One could be easily overwhelmed by the number of separate account com- petitors targeting the affluent market (Figure 4.1), but the competitive advantages favor the advisor willing to develop strong interpersonal rela- tionships with affluent clients. As a matter of fact, industry competitors view the independent investment advisory firms, with their demonstrated ability to build and nurture client relationships, as their most competitive threat.
As larger, well-capitalized competitors enter the affluent market to pro- vide financial planning and turnkey asset management, there will be greater pricing pressure and commoditization of service, which will bring the profits of the smaller, independent advisors under pressure. The Internet will become a communication medium that will revolutionize the financial busi- ness. The proliferation of financial information available on the Internet is already creating the perception that financial information alone has little inherent value. Clients will continue to focus on building a relationship with an advisor who will be able to provide comprehensive problem solutions and overall financial management. One of the societal trends that will ensure the seeking of advice and professional management by the vast majority of sen- iors and boomers is their need to develop an increased quality of life as they mature. As their affluence and account sizes grow, few will opt to risk their financial well-being by becoming their own part-time financial managers using the Internet.
Participants in the Separate Account Market 49
The segment of the financial services industry that caters to the affluent investor can also be separated into subsegments. This segmentation often depends on the distribution channel. For example, national wirehouse advi- sors might be segmented into fee-based, fee-only, and corner-office. Regis- tered Investment Advisors (RIAs) could be segmented into asset manager, wealth manager, and market timer. Independent advisors could be seg- mented into financial planners, certified public accountants (CPAs), and investment advisors.
Wirehouse Brokers/Advisors
Historically, the affluent have often turned to brokers in wirehouses, as well as regional and smaller brokerage firms for investment advice. The average brokerage client is well below the affluent investor threshold. Industry statis- tics show the typical broker does not have many affluent investors with $1 million or more in a discretionary investment account, wrap account, or sim- ilar product. The average broker will have just 5 to 15 percent of his/her clients at this level. The majority of clients will have fewer assets to invest.
50 THE BASICS
FIGURE4.1 Competitors in the Affluent Investor Market.
Firms are taking the initiative to create specialty wealth management groups to assist brokers in finding and working with the affluent. Such groups bring a highly sophisticated approach to money management, offering more intricate products such as hedge funds and control accounts, plus estate plan- ning services.
These initiatives will enable brokers to meet a wide variety of the financial needs and wants of the affluent. The question that brokers are asking is,
“Does the brokerage house offer sufficient compensating value for the share of revenue they receive?”
Part of the wirehouse share offsets administrative costs, costs of recruiting and training new brokers, developing new products, positioning the firm and its brokers, and so forth. This group has tremendous back-office support and years of experience. Some of their separate account platforms will be based on legacy technology, and will struggle to meet clients’ needs in the rapidly evolving separate account environment.
As a general rule, their marketing budget is bigger than most financial advisors’. Individual financial advisors just won’t be able to compete with them on marketing. As a matter of fact, one of the reasons Merrill Lynch and Charles Schwab are growing so quickly is that they’ve become the default investment source for investors who don’t know where to go. Merrill Lynch’s advertising budget is greater than some countries’ gross national product!
The Independent Advisor
The asset management industry is one of the few industries in America today in which an individual can get started with almost no capital. In a short period of time, an investment advisor can build a substantial income and a lucrative business, establishing the foundation for personal wealth and family security.
This means you are going to continue to have strong competition coming into this industry. There are around 45,000 RIAs, of which only about 24,000 are active. If we subtract the 7,583 who earned commissions and other income, we find 16,427 who are fee-based or fee-only. Separate out the 1,376 institu- tional managers, and we find that there are 15,051 managers of fee- compensated, individual assets.
These 15,051 financial advisors control $870 billion of assets under man- agement. These assets are not evenly divided. Only 175 advisors have assets under management of more than $1 billion. A larger number, 812, have assets totaling between $200 million and $1 billion. Together, these advisors control 72 percent of the individual managed assets. The remaining 14,064 managers, with up to $200 million of assets under management, share a total of $240
Participants in the Separate Account Market 51
billion in assets. This averages approximately $17 million per advisor in the below–$200 million group—certainly nowhere near what it takes to run a successful business.
So why is the majority of the individual managed assets under the control of so few? The successful advisors have targeted the affluent investors and follow a focused plan to reach that market. Most advisors don’t; their approach is bird-shot at best and reactionary at worst. They sell separate accounts the same way they sell a mutual fund, not realizing their full poten- tial.
Accountants/CPAs
Accountants are also moving into the investment management business.
Most accountants stop short of wanting to perform the direct investment management tasks. Nearly all of the accountants surveyed (91.8 percent) report that they do not see themselves as portfolio managers in the sense of selecting specific securities (AICPA meeting Jan. 2003).
Those who enter this field will do so as independent investment advisors.
Because of their training and professional culture, accountants generally see themselves as impartial advisors and consultants. Rather than become directly involved in portfolio management, accountants would prefer an advi- sory status, allowing them to still participate in the flow of fees.
