It’s my view that we may well remember 2015 as the year that wirehouse recruiting packages topped out. Deals may remain at eye-popping levels for the near term, but future changes will be in one direction only: down.
For the past few years, first- and second-quintile producers have been able to command upfront bonuses of 150% of their trailing 12 months’ (TTM) gross commissions — plus potential back-end bonuses that have driven total packages to more than 300% of TTM.
An aging and shrinking advisor population has compelled firms to strike stratospheric deals in order to attract these top-line revenue generators. According to Cerulli Associates, nearly half of all advisors are 55 or older. Their ranks continue to shrink. In the next 10 years, one-third of all advisors are expected to retire.
Meanwhile, wealth management has become more indispensable to wirehouse profitability as other profit centers have faltered.
Dodd Frank has shuttered proprietary trading desks. The low-interest-rate environment has prompted fixed income departments to reduce headcount, as volatile markets have paralyzed syndicate departments, reducing new issues to a mere trickle. A Steady Eddie wealth-management franchise has never been more essential to the financial well-being of wirehouse firms than it is today.
In the winner-take-all, zero-sum game of advisor recruiting, packages have reached their zenith and have remained there for the past few years. A boost in recruiting deals from the current term of nine to 10 years would require advisors to sign on for even more years, so that hiring firms could realize the desired return on their recruiting packages.
Thus far, an aging salesforce has resisted lengthier deals. Many advisors are leery about signing deals that require more than a nine- or 10-year commitment to a new firm. That’s especially true of advisors in their later 50s or early 60s, who don’t want to sign deals that would tie them up until sometime in their 70s.
In my view, advisor deals have topped out, simply because advisors are not willing to sign the lengthier contracts that even heftier packages would require. But there’s another factor putting limits on today’s stratospheric recruiting deals: firms need to be generating the profits to pay for them. Right now, wirehouses suddenly find themselves confronting a more challenging environment.
Turbulent markets have pummeled stocks and unnerved investors, driving many to the sidelines and reducing firm revenues. Bank of America’s Global Wealth Management and Investment Division, which includes Merrill Lynch, reported a 13% drop in net income during in the fourth quarter of 2015.
Morgan Stanley’s profits tumbled 74% in the same period — from $1.8 billion in Q4’14 to $480 million in Q4’15. Meanwhile, the pretax wealth management profit margin dipped from 22% and 23% in the two preceding quarters to 20%.
At some point, the seven-year bull market will come to an end. And, of course, Wall Street firms are much less profitable in bear markets. That’s because it’s not just investors who trade stocks who are spooked by plunging markets. Fee-based clients are less willing to pay for accounts that are underwater.
The new fiduciary standard is another tempest. The Department of Labor weighed in, and the SEC is expected to do so in the future. While it’s not clear exactly how much these new regulations will cost firms, one thing is certain: the fiduciary standard will not help wirehouse profitability; in fact, the new rules probably are going to hurt it.
Morningstar estimates that $3 trillion, or 43%, of the $7 trillion in client assets held in IRAs across firms are transaction based. They make up about 30% of client assets for the full-service firms and generate $19 billion in revenues for them.
With the new DOL rules, some investors with commission-based retirement accounts may transfer their holdings to discount brokers or sign on with cheaper robo-advisors.
Other clients will likely remain with the wirehouses and keep their commission-based format with advisors operating under a Best Interest Contract Exemption (or BICE) standard. And there will be some clients who want to move into fee-based investments for which the wirehouses may charge them more.
Also, firms will need to tweak their technology, so advisors can document their adherence to a fiduciary standard. More red tape could potentially slow sales, thereby reducing firm profits.
Until the smoke clears, it’s going to be hard to sort out precisely how these new regulations will impact the firms’ bottom lines.
A new recruiting paradigm is likely to emerge. Advisors with large fee-based practices will continue to command the top deals at major wirehouses.
Nothing is likely to change for fee-based advisors with $1 million-plus in gross production and $100 million-plus in assets under management. Once firms have less to spend on recruiting, because of either a market downturn or an onerous compliance regimen that pares back profitability, they will trim their deals for less desirable producers.
With fewer recruiting dollars to spend, smaller producers and those advisors who are top heavy with accounts that are not being serviced in accordance with the new fiduciary standard are most at risk.
Still, even if recruiting packages dip a bit for some producers, it may not turn out to be a nightmare. An aging and shrinking advisor population means that successful advisors will always be in demand.
Firms certainly will continue to compete for them with lucrative offers, so they can land as many good producers as possible. How many other businesses in our problematic economy offer solid players the wherewithal to switch firms and capture mega-deals whenever they are so inclined?
Cheer up! Even when firms have less to spend, recruiting packages are and should remain pretty darn good.