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The Way We'll Be

Three major forces that will shape the industry in the years to come. Are you prepared?

Linda Lador Deane has been in the retail brokerage business for 33 years. She started out as a broker in the New Orleans office of Bache & Company, the storied Wall Street firm that was later bought by Prudential. Like most people in the business, she sold stocks and bonds on commission, relying on in-house research to make her selections. “Back then, you were just a broker in a branch office, and your branch dictated so much of what you could and could not do,” she says.

But in the late 1980s, she began to convert her business to managed money. Today, she is 100 percent fee-based, manages a branch office for Raymond James in New Orleans and specializes in retirement issues. She's has never looked back, she says.

Lador Deane's evolution reflects a number of shifts in the financial-advice business over the last few decades. Since Registered Rep. made its debut (as The Registered Representative), with a combined August/September issue in 1976, the retail broker has morphed into a very different kind of animal. The cold-calling stock jockey of yore, who could rise through the ranks from mailroom clerk to top producer, has been supplanted by a highly credentialed professional, with knowledge of a vast array of products and financial-planning strategies and a client list built upon referrals. (At least that's the model everyone is pursuing.) The major brokerage firms that everyone wanted to work for in the 1970s — E.F. Hutton, Shearson Lehman, Dean Witter, Salomon Brothers — have been absorbed by the likes of Morgan Stanley, Wachovia and Smith Barney.

Meanwhile, a whole new breed of firms has cropped up: The independent broker/dealers started to take root in the mid-1970s, while independent RIAs began to gather momentum in the 1980s and 1990s. These new firms have led the industry down a new path: Open architecture has become the rule of the day; fee-based “wrap” or managed-money programs have taken the place of commission-based mutual funds and individual stocks and bonds; financial-planning and wealth-management strategies are elbowing out simple investing advice and product sales; and the lone-wolf broker, living by the motto “eat what you kill,” is giving way to teams of advisors with complementary areas of expertise.

While it's clear how we got here, it's not so easy to predict where we're going. And so, on the magazine's 30th anniversary, Registered Rep. examines three major forces that will likely shape the industry over the next five to 20 years: the age of retirement, the margin squeeze and the RIA phenomena.

The Age of Retirement

By 2030, the demographics of some 32 states will resemble those of Florida today, according to Jackson National Life, which got its data from the U.S. Census Bureau. That means people with gray hair, hip replacements and orthopedic shoes. Aside from their sheer numbers, baby boomer retirees are different from the last generation of retirees in a couple of key ways: They will live longer than previous generations, and they are also severely underprepared for retirement. Only about 41 percent of workers between the ages of 25 and 64 have any kind of retirement account, and half of those who do carry balances of less than $33,000, says the U.S. Census Bureau. Meanwhile, life expectancy has doubled over the last century, and the average length of retirement is 19 years, according to the Counsel of Life Insurance.

On the most basic level, this mass baby boomer retirement wave means a lot of advisors will need to shift their focus from asset accumulation to capital preservation and income distribution. But advisors also will need to understand a broader and more sophisticated set of retirement risks than ever before, says McKinsey & Company consultant Alok Kshirsagar. These retirees will need more cash than previous generations, inflation will make a bigger dent in their savings and health care will be a much bigger concern, he says.

The good news: The crisis faced by today's unprepared boomers could improve the investment and saving behavior of future generations. Like people who watched their parents struggle through the Depression, these Americans may become methodical savers and careful investors, says Dennis Gallant, an analyst with Gallant Distribution Consulting in Boston. As thousands of baby boomers struggle to make ends meet or maintain their standards of living, their children will witness their mistakes and their heartache. And that could inspire them to get smarter sooner about financial advice, creating a new and more financially savvy group of future clients for financial advisors — or so the theory goes.

The Margin Squeeze

In the near term, however, it's going to get harder for full-service and independent firms to earn a decent buck in this business. Why? The most obvious cause is competition: The number and kind of firms going after wealthy, profitable clients has exploded over the past few years to include insurance companies, banks, RIAs, accountants, even credit unions. In addition, the acceptance of open architecture is cutting into a source of profits for the big firms — manufacturing proprietary products, a business that typically posts pretax operating margins of around 30 percent, compared with retail brokerage's 15 percent to 20 percent. The shift to open architecture also makes it easier for advisors' to take their clients with them if they leave. (It's easier to transfer nonproprietary products to a new firm.)

