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Technology > Marketing Technology

Part 1: The Two Faces of Schwab

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After six years of covering Charles Schwab and its Services for Investment Managers (SIM) division, and after interviews with hundreds of advisors, I have finally realized there are actually two Schwab SIM divisions. There’s the division that Schwab executives tell me about, the one that advisors love and shower with accolades for making them prosper. And then there’s the other SIM division, which advisors distrust, fear as a competitor, and resist becoming more dependent on.

I come into contact with many more advisors who are suspicious of Schwab SIM than adore it. In fact, it’s rare that I come across an advisor who praises SIM and who does not voice reservations about being part of the Schwab Advisory Network’s referral program or about relying on Schwab’s proprietary technology platform. Maybe a Schwab SIM executive who I’m friendly with was right when he recently told me that Schwab supporters are not likely to call me–a reporter who is viewed as a clearinghouse for criticism of SIM–to sing Schwab’s praises. The facts belie this notion, however.

Recent numbers on advisor assets coming into SIM versus its competitors indicate that Schwab’s share of the market in providing custodial services to independent advisors has been dramatically reduced recently. Schwab brought in net new assets of $18 billion from January 1, 2002, through October 31. Fidelity Institutional Brokerage Services says it brought in net new assets of $10.5 billion during that same time. Meanwhile, TD Waterhouse Institutional says it lured about $3 billion in net new assets. And Raymond James Investment Advisor Division lured $750 million.

Based on these numbers, we’re seeing a significant shift in advisor custodian preferences. Schwab has $220 billion in assets and relationships with 6,000 RIAs. Fidelity has $70 billion in advisor money and relationships with 1,250 RIAs. Even though Schwab had a base from which to lure new assets that at the beginning of 2002 was four times larger than Fidelity’s, Fidelity attracted 60% of the amount of net new assets that SIM did. The drop in repeat business from SIM’s much larger base of existing advisors is notable. Advisors are not transferring assets out of Schwab, but they appear to be increasingly willing to place new money elsewhere.

It was only three years ago that 75% of advisor assets going to custodial firms went to SIM. Now, with Fidelity and Waterhouse being joined by new entrants like Raymond James, Ameritrade, Bear Stearns, and Merrill Lynch, my guess is that SIM is getting about half the new inflows into the market. Schwab still dominates the market but its grip is much weaker.

Part of the problem SIM faces is undoubtedly the perception that it competes directly with advisors for business. SIM’s perception problem surfaced publicly on November 15, when I moderated a panel discussion entitled, “The Future of The Advisor-Custodian Relationship,” at the northeast regional meeting of the National Association of Personal Financial Advisors. Executives from Schwab, Waterhouse, Fidelity, and Raymond James appeared on the NAPFA panel.

I opened the session by asking how many of the 85 or so attendees did business with Schwab, Waterhouse, Fidelity, and then Raymond James. Then I asked how many of them doing business with Fidelity did not like the fact that Fidelity had a retail presence that competes with advisors. A few hands went up. Then, I asked whether the advisors doing business with Waterhouse were concerned about its retail presence, and only a couple of hands went up. But when I asked how many Schwab advisors were concerned with competition from Schwab’s retail presence, a bunch of hands rose.

Schwab is judged by a different standard than the other custodians. Maybe it’s because Schwab is much bigger in the retail market. Maybe it’s because Schwab is perceived by some to have double-crossed advisors by saying in the mid-1990s it would not compete directly with them only to do exactly that in the late 1990s. Maybe it’s because of the corporate swagger that Schwab projects as the industry leader. Or maybe it’s Schwab’s construction of a proprietary technology platform that is widely perceived as a way to make it harder for independent advisors to ever leave SIM. It’s probably a combination of all these things.

These negative perceptions also affect SIM’s market share. Schwab’s competitive position is hurt by these perceptions combined with the fact that technology has made it much easier for advisors to have multiple custodial relationships.

Use of the Internet has freed advisors to get more downloads into their portfolio management software. Advent Custodial Data Service from Advent Software, TechFi’s AdvisorMart, and other service bureaus, as well as direct downloads from Depository Trust Company, DST Systems, and others, have allowed RIAs to trade through multiple custodians. And this trend is accelerating. More independent technology companies are gearing up to support multiple custodial relationships for RIAs.

The result will be that custodial services will become more like a commodity. Custodians will have to find new ways to market themselves, new ways to add value to their relationships with RIAs, new ways to differentiate themselves. Schwab sees this trend and, as the market leader, it stands to lose the most from it. It’s not standing still.

SIM is about to unveil several new technology initiatives designed to differentiate itself and compete in this new multicustodian market. The most overt attempt to compete in the new environment is the introduction of its own service bureau.

