Wall Street firms are running out of retail brokers

In the post-recession world, traditional brokerage/investment banking firms have become much more interested in the steady income that can come from providing financial advice to individuals.  This is partly due to the demise of proprietary trading, partly a new respect for recurring income.   But Wall Street is finding it hard to maintain its retail sales forces.

One would think that with the Baby Boom beginning to retire, and having 401ks and IRAs rather than traditional pensions to support them in their “golden” years, there would be a lot of demand from this quarter for professional investment advice.  Yet, brokerage firms are finding it hard to recruit salesmen.  The demographics of the big (or “full service,” as they’re called) brokerage forces themselves are also telling:  lots of over-fifties, few under-thirties.  Why is this?

In general:

1.  The internet has replaced financial services as the destination of choice for ambitious college graduates.

2.  Brokerage firms have traditionally been hostile toward women, thereby eliminating half the possible job candidates.

3.  Being a financial adviser is–something I kind of get, but kind of don’t–a relatively low status position, down there with used car salesman.


4.  People under the age of, say, fifty (maybe it’s sixty, though) would prefer to deal with a discount broker over the internet than face-to-face with a traditional brokerage salesman.  I have no short answer as to why, but they do–even when introduced to an honest, competent broker by their parents.  Of course, maybe that in itself is the kiss of death.

5.  Traditional brokerage firms have decimated their research departments as cost-cutting measures during the recession.  This eliminates the only reason I personally would consider a traditional broker.

6.  A broker typically gets a little less than half of the commission revenue he generates (see my post on how your broker gets paid for more detail).  The rest goes to the firm, which uses part of that to pay for offices, recordkeeping, and marketing…   For many years, however, firms like Fidelity, Charles Schwab or other, more low-profile companies have been willing to provide established brokers with back-office support for a small fraction of that amount.  I’m not current on today’s arrangements, but while I was working a broker could easily increase his “net” commission from 45% to 80% by switching to one of these firms.  Yes, he might have to provide his own office, but the headline is that he could increase his income by 78% with the move.


What’s new about this situation isn’t that it’s happening–this has been going on for well over a decade–but that traditional brokers are finally concerned.   Their retail business model is broken, however, and I don’t see it getting fixed any time soon.  My question is how Baby Boomers are going to get the financial advice they need to manager their money during retirement.








Bill Miller and the Legg Mason Capital Management Value Trust mutual fund

Last week, Bill Miller of Legg Mason announced that he is stepping down as portfolio manager of that firm’s Capital Management Value Trust fund after 20+ years at the helm.

Mr. Miller was once the envy of equity portfolio managers everywhere for the fame and fortune his beating the S&P 500 for 15 years in a row brought hi.  In recent times, he has become the embodiment of very pm’s worst nightmares, however.

His previously hot hand–which had earned him designation by Morningstar as a “Manager of the Decade” turned icy-cold in 2006.  Ensuing weak performance erased the gains in relative performance his portfolio had made since “the streak” began in 1991.  The assets in his fund fell by almost 90% from the peak of $21 billion +.

my thoughts

I should say at the outset that I don’t know Mr. Miller and that I haven’t studied his portfolio composition carefully.  And I’m not interested enough to look up his past SEC filings to try to document my impressions.  With that warning, here’s what I think:

1.  It took Legg Mason a very long time–and the loss of the vast majority of Value Trust’s assets–before it made the change.  At the asset peak, the fund was generating management fees for LM at a $140 million annual clip.  It’s now generating under $20 million.

Why not act sooner?

Part of the reason is likely that after sagging in 2006-2008, the Value Trust outperformed in 2009.  More important, I think, is that the fund’s marketing has been all about “the streak” and the extraordinary investing prowess of Mr. Miller.   It’s a good story and an easy sell.  But it’s a risky strategy.  If it’s all about the numbers, and someone with even better results comes around–and invariably someone will–what do you do? You’ve already made the argument to your client to switch into the Value Trust because of the numbers; how can you now argue against numbers that tell him to switch out?

This selling direction also gives the manager himself a huge amount of power.  What’s the Bill Miller show without Bill Miller?  So if Mr. Miller wants to continue to run a concentrated portfolio with a strong emphasis on financials, despite steady underperformance, how do you stop him not to?

