Schwab gives hybrid advisors another vote of confidence in its own new study yesterday

February 25, 2011 — 3:12 PM UTC by Lisa Shidler

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Independent broker-dealers should pull out the stops to embrace a model of serving the growing army of hybrid advisors, according to Pershing LLC, which gave RIABiz a glimpse at a white paper on hybrid advisors that will be released in a few weeks.

The Jersey City giant of IBD clearing had always treated the approach of these advisors — who have one foot in the world of commissions and the other in the world of fees — as a viable option. Now, it has taken a more definitive stand based on its new study.

The findings of the report, “The Economics of Constructing a Hybrid Platform,” show that IBDs will be better able to support the model because registered reps are – in an era of increasing regulatory scrutiny and complexity – much more comfortable with paying a custody fee for the RIA assets.

Loss leader

For many broker-dealers, oversight of those fee-based assets traditionally has been a bit of a loss leader to pave the way for handling the hybrid advisors’ transactional business. (See: Nine things I learned as an RIA infiltrator in an IBD world.)

The low or nonexistent profit margins made supporting the model more marginal — but that has changed.

“Independent broker-dealers who choose to ignore the movement to advisory and hybrid models may see their growth marginalized. ...The hybrid model represents an opportunity for broker-dealers to grow and compete in the next decade and beyond,” Pershing’s report says. It goes on to say that of the more than 1,200 IBDs, those who use a hybrid strategy will boost their ability to grow and improve their ability to recruit advisors.

The new stance by Pershing arrives virtually at the same time that Schwab Advisor Services has issued its own report on the burgeoning hybrid market, a report in which the largest custodian for independent RIAs takes a few more steps toward embracing the hybrid business model.

Taken together, the two reports indicate a shift in the marketplace. Where hybrid advisors have been seen by many companies as inhabiting a strange in-between zone, the hybrid model is developing into a viable long-term business.

“For awhile it looked like the hybrid model was a holding pattern but now we’re seeing that as the regulatory burden continues to grow, hybrid will be the legitimate destination for people,” said Eric Schwartz, chief executive officer of Cambridge Investment Research.

Cambridge, of Fairfield, Iowa, is among the few independent broker-dealers to have built a business model embracing hybrid advisors. About 90% of the firm’s 1,900 advisors use commission-based and fee-based model, said Schwartz.

See: 5 Reasons why the hybrid RIA model may be a bigger deal than ever.

The welcoming attitude of companies such as Cambridge, First Allied and Capital Analysts may spread to other IBDs as the economics of the business evolve, Roth said. That trio of IBDs generally has offered custody services for free. See: Two Broker-dealers pick Pershing for hybrid tech after HybridOne comparison [part two of three in a series].

The hybrid, defined

There are different definitions of hybrid advisors, but for the most part these are advisors who work under a fee-based model as an RIA following the rules of the Securities and Exchange Commission while also completing commission sales through a brokerage firm under FINRA’s rules.

Data from Boston-based Cerulli Associates in 2010, quoted in both papers, shows tremendous growth in the hybrid model. For instance from 2004 to 2009, the number of dually registered advisors grew from 7,120 to 14,160.

That meant annual growth of nearly 15% for hybrid advisors, almost three times the 5% annual growth rate of RIA-only firms. Annual growth among broker-dealer channels during the same time period was flat or negative.

Hybrid models show no signs of slowing down, said Scott Smith, a Cerulli analyst. Smith predicts that growth among hybrid advisors will continue to outpace growth among other kinds of advisors.

The Schwab paper: accepting hybrids

Schwab is bending its longtime stance against hybrid models, realizing it’s difficult for advisors to make an abrupt switch to the RIA space by completely dumping their commission-based business, Smith said.

“Schwab has always been big advocates of RIA-all-of-the-time, but they’re recognizing that they’re doing a disservice to their RIA-base who want to have commission products,” Smith said.

About 20% of Schwab’s advisors operate under a hybrid model, said Tim Oden, senior managing director for business development for Schwab Advisor Services. That’s been true for several years, he said.

Some are advisors who take on the hybrid model for a few years before ultimately going fee-only; another group of advisors remain as hybrids long term.

He believes both groups will continue to grow.

About a year ago, Schwab announced a partnership with National Financial Partners Securites Inc. Right now, advisors with Schwab are affiliated with 25 independent broker-dealers.

He acknowledges that some advisors feel the hybrid model is best for them, but he cautions there are problems they face.

Tim Oden: If this business model makes sense for advisors then they’re willing to put up with increased oversight,
Tim Oden: If this business model
makes sense for advisors then they’re
willing to put up with increased

“If this business model makes sense for advisors then they’re willing to put up with increased oversight,” he said. For instance, the white paper points out that because hybrid advisors oversee both brokerage and advisory business, they are subject to regulations from the SEC and FINRA.
Likewise, advisors might also have more back-office problems since they’ll be working with two companies, Oden added.

“The two companies could have different views on the back office operations and that can lead to inefficiencies that can cause headaches,” he said.

The white paper also adds that advisors who choose a hybrid model may face challenges in their equity ownership as well as the payout calculation. The paper notes that calculating the potential payout is one of the biggest challenges for hybrid advisors.

Schwab is having increasing success attracting hybrids. See: IBD reps are new wave of breakaways to the RIA channel, say some recruiters and custodians.

The Pershing paper: Advocating the model

For some time, Pershing has been encouraging advisors to consider using a hybrid model, said Jim Roth, managing director of Pershing, who oversees the clearing business. But in its study released today, the firm takes a staunch stance by advocating the hybrid advisor as the model of choice.

This recommendation is based on his company’s position as the clearing company for several hundred independent broker-dealers.
He points out that broker-dealers support the hybrid model. The study is written for the perspective of broker-dealers.

Roth says the fundamental factor affecting Pershing’s stand on the issue is that regulatory requirements are becoming stiffer and the need for consistency more important. This has given IBDs the prerogative to charge oversight fees on RIA assets.

In its study, Pershing shows the advantages going to hybrid. The white paper says the startup costs are minimal. A broker dealer can act as a custodian and charge a custody fee.

Independent broker dealers are continuing to accept unique approaches as they work with hybrid advisors, says John Furey, principal of Advisor Growth Strategies, LLC in Phoenix, Ariz., who helped write the Pershing hybrid report. “That’s the beauty of it,” he says. “Broker dealers are accepting unique approaches.”

Fast growth elsewhere

Fidelity Institutional Wealth Services spokesman Steve Austin said the hybrid model has been the company’s largest growing channel and expects those numbers to continue to grow. He said the company offers two sophisticated platforms which meet distinct needs of both advisors and brokers. Fidelity has web-based platforms, Streetscape and WealthCentral that are used by hybrid advisors.

“We have played a key strategic role in facilitating the creation of new business models that specifically target hybrid advisors,” Austin said in an e-mail.

Shifting RIA attitudes

More RIA firms are also offering the flexibility to advisors who arrive under their umbrella to keep an affliation with a broker-dealer.

For instance, there are like advisors Beacon Point Advisors in Newport Beach, Calif., who remain registered with a broker-dealer, says Matt Cooper, president of private client services for the RIA which manages about $4.5 billion in assets.

“We’re facilitating a hybrid-type of arrangement,” he said. “It makes it easier for advisors to come here. If you’ve got $30,000, $40,000 or $50,000 in annual income from trailers then you don’t want to walk away from it all.”

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Mike Byrnes said:

February 26, 2011 — 4:16 AM UTC

Lisa, solid article.

Mike Byrnes, President, Byrnes Consulting, LLC

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