As I was jetting home recently from my fifth broker/dealer due diligence meeting since January, with another five on tap before year-end, and ten years of the same under my belt, I realized that recruiting financial advisors for independent broker/dealers has been our bread and butter. This deep immersion has, I humbly submit, shaped a unique insider’s view on that world and the executives and representatives who inhabit it.
During this challenging time for the industry, I thought it might be helpful to define the three major B/D business models—value pricing; value added; and specialization—and suggest which models are best poised for success.
Value Pricing In retail sales, a "loss leader" means selling one product at a loss to sell others for a profit. Independent broker/dealers use a variation of that strategy that I call "value pricing." Instead of selling anything at a loss, value-pricing firms reduce profitability to (or near) the breakeven point, and leave other profitable pricing alone.
Independent advisors often don’t know when they’re being overcharged or by how much. Traditional firms may be charging 15-25 basis points in administration fees for billing, statements, and recordkeeping on self-directed advisory platforms, for example, while value-pricing firms can lower those expenses to 0-5 basis points! If you have a book of business where a large portion of your assets are in self-directed advisory, lowering your administration fees can make a huge difference in what you ultimately net.
It’s disheartening to see some of the extremes that broker/dealers are reaching in devising new profit centers. Marking up errors and omission insurance a couple hundred dollars, haircutting VUL commissions from the 98% to 104% range down to 90%, or tacking 20 to 30 basis points onto the management fees of third-party managers is unfortunately becoming a growing practice. Advisors typically don’t have a clue as to what the profit centers are at broker/dealers and, frankly, the broker/dealers would like to keep it that way. Lack of transparency is just as big an issue between broker/dealers and advisors as is it is between advisor and client.
Value AddedMost traditional independent broker/dealers process business, pay commissions, and monitor compliance; our second B/D category—value-added firms—bring much more to the table. Here’s what we’ve been seeing lately from these firms:
Marketing Support. This includes third-party and proprietary marketing programs with track records for increasing advisor production 35% to 50%. Stay tuned: even juicier marketing programs are coming online at even lower prices.
Lead Generation. This runs from data mining to elaborate target marketing programs for elite groups such as medical professionals, athletic directors, teachers, and union employees. The goal? A steady supply of highly lucrative 401(k) rollover business and new clients.
Practice Management. Broker/dealers know exactly how profitable practice management can be, but many advisors don’t realize the effect that saving time and boosting efficiency can have on their bottom lines. When they do, you can count on them to begin delegating such labor and resource intensive necessities as:
• Technology training• Staff training• Event planning• Business planning• Client surveys• Succession planning and book acquisition assistance and financing• Financial planning/advanced case design• Hiring and staff management
Sophisticated practice management comes to brokerage houses with price tags, however, and the cost of extra staffing needed to offer those benefits is passed on to broker/dealers as a general expense. As an advisor, you need to be using these practice management tools and support; otherwise you will wind up paying for expensive platforms you never use. But if you’re self-sufficient and don’t need outside support, you’re better off finding a value-pricing firm.
Specialization The third most common type of B/D business model is specialization, in which smaller firms tend to do especially well. Many firms with which we contract for recruiting purposes have one area in their business models in which they have extensive depth of product and flexibility, most commonly alternative investments, advisory services, or institutional stock and bond business. A firm specializing in alternative investments, for instance, may contract with 40 to 50 product vendors for:
• Direct participation programs and limited partnerships• Equipment leasing• Private REITs• 1031 TICs• Managed futures• Private notes• Hedge funds• Private equity
To specialize in advisory, you’ll see firms with open architecture platforms tied into outside custodians such as Schwab, TD Ameritrade, and Fidelity. You’ll also have the ability to work with those vendors under your own RIA or under the corporate RIA of the broker/dealer. Some firms are even making the administration of these outside platforms available at nominal fees. Other substantial benefits of firms specializing in advisory are discretionary trading and margin accounts coupled with a broad array of third-party and separate account money managers.
A downside to specialization is becoming too specialized. Recently, an advisor client had been with an overly specialized broker/dealer that only offered 1031 TIC business. With the 1031 business having dropped off a cliff lately, this advisor (understandably) wanted to branch out and begin selling oil and gas partnerships and equipment leasing; but his firm was a one-trick pony offering only 1031 TIC’s.
So we were not surprised when the advisor came to us looking to affiliate with a broader-based firm; also not surprisingly, we soon discovered that his former B/D has been seeking a buyer.
Generalization's Downside Even under the best of conditions, broker/dealers have a hard time standing out from their competitors, yet stand out they must. Firms that take a generalist approach—with limited product selection, no value-added propositions, and above-average expenses—are having the greatest challenges today; and we expect those challenges to become even more formidable going forward.
We were starkly upfront with a broker/dealer manager who approached us last year for recruiting leads. Your costs are too high, we explained, your product selection is too narrow, and you have nothing that really makes your firm stand out. "But everyone says we have great service!" the manager exclaimed.
While we acknowledged that service was important, we explained that it is simply not the differentiator it once was. Thanks to the technology available today, most firms have at least adequate service.
A Difficult Time for B/DsIt’s an alarming mix for independent broker/dealers. Many B/Ds have distressed parent companies, and financially many broker/dealers are suffering the double whammy of adding expenses by having to increase compliance staffing while suffering decreasing revenues. Toss in the expected wave of arbitration over the 2008 market nightmare, and a guaranteed increase in regulation.
This combination makes it more crucial than ever that a representative partner with a broker/dealer that not only meets your needs but which has adopted business models that position it in the marketplace not just to survive under our current economic conditions, but to thrive.
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