2.  I’ve never regarded Mr. Miller as a typical value investor, although he’s always described as one and the Value Trust (note the name) is classified with other value vehicles by rating services.  I have two reasons:

–Value investors are belt-and-suspenders kind of guys.  They run highly diversified portfolios, typically with 100-200 names–sometimes more.  Growth investors, in contrast, typically hold 50-60.  Looking up the Capital Management Value Trust on Google Finance told me it has only 46 names. (By the way, in my experience ratings services never pick up high concentration as a source of risk.)

–Both value and growth investors look for “undervalued” securities (only shortsellers want to find overvalued stocks).  That isn’t what the “value” in value investing signifies.  It means a certain approach to finding undervaluation.

Value investors look at the here-and-now.  Their holdings are typically asset-rich companies that have encountered temporary difficulties, which have been crushed by Wall Street and which are now trading at unduly depressed valuations as a result.  Growth investors, in contrast, look for companies whose future earnings prospects are being underestimated by the market.

In this sense, too, I don’t think Mr. Miller is a plain-vanilla value investor.  He has been happy to hold large positions in stocks like Amazon or AOL (in its heyday)–names I think other value practitioners wouldn’t give a second look because the whole story has been the rate of future earnings growth.

I have no idea how Mr. Miller squares this circle.  (The fund’s largest positions are now in technology, according to Google Finance.  But it’s not the same thing.  Today’s stocks are eBay and Microsoft.  Apple, the largest holding, is still a growth stock, unlike the others.  But AAPL trades at a very low PE multiple of current earnings.)

3.  Despite this flexibility, and the issue of heavy concentration aside, it seems to me that classic value behavior has been the Value Trust’s recent problem.  Relative to history, financials were trading at low price to book value (i.e., the balance sheet value of shareholders’ equity) ratios when Mr. Miller bought them.  In hindsight, that was a mistake.

There may have been a second.  If the stocks a growth investor buys underperform, he typically stops buying or lightens up.  Value investors tend to do the opposite.  They regard such stocks as being even cheaper than when they initially bought–and double up.  I suspect the latter is what Mr. Miller did.

two oddities

1. In the early part of my career, alternating cycles of outperformance by value and growth stocks were relatively brief.  Given a year, or two at the most, there would be little to chose between the numbers generated by one style or the other.  The 1990s, however, saw a multi-year value cycle in the early part of the decade, followed by a massive multi-year growth cycle–culminating in the Internet Bubble–at the end.  Despite the fact that the tide was running strongly against value during the latter years, Mr. Miller continued to outperform the S&P 500.  If he did so with value stocks, that’s his crowning achievement.

2.  After creating a strong business franchise under the Miller name, neither he nor Legg Mason did much to protect it.



brokers and standards of care: the SEC study

the report

Last Wednesday the SEC published the results of a study on the differing legal obligations of brokers and investment advisers to their clients.

The SEC’s bottom line:

–while customers are generally satisfied with the investment advice they receive, they don’t really know what standards of conduct their brokers or investment advisers are legally held to.  In addition, they sometimes mistakenly think brokers are required to perform to the same high standard as investment advisers.

–the standard of conduct for brokers should be raised to match that for investment advisers, “when providing investment advice about securities to retail customers.”

why the study?

One might think that it was driven by the realization that millions of Baby Boomers will be retiring in the US over the next decade or so.  The vast majority–government workers are the biggest exception–will not have the security of defined benefit pension plans backed by their former employers. Instead, they have the money they’ve saved in IRAs or 401ks, for which they will have investment responsibility, to support them in retirement.

That’s not the reason, though.  The SEC did the study because it was ordered to in the recently-passed Dodd-Frank Act.

broker or investment adviser:  what’s the difference?

in law…

Investment advisers are regulated by the Investment Advisers Act of 1940.

Broker-dealers are regulated under the anti-fraud provisions of the Securities Act of 1933 and the Securities Act of 1934.

Broker-dealers are specifically excluded from regulation under the Investment Advisers Act.

…and in practice

Investment advisers are fiduciaries.  In practical terms, this means three things:

–the adviser must do what’s best for the client

–the adviser must put the client’s interests ahead of his own, and

–the adviser has to make extensive disclosure of possible conflicts of interest.

Broker-dealers are not fiduciaries.  As a result,

–although brokers aren’t permitted to act in a way that harms their clients,

–they can recommend an investment that is less good than another but which provides a higher profit to the broker.

I’m not sure what the technical requirements for disclosure of conflicts of interest are for a broker.  My experience is that such disclosures are, at best, buried in the middle of large amounts of fine print and couched in language that only a specialist would understand. Goldman’s trading “huddles,” exposed in an article in the Wall Street Journal in 2009, are a recent example of differential treatment of institutional clients, not retail, but it’s still a good illustration of the broker mindset.

