Executive Summary
Enjoy the current installment of "weekend reading for financial planners" – this week's edition kicks off with the news that Fidelity has not only decided after all to match competing custodians with zero-commission trades on US stocks and ETFs, but is further accentuating how it provides better default money market options and eschews payments for order flow in an even further amplification of the competitive pressures of the RIA custody model.
From there, we have several more articles beginning to explore the implications of the industry's rapid shift to zero-ticket-charge RIA custodians, including how the collapse of trading commission revenue could force RIA custodians to assess new custody fees (or else have to cut services given the lost revenue?), the way zero-commission trading may further accentuate the differences between broker-dealer platforms and RIA custodians (and further accelerate the breakaway broker trend), and the compliance issues that suddenly have emerged for RIAs that previously negotiated asset-based pricing on trades and especially those that bundled their asset-based trade pricing into a holistic wrap fee that may no longer be priced appropriately in a zero-trading-fee world.
We also have a number of articles on RIA and broker-dealer industry trends, from a look at the latest FINRA data showing that the number of brokers changing broker-dealers or switching to the RIA channel is actually declining (at least for now?), to the challenges of large broker-dealers that aren't always leveraging their economies of scale for better service to their brokers (and sometimes use their scale to negotiate better distribution agreements for themselves instead), whether the industry is starting to shift away from revenue-based compensation for advisors (and how the rise of Merrill Edge could drive the shift in large firms), and how advisory firms learning to bring in their own clients (whether by centralized marketing or inorganic acquisitions) are leading to a rise of restrictive non-compete and non-solicit agreements in the RIA channel that may even be more limiting than the wirehouse channel those independent firms criticized just a few years ago.
We wrap up with three interesting articles, all around the theme of how we find and consume good news and other content in an increasingly complex (and algorithm-driven) world: the first provides some recommendations on less-commonly-known blogs and news sites to help advisors who want to try and figure out what the market 'consensus' is (in order to identify potentially-market-moving news); the second offers up another series of blog and media site recommendations for content that will challenge you to think differently; and the last takes a fascinating look at how after nearly a decade of increasingly-algorithm-driven content recommendations, companies from Netflix to Apple are bringing back human curation to provide the contextually relevant suggestions for readers/viewers that algorithms just haven't seemed to be able to master (or at least, haven't yet?).
Enjoy the 'light' reading!
Fidelity Eliminates Commissions, Scoffs At Competitors' Low-Yielding Cash Default Options (Michael Thrasher, RIA Intel) - After initially holding out in the face of Interactive Brokers, Schwab, TD Ameritrade, and then E-Trade all cutting their trading commissions to zero over the past two weeks, this week Fidelity too announced that it was cutting trading commissions on its US stocks, ETFs, and options to $0 (effective immediately for individual investors, and on November 4th for RIAs). Notably, though, in its press release announcing the cuts, Fidelity didn't only cut its trading commissions to $0 to match competitors... it also specifically highlighted its recent announcement to default investor cash to a more favorable (albeit-still-Fidelity-owned) 1.58%-yielding money market fund that yields substantially more than competing discount brokers' cash sweep programs, and further noted that it can execute trades better because it doesn't accept any conflicted-incentive payments for order flow. In other words, Fidelity not only matched competitors on no-transaction-fee trades, but further threatened competing brokerage firms' economics on their earnings on cash and for order flow, suggesting even further competitive pricing pressures for RIA custodians. Of course, the caveat is that in the end, RIA custodians and discount brokers must still generate revenue somehow... raising the question of whether the elimination of trading commission (and potentially other lucrative custody/clearing revenue sources) will just further drive brokerage firms towards offering fee-based accounts and other managed-account solutions as a revenue alternative... or an asset-based custody fee in the case of RIAs on their platform?
