Hybrid model's appeal swells

Revenue from fees stabilizes income in commission-heavy industry

Apr 21, 2013 @ 12:01 am

By Dan Jamieson

Independent broker-dealers expect to see fee-based business continue to grow, thanks in large part to the fact that the model appeals to brokers and clients alike.

Last year, fee-based revenue at the top 25 independent broker-dealers grew to 32.9% of total revenue, up from 31.4% in 2011 and 29.7% in 2010, according to the InvestmentNews B-D Data Center.

At the individual level, 48% of advisers at independent broker-dealers earned revenue from fee accounts last year, according to Cerulli Associates Inc. That figure is expected to grow to 59% over the next three years.

Such robust growth isn't surprising, given the perceived advantages of fee-based business.

“The appeal [of fees] is that when you start the year in January, you have a pretty good idea what your income flow is going to be,” said Jon Henschen, founder of Jon Henschen Associates LLC, who recruits into the independent B-D channel.

Fee business is “a better business model, but we often say it's a better client model, too,” added Greg Gohr, vice president of advisory services at Commonwealth Financial Network. That's because asset-based fees align the interests of advisers and investors, he said.

Commonwealth gets nearly 60% of revenue from fee-based assets, Mr. Gohr said.

At LPL Financial LLC, fee-based assets grew 20% last year, versus the brokerage side's 11% growth, said Derek Bruton, managing director of national sales. Fee assets now total 37% of overall assets at LPL.

Since 2008, the mix of fee accounts at Raymond James Financial Services Inc. has grown to 37% of assets, up from 24%, said Scott Curtis, president of its independent-contractor unit.

Fee revenue accounts for about 55% of total revenue at Cambridge Investment Research Inc., according to chief executive Eric Schwartz. That amount is pure advisory assets. Throw in trail fees and other recurring revenue from the brokerage side, and it's more like 75%, he said.

Industrywide, just over half (52%) of fee assets at independent B-Ds are in mutual fund wrap programs, according to Cerulli, with another 41% on platforms that advisers manage themselves, on either a discretionary or nondiscretionary basis, using a wider menu of products such as stocks, bonds and ETFs.

Independent advisers like fund wraps for their low minimums and simplicity, Cerulli analyst Sean Daly said.


Regardless of the platform, though, most advisers using fee accounts at independent B-Ds manage the money themselves. Mr. Schwartz figures that about 75% of fee-based assets in the independent B-D channel are being directed by individual advisers. Independent advisers cherish having control and want to stay on top of clients' funds, especially after the market crisis in 2008-09, observers said.

That fierce independent streak may be weakening a bit, however.

Independent B-D executives say they've seen some shift toward prepackaged allocation programs and the use of third-party investment managers.

Poor investment results have caused some of that shift, observers said.

Over time, adviser-managed accounts “tend to fall behind more-packaged programs,” Mr. Daly said. Cerulli research has found what “looks like the equivalent of market timing going on, [which] might not be what you want to do” with client assets, he said.

“There are plenty of home office executives who would love to bring those assets in-house,” Mr. Daly added. “In these rep-driven programs, it's very hard to track what's going on all the time.”

Many advisers, as well, “are realizing the value they add is not as a portfolio manager ... it is as a relationship manager, being somebody that can deliver peace of mind to [clients and] spend time with them,” Mr. Bruton said.


How much fee business independent B-Ds ultimately end up with may depend on the regulatory environment.

“If [regulators] actually start auditing independent registered investment advisers, and take seriously the unlevel playing field [between RIAs and brokers], a lot of people would stay with a B-D just to have that big brother” taking care of oversight, Mr. Schwartz said.

And pending Labor Department rules on the standard of care for retirement plan advisers could make it difficult for them to use commissioned products in individual retirement accounts.

“That would push up a whole bunch of broker-dealers' [mix] of fees almost immediately,” Mr. Schwartz added.

Pete Dorsey, head of sales for TD Ameritrade Institutional, agrees that regulation will affect breakaway numbers. TD's custody business recruits heavily from the larger independent B-Ds.

“What's attracting people out of that channel is that it's still heavily restricted from a compliance standpoint,” which interferes with client communications and marketing, Mr. Dorsey said. Recruits also want better opportunities to build enterprise value, he said.

Some independent B-Ds have responded by allowing their hybrid reps to set up separate RIA firms rather than use the broker-dealer's corporate RIA. A separate RIA also makes for an easier transition to one of the RIA custodians, Mr. Dorsey said.

Independent B-Ds are convinced that many advisers want the ability to offer both fee and commission accounts, and have positioned themselves to capture this fast-growing hybrid market.

Cerulli expects the asset share of dually registered advisers to grow by 2.4 percentage points through 2014 to a 10.3% share of the market. These are people who run their own RIAs but maintain a broker-dealer affiliation. The traditional independent B-D channel will lose 1.5 points over that period, falling to a 12.6% share, the research firm estimates.

The reason for the growth in this hybrid market is simple, Mr. Curtis said: Not all products belong on a fee platform.

“Take 529 plans, for example,” he said. “The vast majority is commissioned-based, and that's probably appropriate since you make limited changes and have limited investment selections.”

Many alternative investments are not available on fee platforms, and so remain in traditional brokerage accounts, observers noted.

And finally, the financial crisis made clear the advantage of maintaining a securities license.

In the downturn, “a lot of in-vestors looked at paying a fee for assets [that were] essentially halved,” which did not go over well with some, Mr. Bruton said.

As a result, advisers and clients shifted toward products with guarantees such as variable annuities, which are traditional securities products, he said.


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