms stood at $645,264. By the end of the decade, that amount rose to $672,361. Profits per employee rose even faster, according to SIFMA data. At the beginning of the last decade, after-tax profits per employee stood at $31,095. By the end of the decade, that amount had more than doubled, to $65,473

“It seems to me that it’s kind of hard to argue that the past 10 years have been a lost decade when the average producer at Merrill Lynch is grossing $931,000 [for his firm] and his counterpart at Morgan Stanley is not far behind at $767,000,” Elzweig asserts. “What’s happened is that the wires have weeded out lower producers and are requiring their advisors to [earn] more with bigger clients.”

In other words, the volatility of recent years has wiped out trainees and those advisors with weaker franchises. Those who remain are managing larger pools of money. If they perform well, they are being rewarded with referrals to new clients.

“Many advisors expanded their businesses this way,” Elzweig says. “Right now, a stagnant advisor pool is chasing expanding pools of wealth located worldwide. If you’re an advisor who is still in the game, that’s a good thing.”  

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