Price-Pressure Trend Shines New Light On RIA-Custodian Relationships (Jeff Benjamin, Investment News) - From the client's perspective, the collapse of trading commissions at the major RIA custodians is a cost they're happy to see eliminated. From the advisor's perspective, though, the situation is more nuanced, as while the eliminated cost is appealing, the fact that ticket charges generated material revenue for most platforms (that don't necessarily have very good margins to begin with in the highly commoditized business of RIA custody) is now raising concerns that RIA custodians may be compelled to cut support services they provide to their advisory firms to align with their reduced revenue... or, alternatively, to find a new arrangement for how RIAs pay for custodial tech and services beyond just letting the platforms profit off their clients' underlying investments, cash, and trading. In other words, under the current model, clients pay advisory firms for the advisor's services, but advisory firms don't pay RIA custodians for their custody services, as those costs instead are borne indirectly by clients in the form of those ticket charges, securities lending revenue, payments for order flow, interest rate spread on cash holdings, etc. Which raises the question of whether this fundamental misalignment (where RIAs count on their clients to foot the cost of the RIA's custody services in a non-transparent manner), coupled with the loss of a key revenue source that custodians were drawing from clients to support the advisor's custodial services, may finally be the trigger to restructure the RIA custody business into a more-aligned asset-based fee instead. On the plus side, though, if advisory firms begin to pay directly for RIA custody, it may also help to ensure that the revenue RIAs contribute to their custodians actually goes more directly back into services and technology for their RIA customers.
Zero Commissions A 'Huge Deal' For Advisors, B/Ds (Janet Levaux, ThinkAdvisor) - The collapse of trading commissions amongst retail online brokerage firms and RIA custodians is now raising questions about the popular broker-dealer clearing platforms (e.g., Pershing and Fidelity's National Financial Services) about whether they, too, will lower their ticket charges. In the near term, it creates a challenging incentive for broker-dealers that solely custody with one clearing firm that still assesses ticket charges, and an incentive for brokers to select broker-dealers that are dual-clearing (e.g., Ladenburg, Geneos, or United Planners), along with an incentive for hybrid brokers to shift even more of their client assets into advisory accounts that can be held away from the broker-dealer at a third-party no-transaction-commission RIA custodian instead. In turn, broker-dealers (and their clearing firms) that hold out run the risk that their brokers (and especially wirehouse brokers who tend to be more active traders and already use fee-based wrap accounts) will decide to switch entirely to the RIA channel, just to get their clients access to stocks and ETFs with no ticket charges or zero asset-based wrap fees.
As Brokerages Race To Cut Commissions, RIAs Should Check Their Fees (Max Schatzow, ThinkAdvisor) - For advisory firms whose clients simply pay their ticket charges for each trade the firm makes on their behalf, the recent collapse of trading commissions down to $0 for most major RIA custodians is a welcome savings. But as Schatzow notes, some RIAs weren't actually paying ticket charges for each trade, and instead had negotiated asset-based pricing for their clients. And because asset-based pricing arrangements are contractually negotiated between the RIA and the custodian, it's not necessarily automatic that the wrap fee is reduced to 0% just because individual trading commissions have been eliminated... which immediately puts pressure on advisory firms to revisit their asset-based pricing arrangements, and whether it's still justified to include/assess those fees against clients for trading (given that they might otherwise just convert to per-trade pricing at a $0 price point anyway). Of course, the caveat is that not all trades are now free via RIA custodians, as the recent price cuts generally only apply to U.S. stocks, ETFs, and options, but not foreign stocks, bonds, or mutual funds. Accordingly, it's not necessarily the case that their asset-based pricing would have dropped to 0.0% anyway. But as Schatzow notes, at a minimum, advisory firms have an obligation to monitor for best execution that would necessitate them to revisit their exact asset-based pricing arrangements for trades, and determine whether the agreement at least needs to be renegotiated now. And it's especially important to revisit pricing arrangements if the advisory firm was absorbing client trading costs in the form of a wrap fee program, as if the advisory firm's trading costs are reduced, arguably the trading-fee portion of their wrap fee charge to clients should be reduced as well.