Add to that the recruiting war for top talent and you've got near-term trouble. Some 17 percent of reps left their firms in 2005, nearly half of whom joined a competitor, according to the Securities Industry Association. Recruiting packages at firms like Morgan Stanley and Smith Barney are as high as 200 percent of trailing 12-month production (for the best FAs). With packages like these, it can take a firm five years just to break even on a top producer, according to a September research report from Morgan Stanley. And the recruiting frenzy is not expected to abate; as few new advisors are being trained and old brokers retire, the stakes are rising, say consultants.

To top if off, compliance costs have gone way up: Industrywide, they have nearly doubled in the past three years — to $25 billion in 2005 from $13 billion in 2002, or 5 percent of the industry's annual net revenues, according to a February study by the Securities Industry Association.

How will firms reduce attrition and cut costs? They're already working on one solution: teams. It's harder to pull in multiple people with a single recruiting offer, and if one guy leaves the team, he can't necessarily take his clients with him, explains Gallant. Some firms, like Smith Barney, are actually providing compensation incentives to advisors who join together in teams. Merrill and Morgan Stanley are putting greater emphasis on bank products, like deposits and mortgages, which carry a lower payout for the broker and tend to generate more loyalty among clients to the firm rather than the advisor.

RIA Revolution

It's starting to look like the independent RIAs mean business. Assets managed by RIAs have more than doubled from $1 trillion in 2000 to $2.35 trillion today, and their share of U.S. liquid assets has risen to 12 percent from 9 percent three years ago, according to research firm Celent, a research and consulting firm. By comparison, the full-commission brokerage firms manage 27 percent, discount firms manage 11 percent and independent b/ds manage 5 percent. (In 2003, full-service brokerages and discount brokerage managed a combined 43 percent of U.S. investable assets; independents managed 3 percent.)

While there has been a lot of talk about a migration of advisors from the full-service b/ds to the RIAs and independents, it's hard to find data that indicate whether they're losing top producers or the bottom rung. Still, analysts say anecdotal evidence suggests that top wirehouse reps are defecting to the RIAs. “The really big guys are going to the RIAs, the middling ones are going to independent b/ds,” notes Stephen Winks, founder of The Society of Senior Consultants, an advisor advocacy organization. Close to 700 advisors left full-service firms between 2004 and 2006, while independent b/ds gained close to 30,000 reps and RIAs added 7,000 during that period. Meanwhile, assets managed by RIAs grew by $37 billion, to $2.35 trillion between 2004 and 2006.

As the biggest RIAs get bigger and more sophisticated, some of them are planning to merge, create national firms and go public, which will give them even greater access to capital for future growth, says Winks. (He declined to disclose names.) How will the wirehouse firms respond? If independence starts to gain too much momentum, they'll start to offer reps more autonomy and a higher payout, while charging higher fees, says Gallant. “It hasn't come to that, but it's a potential future evolution,” he says. Some full-service firms, like Wachovia, are already trying it. (See related story on p. 17.)

“It's not that RIAs are going to take over the world,” Gallant says, “but they're able to consolidate assets, capture wallet share and increase assets under management more rapidly than any other channel. Every year the industry looks more and more like the RIAs, but some of them will always be a step ahead.”

RIAs have one advantage that won't go away: They can be innovative precisely because they're not big. “Historically, the competitive advantage we've had is that we're small and nimble,” says Mark Balasa, co-president of Balasa Dinverno & Foltz, an RIA based in Itasca, Ill., with $1.1 billion in assets under management. “I can't imagine the need for an affiliation with a b/d. The b/d gets in the way, creates extra layers of compliance and they want a piece of the revenue, and I'm not sure for what.”

RIAs Grabbing Market Share

Market share of US investable assets, by channel:
Independent RIAs 9%
Independent b/ds 3
Bank trust departments 10
Retail banks 24
Insurance companies 1
Full-service and discount brokerage firms 43
Mutual fund companies 10
Independent RIAs 12%
Independent b/ds 5
Bank trust departments 10
Retail banks 25
Insurance companies 1
Full-service brokerage firms 27
Discount brokerage firms 11
Mutual fund companies 9
Source: Celent Communications
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