The huddles are weekly meetings of analysts and traders that ended up generating ideas, some of which go against Goldman’s official stock recommendations.  These trading ideas are communicated only to a few of the firm’s highest revenue-generating clients.  The official recommendations aren’t changed, so most clients continue to be told the opposite story.  (I just looked at a recent Goldman research report.  This practice is described in paragraph 25 of 30 paragraphs of fine print, covering three pages of the report’s total length of seven.).

if brokers are required to become fiduciaries, what changes?

It may be an exaggeration to say that this would radically change the fundamentals of the retail brokerage industry…but, on second thought, that may not be so far from the truth.  For example,

quality of fund recommendations

1.  Some retail-oriented brokerage houses have their own in-house fund management groups.  In many cases, the records of such proprietary funds is mediocre at best.  Yet brokers are encouraged to sell these funds to clients.  In my view, the main factor–other than the underperformance clients experience–is their greater profitability of in-house funds to the firm. If brokers were fiduciaries, presumably they would have to point out that third-party funds have better track records, or to disclose their financial interest.

2.  Brokers might have to disclose that in general no-load funds sold by Vanguard or Fidelity are a better deal that the load funds brokers sell.

3.  When you go into a brokerage office to have an asset allocation analysis done, it may be that the mutual fund recommendations that the computer spits out come only from fund groups that have paid to have their names displayed to customers–or who have agreed to rebate to the brokerage a portion of the management fee earned on shares sold.  Fund groups that decline to pay get no exposure. In other words, the fund recommendations aren’t the objective assessment they appear to be.

A fiduciary couldn’t do this without clear disclosure.  Actually, I think a fiduciary who tried to do this would be run out of town.

4.  If an individual broker does enough business with a given fund group, he may qualify to bring himself and a guest to  an all expense-paid educational seminar (including nightly entertainment),  in, say, Las Vegas, or San Diego or Disneyworld.  Has any broker ever mentioned that possibility when recommending a fund to you?

quality of stock recommendations

5.  Institutional Investor magazine publishes a yearly ranking of brokerage house research and a list of All-American analysts in each industry.  If brokers were fiduciaries, I think they’d have to tell you if, as many have, they’ve laid off most of their experienced researchers during the recession.  So they have no ranked analysts anymore.  And the report you’ve just been handed recommending XYZ Corp as a “buy” was written by a replacement who only has six months experience, no formal training in securities analysis, and is learning to do research on the fly.

All of this would be a little like watching your meal being prepared in the kitchen of a restaurant that probably won’t pass health inspection.  Certainly, brokers don’t want to be forced to allow you this peek under the covers.

are any changes likely, based on the SEC findings?

I doubt it.  Opposition from “full service” brokerage houses would be too great.  It’s also interesting to note that, while the study was done by the staff of the SEC as Dodd-Frank mandated, its conclusions weren’t endorsed by the SEC.

But this did give me another chance to write about some of the less obvious practices of the retail brokerage industry.  So at least that’s something.

mutual fund investors and their investment advisors

the ICI survey

I was looking on the Investment Company Institute (the trade organization for the fund management industry) website for aggregate data on the size of tax losses held inside mutual funds and ETFs–the topic of Sunday’s post–when I found a report on a survey of mutual fund investors and their investment advisors.  This was supplemented by a later survey that elaborates on the types of financial advisors used.  I thought the information was interesting, and certainly not what I had expected even though I marketed my products to financial advisors for twenty years.  Here are the survey results:


The survey was done by phone in 2006, before the financial meltdown.  1003 households were interviewed by a third-party professional surveying company.  The report didn’t contain either the survey questionnaire or the raw survey data.

Two characteristics of phone surveys to keep in mind:

–they almost never use cellphone numbers because laws in most states prevent machine dialing of cells, so surveys that include them are more expensive.  This distorts the twenty-something demographic, which probably isn’t so important in this case.

–phone respondents tend to portray themselves in what they consider a more favorable, or more conventionally acceptable, light than they would in an internet survey.

The survey wanted to find out about financial assets held outside workplace retirement plans.

The survey defined a financial advisor as “someone who makes a living by providing investment advice and services.”  This includes not just traditional “full service” brokers, but also independent financial planners, bank and financial institution investment representatives, insurance agents and accountants.

the customer base

1.  Almost all the respondents (82%) had access to professional financial advice.

–Almost half (49%) bought mutual funds exclusively through financial advisors.

