September 4, 2013

RIA Growth Inevitable as Brokers Go Indie: S&P Capital IQ

‘Management fees are the right approach for client services, rather than commissions or transaction fees,’ says S&P Capital IQ’s Kenneth Leon

Brokers’ move to independence is one of the fastest growing trends in the wealth management industry, and RIA practices are poised for even more growth as commissions give way to asset-based management fees, according to a recent S&P Capital IQ report.

Most registered investment advisors charge a management fee based on client assets that are either under supervision or actively managed, and today's advisers are more focused on monitoring existing holdings and reviewing suitable investments for purchase, said S&P Capital IQ equity analyst Kenneth Leon in a MarketScope Advisor report published on Aug. 23.

“We think independence would be the best response” for brokers who make the switch to RIA licensed practices,” Leon wrote. “We think management fees are the right approach for client services, rather than commissions or transaction fees, and they give broker-dealer firms a more predictable revenue stream than before.”

Leon cited “positive implications” in the fast-growing RIA trend for large firms that serve advisors, including Morgan Stanley (MS), LPL Financial Holdings (LPLA), Raymond James Financial (RJF), Charles Schwab (SCHW) and TD Ameritrade (AMTD).

He also criticized the pre-2008 pump-and-dump practices of brokerages, saying that independent RIAs have discretion as to managing client portfolios and making recommendations on asset allocation.

“Transactions fees are also lower, as RIAs are compensated away from brokerage commissions,” Leon wrote. “More than a decade ago, brokerage firms would get their brokers hyped up to dial for dollars and churn client accounts with the stock idea of the day or load mutual funds that enabled the broker to get compensated two ways — trading commissions from client activity, and the wholesale relationship with select mutual funds.”

Cerulli Associates projects the combined RIA and dually registered market share to make up 24.7% of the advisory industry in 2014, up from 18.6% in 2010, Leon said, also noting Cerulli’s finding that hybrid RIAs are the fastest growing segment, at 15% of the advisor industry in 2012 versus 7% in 2004.

Looking to individual firms’ performance, Leon pointed out that broker-dealer firms such as Morgan Stanley have set marketing strategies in place to move away from transaction fees to managed fees and now seek to boost the wrap fee structure based on total client assets.

Meanwhile, in the late 1990s, trading revenue comprised 60% of Charles Schwab's total revenue, compared with 17% today, “and management expects it to be around 10% by 2018,” Leon wrote. “The two largest revenue streams for SCHW are asset management and administrative fees and net interest revenue. We think SCHW is ahead of the pack, as industry experts estimate that advisors derive 46% of their revenue from asset-based fees and 45% from brokerage commissions. Most of the major firms are targeting a much higher percentage of asset-based fees in the next few years.”

For advisors thinking of moving out of established wirehouses or large brokerage firms, the process can be a long sales cycle for any custodial firm trying to bring an investment advisor to an independent model as an RIA, Leon noted.

“Sometimes, large, independent broker-dealers like LPL Financial will have conversations with advisors at wirehouses for one to two years before they're ready to make a move,” he wrote. “Frequently, it is teams and not a single broker coming out of a wirehouse and going independent. SCHW says it has a $30 billion sales funnel of potential investment advisors that may join their firm as RIAs. Historically, about one-third will exit a wirehouse and join one of the custodian firms.”

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Read RIA blogger Mike Patton in 6 Years Post Independence, Rethinking the Value of Financial Planning at ThinkAdvisor.

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