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June 01, 2003 at 04:00 AM
John T. Tapsak is at wits’ end. Since Charles Schwab informed him that it plans to double the fees paid by advisors who custody less than $10 million with the San Francisco-based brokerage firm, he’s been feverishly searching for a new custodian. With Schwab’s fee hike set to take effect July 1, Tapsak says he’s run through the short list of custodians that are willing to take on his small Minneapolis practice, John T. Tapsak Advisory. His biggest worry, he says, is that these firms might “pull a Schwab a couple years down the road.” Another concern, he says, is small advisors’ inability to kick the tires before signing on with a new firm. “Without test-driving the machine, you don’t know how much better one [firm] is going to be over the other, since they claim they have the same services.”
Tapsak isn’t alone in his search for a new home for clients’ assets. After Schwab decided to sharply raise its fees, and Vanguard recently exited the custodial business, many other small advisors face the same daunting task. The good news is that there are firms like TradePMR, Foliofn, DATAlynx, EAInvest Securities, Ameritrade, and Shareholder Services Group, Inc. that are willing to step up to the plate–and that claim they won’t offer competing services. But the bad news, says Bert Whitehead, founder of the Alliance of Cambridge Advisors, a group of fee-only personal financial advisors serving middle-income Americans, is that custodial firms will continue to institute more onerous servicing terms on small advisors. “The wirehouses are really squeezing the small practitioner out, and that’s partly because the small practitioner is too expensive for them to service,” Whitehead says. Small advisors will continue “to get squeezed; this is just the second inning in a long ballgame.”
The Worst of Times
Having just reached the fourth year of a bear market, Tapsak says Schwab’s decision to sock it to smaller advisors couldn’t come at a worse time. Schwab’s “doubling [fees] after everybody’s assets have gone down in the last few years seems to me patently unfair,” he says. “Schwab’s looking out for Schwab as they’ve always done. They have no concern about small advisors, obviously, or clients of advisors–the investing public.” Once Schwab’s new fee rate kicks in, advisors with less than $10 million in assets will be charged $1,200 per quarter, double the previous $600 charge.
Lance Berg, a Schwab spokesman, says the new fee is justified because Schwab has “been steadily improving our product and service offering; the new quarterly fee puts pricing more in line with the value we provide.” He says Schwab’s “guiding principle remains unchanged: To be the best place for advisors to grow their practices, and to compete and succeed in the marketplace. We support advisors and their practices in ways that no other custodian does.”
John Gavin, a CFA with First Watch Investment Advisors in Plymouth, Minnesota, whose firm manages $6 million in client assets, says he understands Schwab’s need to look out for its bottom line, but he can’t help feeling somewhat betrayed by the fee increase. When his firm started up in 2000, Gavin searched hither and yon for a custodian, and settled with Schwab because the firm told him “how committed it was to the emerging advisor, and how dedicated their infrastructure was” to smaller firms. “We didn’t realize those were hollow words,” he says, “and that [Schwab] was committed only in good times.” Gavin says his firm is “actively reviewing” other custodians, “and will make the best decision for our clients.” One snag advisors might run across when deciding whether to move to another custodian is if their clients have taxable accounts, Gavin says. If so, “their funds may not transfer” to another custodian. The advisor “could trigger tax events for their clients” if they shift. Luckily, this scenario doesn’t apply to Gavin’s clients.
Whitehead says he understands Schwab’s decision to weed out smaller advisors. He’s trained more than 100 nascent advisory firms that have joined the Alliance of Cambridge Advisors, and experience has taught him that small advisors require lots of handholding, and can be expensive to serve. But being shunted isn’t the only thing that irks Tapsak; he’s also perturbed with Schwab’s insistence on labeling advisors that aren’t looking to grow their practices as “useless, and not a good advisor.”
Getting Around the Dilemma
The best way advisors can get the attention they deserve from the big three custodians, Whitehead says, is by creating ensemble practices. An alliance of firms would make it “profitable for Schwab and TD Waterhouse to treat them as an entity,” he says. Philip Palaveev, senior consultant at Moss Adams LLP, who specializes in financial advisors and broker/dealers, is of the same mindset: Small advisors “should seek to join other advisors with complementary practices, to either offset back-office costs or achieve some type of synergy,” he says. Palaveev also takes the somewhat controversial stance that most small independent advisors are better suited for a broker/dealer relationship. Advisors need a “certain critical mass to be fully independent and use a custodial platform,” he argues. Advisors managing from $10 million to even $50 million, Palaveev says, are better off joining a broker/dealer. “There are a significant number of broker/dealers that are not insisting [that advisors sell the B/D's] proprietary product, and that would allow reps to do fee-based planning and fee-based business, and will allow them to have their own RIA or use the [B/D's] umbrella RIA.” Palaveev believes advisors that are satisfied with pulling in $100,000 in total revenue are “not adequately incorporating the risk of being in business and return on equity.”