It's Official: Brokers Have Tempered Their Wanderlust (Mason Braswell, AdvisorHub) - According to the latest "Industry Snapshot" report from FINRA, only 10,000 of the securities industry's nearly 630,000 registered representatives (or about 1.5%) changed broker-dealers in 2018, down 63% from the 27,433 (over 4% of brokers) who switched firms in 2017, which itself was down more than 50% from the 69,175 brokers (9% of all registered reps) who changed firms in 2009. Similarly, the number of dual-registered brokers dropping their licenses to become standalone RIAs also decreased last year, declining to 2,482 in 2018 (from 3,163 in 2017). The downward shift in mobility of brokers is a surprise for many, especially given that many forgiveable loan retention deals issued in the aftermath of the financial crisis are just now winding down (making brokers at many firms more 'financially free' to switch). Ultimately, though, the reduced turnover at broker-dealers appears to be driven at least in part by the strategic shift of broker-dealers themselves to spend less on lucrative recruiting deals to draw brokers from other platforms, and more on retention to keep the brokers they already have. Not to mention the withdrawal of both Morgan Stanley and UBS from the Broker Protocol in late 2017 as well, coupled with a rising volume of lawsuits by major firms from Morgan Stanley to Charles Schwab against their departing brokers that may be further chilling the willingness of brokers to change firms at all. In the aggregate, though, broker-dealers are still struggling with overall stagnant growth, with the number of brokers up by 7% with new entrants, but down by 7% with attrition (for a net growth that rounds to 0%), and the number of broker-dealers themselves down 3.2% (or 119 firms) from 3,726 to 3,607 (with an overall 10% decline in broker-dealers since 2014).
The Dark Side Of Broker-Dealer Scale: Pain For Advisors (Jon Henschen, ThinkAdvisor) - One of the most common benefits that large broker-dealers tout is that their sheer size allows for economies of scale, allowing them to do more for their advisors yet charge them less (i.e., offer higher grid payouts). Yet as Henschen notes, large broker-dealers in practice don't necessarily have higher servicing levels just because they're larger with ostensibly better economies of scale. Instead, it's necessary to look at actual staffing levels - i.e., the number of brokers relative to the number of staff members supporting them - ideally finding a ratio of 5:1 or less (while some broker-dealers that have been consolidating for 'efficiency' now have advisor:staff ratios of 10:1 or more). Even with a low ratio, though, strong staffing levels still aren't necessarily an indicator of better service, because in some cases the firm has poor operational technology (such that the high staffing ratio is just making up for poor internal systems), while in others the firm may be experiencing high turnover (which means the staff that are available may not actually be able to answer questions or resolve issues effectively). For some broker-dealers, servicing challenges for at least their top brokers are handled by at least offering a higher-tier service layer for big producers... with the caveat that such 'premier' service desks can further draw away talent from the rest of the service desk team, even further undermining service quality for all the rest of the brokers at the firm who don't qualify. In the meantime, Henschen also notes that some broker-dealers may have gone too far in the push for bigger payouts and trying to leverage their economies of scale, and are now using their size to instead mark up the cost of solutions on their platform, which may be manifested in either platform fees or marked up costs (e.g., the 'advisory' fee for a third-party manager includes 15-25bps payable direct to the broker-dealer), or even replacing with their own in-house solutions. Which in turn is creating even more conflict-of-interest challenges between advisors working at a broker-dealer and their B/D itself.
The End Of The Revenue-Based Compensation Model For Advisors (Jeff Mardsen, Wealth Management) - Historically, financial advisors were salespeople, responsible for either selling insurance products, mutual funds, or more recently fee-based managed accounts; accordingly, it was only natural for advisors to be compensated based on the revenue they generated (as is commonly done for many types of 'business development' roles). However, as advisory firms increasingly shift away from the sales business and into the advice business, there is an emerging shift towards alternative compensation models that are better aligned to the new reality of what advisors actually do and are responsible for. For instance, a growing number of firms are adopting a salary-plus-bonus approach to advisor compensation, as the stable salary better supports providing stable ongoing services to existing clients (rather than always incentivizing advisors to grow their revenue by seeking out new clients), with bonuses that are still strategically aligned to create the desired incentives (e.g., a separate bonus that may still apply for business development, but could be coupled with bonuses for deepening the breadth of an existing client relationship and the amount of financial planning services being provided). In addition, the rise of deeper CRM and other data systems is making it feasible to track a wider range of activities within advisory firms (e.g., the percentage of clients receiving financial plans and being met with in regular ongoing financial planning meetings), along with better feedback systems (e.g., surveying clients to determine a Net Promoter Score [NPS] to understand which advisors actually have the most satisfied clients), which in turn is leading to a focus on new metrics (besides business development) that can be incorporated into advisor compensation. The 'holy grail' of measurement, though, is still an overall assessment of the 'quality' of an advisor in the services they provide to clients... which is still difficult to measure, but with a growing range of firm data, may soon become another key factor that contributes to advisor compensation.
