Small Custodian Cover

When it comes to the custody of client assets, most registered investment advisers are drawn toward the brand names of Schwab, Fidelity, TD Ameritrade and Pershing.
But beyond the big four, which combine for more than $2 trillion in RIA custodian assets, there is a thriving industry of smaller custodians that are making inroads and gaining market share in various forms.
Millennium Trust Co., for example, has attracted $20 billion since its launch in 2000 by specializing in the custody of alternative investments.
“There’s an added level of specialty that goes along with holding many of these asset types,” said Tom Daley, managing director of the alternative solutions group.
Shareholder Services Group, which was launched in 2002, has carved a niche by targeting start-up and smaller state-registered RIAs.
“We compete quite well,” said Barry Boyte, executive vice president.
“Most of the big custodians have minimum requirements and their cost structures are different from ours,” he added.
Folio Institutional, which doesn’t disclose custody assets but has 424 RIA clients, has made its mark over the past 12 years by specializing in client-level customization, including fractional-share investing, tax management, and a growing list of social-screen applications.
“I’m sure the big custodians are watching the smaller firms, but I can’t tell you what the reasons are,” said Greg Virgrass, Folio president.
“They might be just trying to figure out what it is that would attract an RIA to a custodian like Folio,” he added.
While the largest custodians, which can leverage their scale to tower over the financial advice industry like big-box suppliers, generally try and ignore the smaller industry players, many of the second-tier custodians operate with the kind of ferocity and ingenuity that appeals to independent registered investment advisers.
“The smaller custodians fill in niches and gaps in the landscape that aren’t served well by the large players,” said Michael Kitces, partner at Pinnacle Advisory Group, which spreads its $1.8 billion in client assets across custodial relationships with Schwab, Fidelity and TD Ameritrade.
“I don’t think the big custodians worry about the second-tier firms at all,” Mr. Kitces added. “The reality is that they’re literally one to two orders of magnitude smaller. Schwab literally has more than 100 times the adviser asset base of any of the second-tier custodians, and grows more in a single year than some others have in total cumulative assets.”
No doubt that Schwab Advisor Services’ industry-leading $1.3 trillion in custody assets represents an impressive advantage over the average $15-billion second-tier custodian, but size doesn’t always seal the deal when it comes to RIAs.
Tim Sobolewski, president of The Financial Planning Center, is a state-registered RIA with less than $100 million under advisement, said he uses Scottrade Financial Services because dealing with them “isn’t like calling into the cable company.”
“They were the least expensive platform, and everything they said they were going to do they’ve done,” he added. “I have looked at other custodians, but it’s a pain to switch, and the bigger firms keep moving the goal posts by penalizing smaller advisers with higher fees.”
The fact that Scottrade is in the process of being acquired later this year by TD Ameritrade is a reality that Mr. Sobolewski is monitoring.
“I don’t really know what it will be like once Scottrade becomes part of TD, but I know it won’t happen for probably a year,” he said. “I do have some friends who are working with TD, and they don’t have any complaints.”
Scottrade, a 12-year-old custodian with $10 billion in assets from 1,000 RIA firms, made its mark by focusing on state-registered advisers with less than $200 million under advisement, according to Brian Stimpfl, senior vice president of adviser services.
“When you look at state-registered advisers, they’re looking for three things: competitive pricing, service and a solid technology platform,” he said. “That’s really been Scottrade’s core value proposition.”
Going forward, as Scottrade becomes part of TD Ameritrade’s $300 billionTK custodian operation, Mr. Stimpfl would only say that “It’s still pretty early days.”
“We’re committed to the best possible service, but there is not a lot of detail that can be shared at this point,” he added. “Our expectation is that our advisers will move over to the TD platform and get the advantages of being on that platform.”
In the custodial space, fees are rarely disclosed and no custodian tries to market itself as the discount-provider.
More often the big-box firms will promote their size and scale as an advantage for being able to provide more service, better technology and practice management support.
