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Online brokers may be bigger threat to financial advisors than they realize, study says

E*Trade, Schwab and Fidelity win assets from advisors and relinquish them grudgingly, according to Aite Group report

Monday, April 19, 2010 – 7:27 AM by Brooke Southall
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Adam Honoré: Nearly 70% of financial advisors see online brokers as being no threat to their business.

Financial advisors are asleep at the switch about what constitutes one of the gravest threats to their business – online brokerage firms, according to a new study by the Aite Group.

Online brokers are the most likely of all channels to take clients away from financial advisors and they are also among the more difficult competitors to pry assets away from, according to a report originally released in December entitled: “The Direct Business Ambush: Advisors Not Seeing the Threat.”

When the 402 advisors who participated in the study were asked what kind of firms they lose the most business to, online brokerage firms were chosen 23% of the time — the most frequently chosen category. It was followed by regional brokerage firms, independent RIAs, traditional banks, wirehouses and “other” with 22%, 17%, 13%, 13%, and 6% of the responses respectively.

Charles “Chip” Roame, managing director of Tiburon [Calif.] Strategic Advisors, has long warned the advisory community that online brokers are a major threat to their businesses.

Little value in financial advisors

“I am glad someone gets it and admits the truth, so kudos to the study,” he says. “There is a segment of consumers, bigger than nearly every advisor-centric person believes, that prefers to do things themselves, trusts few, and/or sees little value in financial advisors.

“I think (online brokerages) are becoming a bigger threat because: 1.) they are further improving their offers and 2.) the financial advisors have not been able to prove they added any value the last few years.”

The online brokerages are hardly shy about helping investors come to these conclusions with their unrelenting advertising campaigns, says Adam Honoré,research director of the capital markets group for Aite Group of Boston and author of the study.

“The pseudo-cartoons of Charles Schwab, talking infants of E*Trade, “Law and Order” celebrities of TD Ameritrade and Roger Riney flying in his helicopter for Scottrade are all promoting the same theme: Investors do as well if not better than their advisors but without the added cost,” he writes in the study’s introduction.

Messages like these are effective enough that they need to actively countered but the vast majority of advisors are content to ignore them, according to Honoré.

Advertising onslaught

“Despite the advertising onslaught by discount brokers, a recessed market, routine news on fraudulent money managers and brand tarnishing by the largest firms on Wall Street, nearly 70% of financial advisors see online brokers as being no threat to their business,” the researcher writes in the study.

Advertisements like E*Trade’s talking babies are no joke for competing financial advisors, Aite Group study shows.

“Advisors need to wake up to the reality of the threat and…combat the messaging coming from these firms,” he writes.

The online broker that is perceived as the biggest threat by the advisors in the study was E*Trade, which was picked by 25% of the survey participants followed closely by Charles Schwab & Co. with 23% and Fidelity Investments at 22%.

Skeptical about the threat

Matthew McGinness, principal of Best Practice Research in San Diego, is skeptical about the threat posed by online brokers. “The question is: how big are the assets?” he asks.

The advisors that McGinness speaks to say that often the assets lost to online brokers are low-balance clients who were high maintenance, hence undesirable. These clients were chafing at giving up control of their investments to a third party all along.

But Roame believes that there are plenty of self-directed accounts held by high net worth investors.

“Self-service is alive and well, and has many more wealthy clients than anyone who is advisor-centric wants to believe,” he says.

Inherently challenged

Based on his experience as a researcher, Philip Palaveev, president of Fusion Advisor Network, says that studies tracking where assets go based on what advisors say are inherently challenged because they don’t necessarily know where they end up. “Clients don’t call to say: I’m going somewhere else,” he says.

The study does offer food for thought when it comes to something advisors are able to track more accurately: where assets come from. Online brokers are among the hardest firms to win assets from, according to the study.

Asked which firms they gain the most assets from, survey participants named regional broker-dealers 23% of the time. This was followed by traditional banks, wirehouses, online brokerage firms, RIAs, credit unions and other with 22%, 21%,14%, 12%, 5% and 2% of the responses respectively.

Roame believes that there’s another reason why advisors are oblivious to where their lost assets end up.

Can’t handle the truth

“FA-centric people do not want to see these firms as a threat because they then need to admit that maybe they are not adding so much value if it can be replicated by a online tool or a lower end rep,” he says. “I’d love to see evidence that these smart wirehouses or even RIAs are better at picking funds than Schwab’s select list. I’d guess it about the same. And one is free! See the truth.”

Asked what online brokerage attribute is the biggest threat, 69% of participants in the Aite Group study said price, followed by technology at 16%.

But Roame says that price and technology are only part of the explanation for online brokerage success. The other factor is quality.

“These online brokers are a threat to advisors because they often have good offers, and those offers often have a good price point,” he says. “Schwab’s in-office consultations, T. Rowe Price’s online tools, Vanguard’s $500 financial plans, Fido’s telephone-based mutual fund wrap program, TD Ameritrade’s online ETF wrap program, are all logical products for certain groups of clients.”

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Mentioned in this article:

Scottrade Advisor Services
Asset Custodian
Top Executive: Brian Stimpfl

Peter E. Shenas

Peter E. Shenas

April 19, 2010 — 10:39 PM

Many independent RIA’s custody their assets at the online firms of Schwab and TD Ameritrade. When these firms pull accounts from a wirehouse or independent b/d the assets are shown to be transferred to the online brokers such as Schwab or TD. The losing advisor isn’t usually informed as to whether those assets are being managed by the client directly or as a client of an RIA. I wouldn’t put too much weight in the polling numbers.