Small planners are also debating whether to go ahead and pay a higher fee in order to get better custodial services. Ron Pearson, a planner with Beach Financial Advisory Service in Virginia Beach, Virginia, says he counsels small advisors to first assess what type of practice they want to have before choosing a custodian. Do they want to stay at their current asset level, or continue to grow? Pearson tells smaller advisors not to pick a custodian “based on expense,” because “five or ten years down the road when their practice is where they want it to be, they may find there are constraints on what they can do because they went to a custodian that was cheap” and doesn’t provide adequate services. It’s a trade-off, Pearson says. If you’re a small advisor that expects to have $25 million to $50 million in assets under management, then it can make sense to go to a custodian that charges more because ultimately, as the advisor’s assets rise, the cost of service will fall. But if an advisor shirks managing assets and charges hourly fees, Pearson says, “then a high-cost provider may be prohibitively expensive.”
One Planner’s Search
Dennis Delphenich, a planner with Capitol Portfolio Advisors, Inc. in Dayton, Ohio, has some of his clients’ assets at Schwab, and is looking for a custodian that will allow him to consolidate all of his $10 million in assets at one place. Not only is Delphenich disappointed with Schwab’s fee hike, but he’s also become disenchanted with Schwab’s refusal to house his variable annuity and variable life business, as well as the noticeable drop-off in service he’s getting from Schwab. “You can feel yourself getting pushed to the back. Hold times on the phone are way up.”
In his search for a new custodian, Delphenich says he considered Ameritrade and DATAlynx, but the front-runner turned out to be TradePMR. He likes Ameritrade’s name recognition, he says, but “I’m worried about the fact that it’s another custodian with a retail focus.” And after initially favoring DATAlynx, he realized he’d have to pay a yearly fee because his average account size is less than $100,000. Gainesville, Florida-based TradePMR is now taking center stage, he says, because it’s “oriented toward investment advisors only” and because of the firm’s “huge” no-transaction-fee mutual fund platform. “I use a lot of NTF mutual fund networks, and TradePMR’s network is twice the size of Schwab’s.” In fact, the NTF list, says Robb Baldwin, TradePMR’s president, consists of about 7,000 mutual funds. Delphenich says TradePMR also has “a lot of the class A shares that normally have a sales charge; they offer lots of those [A shares] as no-loads. That’s interesting because the more I do [business] the more wary I am of custodians that deal with the retail public and funds that deal with the retail public.”
Delphenich says TradePMR is “bending over backward to accommodate me. That’s refreshing.” Another strong selling point, he says, is TradePMR’s “very low” $19.95 commissions on stock trades.
TradePMR started up in 1997 specifically to serve investment advisors. The brokerage firm now serves 60 advisors, and has added 15 new ones in the last 30 days. Baldwin says the firm is “attracting a lot of advisors now” because it requires no minimum asset size. Most of the new and potential recruits, he says, are coming from Schwab, Vanguard, or are startup firms. The company is in talks with five Vanguard refugees, and one has already signed up. “We offer everything online,” Baldwin says. “We try to even offer a complete portfolio management software so that even new advisors don’t have to have Centerpiece or Advent.” TradePMR is getting ready to add a rebalancing tool to its Web site (www.tradepmr.com), as well as total performance reporting, he says. “And we already do block trades and basket trades and bunch trades. All of these services aren’t available with anyone else, according to what we’re hearing.”
Another selling point for smaller advisors, Baldwin says, is the fact that TradePMR “offers them just about everything they need at no charge–real-time streaming quotes, all the performance reports and trade blotters, all the things they need for compliance and regulatory purposes come with the platform for free, which saves them from having to purchase different platforms to manage their business.” And advisors don’t have to worry that the brokerage firm won’t be around. The firm is “profitable,” he says, and makes its money from trading costs and trailers on the 7,000 mutual funds on its NTF platform.
Casting a Wide Net
Tapsak, the Minneapolis planner, has tested the waters at other custodial firms, and is leaning toward Ameritrade because of the firm’s well-known name. He initially contacted TD Waterhouse, but was told the firm wasn’t accepting any new advisors unless they had $10 million or more in assets. Waterhouse “was nice enough,” Tapsak says, to recommend DATAlynx and Ameritrade, but DATAlynx was out of the question, he says, because he didn’t meet the firm’s $100,000 average account size. He considered EAInvest Securities as well, but began to question the firm’s new structure now that BenefitStreet, Inc., a firm that markets 401(k) plan back-office software and support, has acquired it.
