Published October 18, 2017
It’s interesting to sit back from time to time and ponder the forces shaping our industry. From my perspective, I can’t help but feel like there’s a tug of war in our midst, a battle of interests pushing and pulling on each other and inevitably drawing us all closer to the gravitational soup. One thing is clear, though. There’s a dichotomy in the financial advisory industry where on the one hand, this is perhaps one of the most exciting times to be a financial advisor. As the bull market continues to claw higher with record low volatility, advisors and their clients have a lot to be grateful for. On the other hand, the cost of doing business and the complexity of navigating ever-increasing regulatory burdens is really starting to take a toll.
Looking forward to 2018, I wanted to share five things on my radar that I believe will continue shaping the course of the financial services industry. Most trends are already entrenched and evolving, while others are emerging without much attention. While I don’t think of myself as an industry sage, my thoughts are sourced from my day-to-day experiences in talking with industry professionals, reading the industry rags and, most importantly, networking with advisors. So, I ask that you indulge me for a moment as you glean my latest prognostications.
Independent Broker-Dealers Will Continue to Consolidate
In our business, broker-dealer survival is really about achieving economies of scale through organic and inorganic growth. Increased scale has the dual purpose of controlling operational expenses and expanding margins. A perfect example is LPL Financial acquiring the four independent broker-dealers (IBDs) operating as silos under National Planning Holding, consolidating four separate operating entities into one. Self-clearing broker-dealers like LPL Financial will continue to complement their organic recruiting efforts with inorganic acquisitions. It’s a fairly safe assumption that consolidation will continue.
If you’re an advisor considering your options, you should start your search with the largest broker-dealers. Otherwise, you will find yourself being pushed around by a merger at some point. While all broker-dealers are clearly managing continued margin compression, the most profound impact will be felt by non-self-clearing BDs, which rely on clearing relationships with Pershing, National Financial, etc. These BDs are essentially “middle operators” and ultimately have much less control over costs. They then pass many of these costs off to the advisor through nickel-and-diming fees. Friendly BDs, which support “hybrid RIAs,” also fall into this category.
Growth of the RIA and IBD Channels Will Come at the Expense of FINRA
It’s no secret that there’s a turf battle between the SEC, DOL and FINRA, largely attributable to the growth of independent advisors and IRA rollovers. Growth in fee-based advisory business has come largely at the expense of traditional brokerage/commission business. In fact, brokerage is in a race to zero, even at the wirehouses. This change is a clear and present threat to FINRA’s survival. For the DOL’s part, the accelerating trend of ERISA plans rolling over into IRAs is threatening the department’s turf. Just as the DOL inserted itself into the fiduciary world using IRA accounts as a door, FINRA will seek creative ways to hold its ground before fading into obscurity.
If you’re an advisor who is 99% fee-based and 1% brokerage, be aware. FINRA may use that 1% as the door to access and regulate your other 99%! Brokerage is literally the tail wagging the dog, and advisors will increasingly look to exit their brokerage business to alleviate exposure. FINRA will inevitably get more aggressive and lash out as its role is commensurately diminished. Expect more requirements and scrutiny around advisor disclosures and increased fines. Advisors with dings on their records will also find it ever more difficult to switch firms in the future as BD’s shy away from potential risk.
Upfront Recruiting Bonuses or “Transition Assistance” Will Continue to Decrease
Independent broker-dealers provide less upfront transition assistance than wirehouses or captive BDs because they operate on smaller margins. That is, since they give higher payouts to their advisors, they simply have less math to work with. With fewer homes for advisors to go to and more regulatory scrutiny on upfront bonus structures, we can expect transition assistance to continue its waning trend. Nevertheless, advisors crunching numbers will ultimately realize that higher ongoing cashflow and payout trumps upfront money after a short breakeven period of a year or two. Indeed, while the upfront money phenomenon of recent years is cemented in the industry’s mind, the psychology will eventually change focus to long-term economics.
Increased SEC Requirements for RIAs Will Increase Consolidation
With a growing share of the investment management space, the SEC will also commensurately grow in personnel and supervisory functions. Standalone RIAs, feeling safe as fee-only fiduciaries, can expect to face increasing ADV disclosure requirements and a higher frequency of exams. The SEC will also experience more organizational costs as it grows, and this will be passed off to advisors in the form of fees and fines. Advisors can therefore expect the overall cost of compliance to increase year over year. All you need to do is read a few articles to see how the SEC fines and scolds advisors who inflate their AUM data on their ADVs. And that’s just the beginning. The emerging tipping point is that smaller RIAs are finding themselves without the size, scale or desire to operate alone. As this trend continues, they will seek to merge with other RIAs or partner with large RIAs like Private Advisor Group.
RIA Custodians Will Drive Down Costs by Offering Free Custody
RIA custodians have been growing their “annuitized” revenue streams with the goal of becoming less reliant on the volatile nature of commoditized transaction-oriented revenue. The next step will be a game of chicken between custodians, with operational leverage acting as a decisive competitive advantage. Expect custodians to literally give away RIA custody for free, instead relying on expanded margins from their increasingly sophisticated wealth management delivery (through their respective retail branch networks, where they own the client relationship).
With RIA custodians continually reducing their ticket charges for equities, options and mutual funds, this trend is already well established. And while this aspect of growth has created notable controversy with advisors (who feel they are being disintermediated), the trend will only increase. Other drivers subsidizing the new “free custody” model include increasing spreads on cash balances from rising rates, collateralized lending facilities or pledged asset lines, payment for order flow and the rise of in-house centrally managed portfolios.
In closing, the list of emerging trends in the financial advisory industry is never ending and ever changing. Other trends we could discuss include cyber security, the DOL and robo advisors. (Just face it: Millennials don’t want to talk to you or anyone else and are happy being introverted with their robo app!) The silver lining in all of this is that independent advisors will continue to flourish in this environment. Indeed, they are perfectly positioned to meet the largest demographic shift in history, as 65 million baby boomers retire and transfer wealth to 85 million Gen X’ers. That said, independent financial advisors need to have a clear understanding of their future path. Complacency in the face of the great “tug of war” is not a strategy, it’s a death wish! If you’d like to learn about the great things Private Advisor Group is doing for our advisors, feel free to reach out for a friendly conversation. Thanks, and have a great week!