Stephen Winks

Stephen Winks

April 20, 2010 — 12:52 PM

In the late 70s several top brokers at the old Wheat, First Securities which became Wachovia, now Well Fargo, had a competition to see who added the most value with their recommendations. These were top producers who were very able and very well connected. Everyone was surprised to discover these very able brokers were excellant at developing and managing relationships with well healed clients, but their business accumen in winning clients did not translate into equally excellant portfolio construction and management skills.

Because the industry is geared to product sales not portfolio construction, little value is added. Thus, consumers over time have correctly concluded if little or no value is added why pay for the high cost of a broker or advisor. The observation to be drawn is there is immense pressure on brokers and advisors to add value which is driving the industry toward accountability, transparency and disclosure of fiduciary standing. The industry is still not structured to help advisors to add value through portfolio constructiont but is moving in that direction.

The Wheat experiment coincided with the emergence of the use of outside money managers (managed accounts)at EF Hutton and multi manager portfolio construction best illustrated by Frank Russell from which investment management consulting as we know it has evolved.

Thirty years later we are now at a point where the industry understands it is what advisors do with investment products, or a prudent investment process, that adds value not simply a investment product. Case in point is the DFA investment process generating a postive 50% return over the past lost decade that recorded a negative 9% return. It is process or a CIO function that adds value not product. All that is missing is (1) a prudent investment process tied to statutory documentation to support fiduciary standing (2) a functional division of labor (the advisor, CAO, CIO) to simplify execution, (3) technology to support transparency, portfolio construction and the continuous comprehensive counsel required for fiduciary standing and (4) conflict of interest management.

The wheels of progress turn slowly, but we are drawing near the point where the processes (asset/liabilitystudy, investment policy, portfolio construction and management), technology, functional division of labor and conflict of interest management necessary for brokers and advisors to add value and fulfill their fiduciary obligations will transform the industry in a very positive way which would shift the balance of the scale back toward advisors who are adding value, which is not possible now within the brokerage industry, either “full service” or “discount”.


Ron A. Rhoades

Ron A. Rhoades

April 19, 2010 — 9:33 PM

As the article points out, many persons out there do not believe that “financial advisors” add value. Part of this is due to the perception that financial advisors possess, or should possess, a “crystal ball” as to all (or nearly all) major up and down movements in the stock market. This misperception is due, in large part, to the heavy volume of advertising by the wirehouses, predominately, going all the way back to the days of E.F. Hutton, which tout – either expressly or by implication – the view that outperforming the market is what financial advisors are hired to do. Remember the long line of commercials … “When E.F. Hutton talks, people listen.”

The other part of this lies in far more recent events which many individual consumers experience. They purchased products on the recommendation of their financial consultant, which they later found out were grossly expensive, highly tax-inefficient, or full of risks which were not explained to them. The poor recommendations of so many ill-trained “financial consultants” purporting to provide advice, and/or providing advice which is heavily riddled with conflicts of interest, denigrates the reputation of all personal financial advisors. Therein the fault largely lies with the SEC, in permitting those held only to the far lower standard of suitability to utilize titles (financial consultant, financial advisor, wealth manager, etc.) which denote a relationship of a professional advisory nature – when in fact no such relationship exists. The result is that many unsuspecting individual investors place their trust in “financial advisors” – only to have that trust betrayed. Consumers don’t realize that their are huge distinctions in the standards of conduct governing RIAs vs. BDs, and such consumers – once burned – are unlikely to seek out trusted advisors. This is reflected in the numerous articles appearing in the consumer press which question why – given the many conflicts of exist – a consumer would want to work with ANY financial advisor.

As economist George Akerloff explained in the research which won him a Nobel Prize: “[T]he presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence.” George A. Akerloff, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), at p. 495.

Until we get ALL financial advisors held by our regulators to the BONA FIDE fiduciary standard currently applicable under the Advisers Act (and NOT the “new federal fiduciary standard” touted by SIFMA and FINRA – which is NOT a true fiduciary standard, but something far less), the situation will only get worse over time. Good financial advisors will continue to suffer damage to their reputations by those who, pretending to be trusted advisors, act under a far lesser standard. And consumers, unable to discern the difference, will slowly move toward “do-it-yourself” solutions.

This is what is at stake in the “fiduciary debate.” Financial advisors who are willing to be held to higher standards of competency, education, training, and proficiency, and the highest standard of conduct found under the law, seek to promote the profession of financial advice as a TRUE PROFESSION. These proponents realize that if all those who provide financial advisory services / financial planning (and those who hold themselves out as such) are held to a common, bona fide fiduciary standard, the confidence of consumers in such professionals will soar. This in return will fuel greater demand for the professional services.

Those who argue against the application of fiduciary standards to the provision of financial advice are unaware that, by doing so, consumers will slowly move toward “do-it-yourself” solutions (even when they know, or suspect, that in today’s complex financial world they are unlikely to be able to navigate successfully on their own. Consumers would rather make mistakes on their own than have ill-trained poor advisors make those mistakes for them. And – far more important – consumers do not want to see their trust abused. A breach of trust reposed results in a sting just as worse (if not more so) as the hollow, sick feeling one gets when one is the victim of theft.

The failure by our policy makers – Congress, and/or the states, and/or the SEC – to insist upon the application of fiduciary standards of due care and loyalty and utmost good faith – to all relationships in which consumers rightfully place trust in their advisors – will continue to slowly result in the movement of consumers toward the lowest-cost solution, as the article and Professor Akerloff point out.

Brooke Southall

Brooke Southall

April 19, 2010 — 10:59 PM

Hi Peter,

You make a fair point but recall also that financial advisors pegged E*Trade as the online broker that takes the most assets. If they handle any RIA custody, it’s fairly minimal.


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