A New Pay Model: 300 Advisors Move, And The Entire Industry Feels The Shift (Bruce Kelly, Investment News) - Earlier this year, Bank of America announced the decision to move 300 Merrill Edge advisors into its local Merrill Lynch Wealth Management branch offices. The significance of this shift is that, unlike the 'traditional' Merrill Lynch broker in a wealth management branch, Merrill Edge advisors are compensated by salary instead, raising the question of whether the move is part of a broader signal at both Bank of America Merrill Lynch, and the broader wirehouse community, that the age of the "eat what you kill" brokerage model of grid-based compensation may be dying, to be replaced with an "eat what you are served" mindset instead. From the firm's perspective, the appeal of the shift to a salaried model is clear - overall advisor compensation will likely be lower on a salaried basis than paying advisors a percentage of an ever-rising base of revenue (typically 35% to 45% in outright payments, with wirehouse total costs for advisors as much as 50% to 60% of revenues), and to the extent that the firm brings in the clients and "just" assigns a salaried advisor to service them, it will likely be easier for the firm to retain the clients even if the advisor leaves. In the context of Bank of America Merrill Lynch in particular, the move appears to be setting the stage for Bank of America to cross-sell its existing millions of bank clients on wealth management, and not wanting to pay its advisors a percentage of revenue for clients the bank had already brought in, with rumors that Merrill Edge may hire as many as 10,000 salary-based advisors in the coming years. Though thus far, the wirehouses themselves contend that such salary-based positions are mostly for more entry-level 'junior' advisors, or those serving smaller client accounts, and that the grid will remain intact for their wealth management advisors serving more affluent clientele.
Under Pressure: Is The RIA Industry Morphing Into The Brokerage Biz? (Ian Wenik, CityWire) - The trend of breakaway brokers from wirehouses over the past decade has been driven in part by a desire of some to build equity in a business they own, and for others a greater range of products and solutions to offer clients, but arguably the biggest driver of brokers shifting to the RIA channel has simply been the desire of a subset of advisors to have independence, and the ability to choose to serve whoever they want and however they want... a trend that some wirehouses themselves tried to slow in 2017 by dropping out of the Broker Protocol, effectively reducing the limited independence their brokers already had in an attempt to keep them from shifting even further. Yet the irony is that in recent years, large RIAs have increasingly begun to put in place their own restrictive non-compete and non-solicit employment agreements, highlighted by a recent lawsuit that RIA aggregator Mercer Advisors filed against one of its departing advisors when he tried to switch to another firm and bring his clients with him. In fact, industry recruiters note that some large RIA employment agreements are actually more restrictive than the ones typically required at brokerage firms, a trend that appears likely to continue as more private equity dollars flow into the RIA channel, which both drives more acquisitions, and is typically associated with restrictive employment agreements tied to such acquisitions (which means the more deals that occur, the more RIA advisors end out subject to non-compete and non-solicit agreements).
How To Read Financial News Redux: Understanding Consensus (Robert J. Martorana, CFA Institute) - One of the fundamental challenges of trying to consume financial news is that there's a lot of noise and commotion, but not always much clarity in the actual underlying factors driving the news... at least until a consensus emerges, and market prices then adjust to the extent that the new consensus differs from the prior. Which means in practice, one of the key aspects of reading and following the financial news is not just to understand the news itself, but also what the existing consensus is (to understand how the news may alter it). So what are the best sources to keep a handle on what the consensus is in the first place? Martorana suggests a few sources, including: Jeff Miller's Dash of Insight blog (and in particular his Weighing The Week Ahead [WTWA] publication); Brian Gilmartin's Fundamentalis (particularly focused on trends in US corporate earnings); John Butters' FactSet Insight on companies and earnings; and JP Morgan's Long-Term Capital Market Assumptions (complemented by its annual and regularly updated Guide To The Markets). Notably, when it comes to understanding consensus, the point is not just to find interesting stories, per se, but to look at trends in the news itself. For instance, is the particular story one that was covered in lots of different publications (an indicator of consensus) or just one, how frequent is the topic getting repeat coverage (an analysis that can be supplemented by tools like DataTrek, which monitors trends in Google searches and the Industrial Sentiment Survey from Corbin Advisors), and how the stories are framed (which requires also understanding the underlying partisanship or bias of the publication itself, in addition to reflecting on whether the coverage was optimistic or pessimistic). All of which helps to provide further context on how markets in the aggregate are taking in the news coverage in the aggregate (i.e., the consensus).