–A third bought both through advisors and on their own (through discount brokers or directly from fund companies).  No explanation for this behavior, although I think many customers try to control the fees they pay to financial professionals by maintaining two accounts.  One will be  wrap-fee account with a financial advisor;  the second will be a no-fee discount broker “clone” of the first.

–14% bought exclusively on their own.

–4% had no clue where the funds came from.

A total of 60% of the assets were held through financial advisors.

why customers seek advice

For most customers, there’s an event that triggers the search for a financial advisor.

For people in their twenties or fifty-plus, the event is usually receipt of a large lump sum, either an inheritance or payout of a work-related investment account.

For thirty- or forty-somethings, the event is lifestyle-related, usually marriage or the birth of a child.

what they need

The top four things customers want from a financial advisor are:

1.  help with asset allocation

2.  an explanation of the characteristics of the financial instruments they can buy

3.  help in understanding their overall financial situation

4.  assurance that they’re saving enough to meet their financial goals

Although a large minority(about 40%) of respondents seem to want to turn their money over to an advisor and forget about it, most regard their advisor (correctly, I think) as a consultant rather than a money manager and want to play an active part in making the decisions that define their portfolios.

demographics of advice seekers

The predominant characteristic of people with ongoing relationships with financial advisors is that they don’t use the internet to get financial information.  This group is twice as likely to have a financial advisor as those who do use the internet for financial data.  Here the survey really seems to break down, because it doesn’t say whether these customers don’t use the internet to get any information (my guess) or whether it’s just financial information they get elsewhere–if they get any at all.

What’s also interesting is that this (Luddite) behavior is not characteristic of mutual fund holders as a whole.  Other ICI research from around the same time shows that mutual fund owners tend to be intensive users of the internet, with financial information a particular area of interest.  Apparently, this latter–probably younger and more affluent–group doesn’t use financial advisors.

The other ICI research also suggests that the third of respondents who had some advisor-related funds and some not were predominantly in the latter camp.  The fact that 60% of the assets were bought through financial advisors suggests that the non-internet users are substantially wealthier, and probably older, than internet savvy respondents to the financial advisor survey.

Female decision maker households are 50% more likely than average to have an ongoing financial advisory relationship, as are families with over $250,000 in household assets (remember, this is pre-crisis).

The fourth defining characteristic is age. Respondents who were 55+ were 40% more likely than average to have a financial advisor.

who doesn’t want a financial advisor?

This group, a small minority according to the survey, has three defining attributes:

–they want control of their own investments, a desire that increases in intensity with age

they (think they)know enough and have access to all the resources they need to make intelligent decisions on their own.  Sixty-somethings and older hold this conviction the most strongly, followed by the under 45 set.  Those in the 45-59 bracket think so too, but have more doubts.

they don’t like advisors. They think they’re too expensive and that they put their own interests ahead of their clients’.

One in seven respondents, under 45 more often than not, said that they don’t need professional advice because they get it for free from a friend or family member.  Other than my children–who get excellent, if aggressive, investment advice, this group seems to be one fated to live on public assistance later in life.

my thoughts

I wonder if a survey conducted today would get the same results?

Despite long-term planning and all that, many individual investors seem to have sold their equities at the bottom and put the money into bonds, missing the subsequent equity rebound.  According to ICI data, they continue to allocate assets away from stocks and into bonds, despite the fact that bonds haven’t been so expensive vs. stocks in almost sixty years.  Is this conservative move spurred on by financial advisors?  Probably not.

I remember a story that ran in the Wall Street Journal just after the stock market collapse of 1987.  It was about a prescient retail broker in Connecticut who called up all his clients in late summer of 1987, just before the crash, and convinced them to sell all their stocks–which they did.  He called them back in November, at the market bottom, to advise them to buy again.  No one returned his calls.  He packed up and left for Oregon to try to rebuild his business there.

Maybe the same has been happening today.

Another aspect to 1987.  I think the market decline marked a paradigm shift by individual investors.  Prior to that, people typically bought individual stocks through full-service brokers.  Post-crash, I think that many individuals, like those Connecticut customers, lost faith in brokers and turned to independent financial advisors and mutual funds.

Does the financial crisis mark another structural turning point?  Maybe.  If so, it’s probably away from mutual funds to ETFs and away from using financial advisors as consultants with specialized financial expertise to self-reliance.