But even that claim is a matter of perspective.
“There can be a lot of redundant services, and advisers don’t really need everything that is offered,” said Mr. Boyte of Shareholder Services. “Some advisers don’t take full advantage of everything a technology provider offers.”
Carl von dem Bussche, owner of Financial Guidance Group, has custodied client assets at both Schwab and TD in the past, but moved to Shareholder Services in 2003.
“They’re small enough where you get good service,” he said. “They are strictly in the business to service financial advisers, and I like the vibe of it.”
That vibe, which Mr. von dem Bussche described as “plain Jane, with no wood-paneled office walls,” doesn’t necessarily include the best price. But it does include something unique to virtually every second-tier custodian, they are not directly competing with RIAs for consumer business.
“When I went fee-only in 1995, Schwab was my first custodian, but now they’re in the retail business, and you never have to worry about that with Shareholder Services,” he said. “I could cut a deal with another custodian and probably save a few bucks on transaction costs, but it’s just not worth it to me.”
Alois Pirker, research director at Aite Group, sees the opportunity for smaller custodians to thrive, but he also realizes they are up against entrenched competition from giant businesses that can throw a lot of bells and whistles at RIAs to keep them in the fold.
“The top four custodians are doing heavy investments in technology and services, which is expensive, so if you’re a small custodian you need to be positioned accordingly,” he said. “I think there will be some consolidation, and more players with massive scale that will become the backbone of the wealth management business.”
The kind of outlook is generally scoffed at by the gritty second-tier players, who believe they are filling a legitimate niche, and not just scavenging for scraps.
“For those of us outside the big four, it is really a good spot to be in,” said Joshua Pace, chief executive of Trust Company of America, which has $15 billion in custody assets with 250 RIA firms.
“At the big-box custodians you have to fit into a certain mold, and advisers can all look similar from 30,000 feet,” he added. “You’re just a number at those big custodians, and if your number is big enough you get more love.”
The bigger players, meanwhile, generally prefer to stay mum when it comes to the second-tier custodians.
Erica Birke, spokeswoman for Fidelity Clearing & Custody Solutions, which has more than $750 billion in combined clearing and custody assets released the following statement:
“We’re aligning with custody clients that are looking for more than a core custody platform. While we’re focused on delivering custody services exceptionally well, we’re looking to help our clients growth by providing knowledgeable consulting and future-ready technology. We want to be a catalyst for transformation in the wealth management industry.”
Schwab spokesman Rob Farmer said, “We pay attention to the industry, therefore we pay attention to the smaller custodians.”
“I think some of the smaller custodians and upstarts are definitely targeting niches, and that’s smart,” he added. “We at Schwab are targeting all size segments.”
But while custodians like Schwab and Fidelity go far and wide, Mr. Pace continues to bang a drum those big firms don’t have.
“The big box custodians have become hyper-competitive with the RIA marketplace,” he said. “Your custodian could have a robo platform that’s beating you down on price, and also offering packages solutions and financial planning.”
In essence, while the conglomerates juggle RIA relationships while advertising directly to consumers, the second-tier players boast loyalty to RIAs.
“What we’re seeing is almost a violent reaction to the paradigm shift of custodians going after end clients,” Mr. Pace said. “If an end client calls into us we direct them back to the adviser, because our wagon is hitched to the adviser and there is no home here for the end client.”
Jim Combs, chief executive of National Advisors Trust Co., has a similar perspective that as the mega-custodians compete with RIAs by searching for new revenue, the smaller players will benefit.
National Advisors, which was launched 15 years ago, has $10 billion in custody assets from 170 RIA firms.
“Advisers tell us they’re clients are getting mailers from their custodian,” he said. “It’s not about the cost of things, it’s about the value of things.”

Related Topics: Charles Schwab & Co., Fidelity Investments, Pershing LLC, TD Ameritrade Institutional