To Be Well-Informed, Cut The News And Read These 7 Blogs Instead (Nick Wignall, Medium.com - BetterMarketing) - One of the fundamental challenges of making intelligent, educated decisions in the modern era is that it's often difficult just to find the 'good' news sources in the first place (and/or to figure out which really are and which are not). Accordingly, Wignall highlights a series of blogs that help to provide a broad range of perspective - which may cover a span of political views (e.g., from progressive to libertarian) but in an educational context to encourage the reader to think (i.e., content that is politically diverse but not intentionally partisan). Suggested sources for new education and perspective include: Marginal Revolution by Tyler Cowen and Alex Tarrabock (which will "teach you to think like an economist"); Slate Star Codex from "rational psychiatrist" Scott Alexander (with topics on medicine, science, and education, along with some philosophy and futurism); Farnam Street by Shane Parrish, which focuses on the actual process of how to systematically improve your own critical thinking abilities (and also has a podcast called The Knowledge Project); Behavioral Scientist that covers the "front lines of behavioral science"; FiveThirtyEight by Nate Silver that takes a unique data-science approach to journalism; Aeon which blogs about the 'big questions' in philosophy, science, psychology, and art; and The New Atlantis that focuses on the intersections between science, ethics, and policy (e.g., tackling complex hotly debated topics like bioethics).
How Human Curation Came Back To Clean Up AI's Messes (Jared Newman, Fast Company) - With its ongoing ramp-up of original shows, HBO launched a new website a few months ago to help viewers figure out which shows to watch... and made a point of not leveraging computer algorithms and artificial intelligence to make the recommendations, but instead aptly called the solution "Recommended By Humans." In turn, Netflix also announced recently that it was beginning to test a human-curated list of recommendations as well. And the shift towards human curation appears to be going even broader, with Apple hiring a (human) editor-in-chief for its Apple News app (now paired with a dozen journalists who help decide which stories to promote), Apple also redesigning its iOS App Store around picks from human editors, YouTube modifying its YouTube Kids "Collections" by hand-picking videos, and more. The trend appears to be driven at least in part by recent acknowledgments from major companies like Facebook and Google that their algorithmic recommendations may actually be helping to amplify the spread of misinformation and/or have been surfacing inappropriate content (e.g., for young viewers), and more generally whether popularity-based algorithms may actually be limiting the ability of people to discover quality new content (thus Netflix's and HBO's decisions to start testing human curation to help viewers discover new shows in particular). In addition, humans can provide additional context that algorithms may lack - for instance, explaining why a new show might be of interest to watch, instead of just recommending it because other viewers with similar habits watched the same show. The challenge, of course, is that human-based curation is itself more labor-intensive, time-consuming, and harder to scale... raising the question of whether the recent re-emergence of human curation is itself just a temporary trend until machine-learning algorithms can get even 'smarter and better', whether the human inputs will simply be used to train better algorithms, or if the future will always have to be a combination of human and technology working together to figure out what might be of interest and to give it (or keep it in) proper context?
I hope you enjoyed the reading! Please leave a comment below to share your thoughts, or make a suggestion of any articles you think I should highlight in a future column!
In the meantime, if you're interested in more news and information regarding advisor technology, I'd highly recommend checking out Bill Winterberg's "FPPad" blog on technology for advisors as well.
Article Recommendation
https://marker.medium.com/what-i-learned-from-losing-100-000-on-two-failed-startups-b3cb73fc99ab
Thanks Jon, will check it out! 🙂
– Michael