Performance Technologies Inc., which makes Centerpiece performance management software and is owned by Schwab, designed the new outsourcing system and is responsible for its administration. (Schwab, incidentally, has changed the name of PTI to Schwab Performance Technologies, and has changed the name of Centerpiece to PortfolioCenter.) The new service bureau is called PortfolioCenter Outsource, and it will take downloads not just of accounts at Schwab but of accounts at Fidelity, Waterhouse, Vanguard, and Pershing as well as the fund shareholder accounting giant, DST.

Schwab Performance Technologies employees will download the advisor account data and scrub it. Advisors can run reports over the Internet and manually edit the database, which comes in handy when a transaction is shown incorrectly or pricing of an asset is inaccurate and must be changed manually. Schwab says this service is especially attractive to “breakaway brokers,” who are accustomed to having all their reporting done for them.

SIM’s Dan Skiles says Schwab’s strategy with Outsource is to maintain an open platform that recognizes the realities of the multicustodian world. He says it proves skeptics are wrong when they say that Schwab’s proprietary technology platform makes it difficult for advisors to leave the firm.

For advisors who fear the concept of Schwab having access to all their client data, Schwab has inserted a clause in the PortfolioCenter Outsource contract with advisors stating that only Schwab Performance Technologies personnel who support the service can view an RIA’s client data and not other employees at SIM. “This shows our commitment to serve advisors with multiple custodians and to protect the advisor’s data,” Skiles says.

But Schwab is not acting out of altruism. It’s being shrewd. SIM is building Outsource because Schwab stands to lose the most business as advisors increasingly use other custodians. Offering its own portfolio reporting service bureau makes SIM stickier to its clients. Maybe Outsource can charge more to handle reporting on assets held away from Schwab. And anytime an advisor wants to switch from one portfolio management system to another, it is difficult. SIM’s Outsource service is no different. Advisors who use Outsource will find converting to another platform a nightmare, and that will help keep assets at Schwab.

By building a system that supports SIM RIAs who want to trade with other custodians, Schwab hopes to stem the tide of defections to its competitors by making it easy for advisors to keep assets at Schwab yet place some assets elsewhere. If Schwab can automate the performance reporting service and keep its costs low, Schwab SIM can give the service to its best RIA clients for free, or at a large discount. That’s a smart way to encourage advisors to keep new assets coming into Schwab SIM and maintain the most profitable relationships. Pricing has not been set. Ten RIA firms are beta testing the PortfolioCenter Outsource; the beta test is expected to be complete early next year.

At the same time, Schwab Performance Technologies is also planning to release PortfolioCenter (PC), the product formerly known as Centerpiece. Schwab PC is a totally reengineered version of Centerpiece and it moves from a proprietary database to the open architecture of an SQL database. The SQL version was originally promised for June; now it’s not expected until early next year. But some 18 users are beta testing the new SQL version, Skiles says.

Writing the programming to this upgrade is a huge task, since it must convert data in the old database to the new one. “Our focus is to make sure the conversion to SQL works well and we won’t finish the beta test until that’s been achieved,” says Skiles.

The upgrade is free. But that does not rule out the possibility of price increases in annual support contracts for Schwab PC. Centerpiece costs $3,495 for a single user license and annual maintenance is $750. “We don’t know yet if there will be a price increase,” says Skiles. “We’ll need to look at the marketplace once the product is released.” A price increase would seem to make business sense from Schwab’s perspective. Schwab PC will only be sold to RIAs who do business with SIM. Raising the price will give Schwab more leverage to offer discounts on the software to its best clients.

Revamping Centerpiece to be more competitive with Advent’s Axys is also a shrewd business move by SIM. Even if it cost a few million dollars to make the upgrade and rewrite the performance management software program, doing so gives SIM a possible foothold into every RIA’s office by providing them with the portfolio management software that is the lifeblood of their practice.

It also neutralizes a threat from Advent, which has become a “virtual custodian” and a threat to Schwab. Schwab PC might actually be good enough for some firms to switch from Advent Axys. Moreover, Schwab can afford to charge much less for its PMS software than technology companies like Advent that depend solely on sales of their software for revenue. Schwab can give its portfolio management software to good RIA clients for free. Good SIM clients who custody all or most of their assets will get discounts or free technology and those with assets elsewhere may be required to pay the full price.

RIA technology products represent one revenue center for SIM–and presumably it’s a small one when compared with the institutional trading, the mutual fund supermarket, custody services, separate account products, and other investment services. So offering free or cheap proprietary technology is a great way to battle against shrinking market share. Schwab’s proprietary technology products are likely to become the loss leader in another wise, profitable array of products bought by RIAs from SIM.

Some advisors may feel like their arm is being twisted and that their independence would be compromised by accepting soft dollars from Schwab. Others will feel like Schwab is just holding their hand and will welcome the incentive to be a loyal Schwab client.

There must be two Schwabs. That’s the only good explanation for it.


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