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Wirehouse Brokerage in America. Is it a Broken Business Model?

January 3, 2012

The wirehouse brokerage business in America is a broken business model. How can we know? According to Cerulli Associates, the market share of wirehouse firms dropped from 43% in 2010 and forecasted to be 35% by 2013. What is behind this erosion? Will it continue beyond 2013?

Think about it from the perspective of the investor. They are looking for an advisor, but how do they begin the search? Based on what? Are the prices of stocks different from firm to firm? Is there a firm where the investment products perform better than the others? Is there a firm that can assure anyone of reaching financial goals? How does the brokerage relationship and banking relationship fit with one another?

In previous years, brokers (wealth managers, financial advisors, etc) would provide something of value in exchange for commissions and fees paid. For instance, advice on which securities to purchase. At one time the firms competed to provide the best returns to investors. Since the Enron/Worldcom/Tech & Telecomm debacle the firm’s research departments were emasculated. Mediocrity is now the norm. In the absence of quality research, asset allocation models have become de rigueur. How much alpha can be gained between fractional pieces of any asset/sub asset category?¬†The comparison of asset allocation models is an argument of who is better at not capturing the upside and losing less than the market in a downturn.The capability has existed for decades for the firms to provide transparency of returns of all equity analysts, lists, styles, brokerage firms. Yet they have resisted providing that transparency.

Some firms provide proprietary mutual funds, annuity sub account management and separate account management. Yet their returns underperform any other options available to the individual investor. And they all have access to the same money managers.

Fixed income? Most firms have pulled out of underwriting municipal bonds as the market has contracted. And there are no existing competitive advantages from firm to firm within fixed income.

Commodities? Firms have resisted providing direct investments into commodities due to the inherent risks. Yet have provided structured products and ETF’s providing only mediocre results, at best.

Check writing, reward points, credit/debit cards, loans/mortgages? Banks do this so much better!

One important role for firms in the past was to provide shares of new companies (IPO’s) who were coming to market to individual investors. This was extremely valuable because this is how companies raise money to further their business goals. As the institutional investors (funds, pensions, etc) grew in importance (read: had a lot of money to spend) the rules changed in-house so the individual investor could not as easily get access to those shares. One rule applying to individual investors solely is they can not sell shares they purchase for a period of time. If they do, their future allocation of IPO shares will be diminished. Either directly calculated in an index, or their broker/advisor/etc.’s index will be diminished effectively curtailing the shares provided to the individual investors.

So the question shifts to what do firms provide to their brokers/advisors/wealth managers etc. that can not be provided somewhere else more inexpensively to them? We have already established there are no capital market advantages provided. Is it the act of clearing of securities bought and sold? Nope. There are a vast number of firms who provide this more efficiently and more inexpensively.

The differences between firms is so minute, the only difference that matters to most advisors is how much they can be paid to move from one firm to another. The McLagan Reports only report back the results of the acquisition of advisors, and not the execution of a competitive strategy.

As the only core competency attracting advisors to a firm is the firm’s ability to write a check larger than the other firms. In the absence of value, price is an issue.

As the Cerulli Associates stats noted in the beginning, the warehouses are losing market share. The market share will continue to decline as more advisors learn the economics of the independent channel. That is until the wirehouse firms learn to build and execute a competitive strategy.


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