For most accountants, the investment management business is appealing because their current business is not as profitable as it once was. They are coming under considerable competitive pressure for some of their core serv- ices.
Accountants are the most trusted advisors that most business owners, pro- fessionals, and affluent individuals have. Accountants measure their relation- ships with their clients in decades. Nearly two-thirds of the accountants who are interested in participating in investment management service (64.6 per- cent) cite a secondary reason based on demand from their affluent and busi- ness clients.
Some accountants will find that they can enter the investment advisory business directly because of the ready availability of turnkey asset manage- ment programs (TAMPs). These services manage all of the components in the investment management process, including developing an investment policy statement, creating a portfolio, and rebalancing a portfolio. While the accountants eventually master the mechanics of investment management, these TAMPs eliminate a considerable amount of the work.
The most control, as well as the most work, occurs when the accountant 52 THE BASICS
brings in people to perform as investment advisors. Still, it provides the accountant with the greatest command over the process as well as over the relationship with the client.
In many states, the easiest way for accountants to be in the investment management business is to refer clients to investment advisors. In return, they could collect a finder’s fee for the effort. Accountants can lower their expo- sure by recommending a number of investment advisors and insisting that the client make the final advisor selection decision himself/herself. However, this is not an option for many accountants, who are barred by regulations. This option also generates lower revenues.
Insurance Agents
There is a strong push by the insurance industry to enable agents to become fee-based advisors. It’s important to note that it is not the insurance compa- nies that are driving the trend among insurance agents to become fee-based investment advisors. The insurance industry is responding to market demand and competitive pressures. The majority of insurance agents want to be in the investment advisory business, and many have already taken steps to expand their business. This has been relatively easy for insurance agents, as invest- ment advice is a complementary service to what they provide currently.
Anecdotal evidence shows us that the elite insurance agents are excep- tional asset gatherers, possessing the marketing expertise and, more impor- tant, the contacts among the wealthy, to build a $100 million investment advisory business relatively quickly.
Insurance companies have been creating loyalty for quite some time. The insurance industry is structured so that high-end insurance agents are very likely to use the services and products of a number of different carriers.
Insurance companies are already taking action to support agents who want to do more in the investment management field. Many carriers already provide producers with a wide range of products to sell. The goal of insurance companies is to be chosen by agents for business. Forward-thinking insurance companies will continue to take steps to help their agents be effective.
Many high-end insurance agents have a well-developed, affluent clientele that can be leveraged into an investment advisory relationship. They know from experience that it is far easier to sell an existing client a new product than it is to find a new client. With the right products and services, they can go back to their book of business again and again. For some insurance agents, it makes good sense to sell separate accounts in order to leverage those client relation- ships even further. The crossover between the insurance and investment fields Participants in the Separate Account Market 53
has been building over the past decade. Increasingly, insurance agents want to sell investment management services (Figure 4.2).
Younger insurance agents are more excited by the investment manage- ment business than older agents. Agents who are 45 years old and younger (84.4 percent) are much more interested in the investment management busi- ness than agents who are over 45 years old (35.5 percent). Younger agents tend to be more comfortable with the nature of investments and less intimi- dated by the necessary education and licensing requirements.
Insurance agents need to be able to offer a similar lineup of separate account products. By doing this, they can compete head-to-head with all other financial services providers. The front-loaded nature of the insurance business means that they must always be looking for new sales. Moreover, once a sale is made, that particular affluent client is unlikely, in the near term, to need more life insurance. A steady stream of revenue coming in can be very attractive.
The basic hurdle faced by many insurance agents is just how to enter and work in the fee-based investment management business. They have to take 54 THE BASICS
FIGURE 4.2 Younger Agents Are More Interested in Investment Manage- ment (Based on a Survey by Russ Prince & Associates of 494 High-End Insur- ance Agents).
steps to incorporate investment management services into their current business.
If you are a high-end insurance agent seeking to become a fee-based investment advisor, you have a number of options. One approach is to work through your primary insurance company (i.e., the insurance company you use most). Insurance companies have broker-dealers and increasingly are accommodating successful insurance agents who want to work to provide fee-based investment management services to their affluent clients.
Another option might be to affiliate with a producer group or insurance brokerage network that is able to deliver these services. An increasingly pop- ular option is for insurance agents to go independent and affiliate with an independent broker-dealer and/or service firm. Most insurance companies already have broker-dealers. A significant number have their own investment management units. Cerulli counted close to 52,000 independent insurance representatives at the end of 2000.
Bank Representatives and Bank Trust Departments
These entities have been experiencing the slowest growth of all. They recog- nize that they must make competitive offers because the credibility of the bank and the brand is simply no longer enough. They are making those changes, and they’re coming after your clients. And they are doing this suc- cessfully!
Bank trust departments are not yetsignificant players in any part of this market, because they have failed to reach critical mass in assets under man- agement. For whatever reason, consumers do not see bank providers as hav- ing the sophisticated tools. Now, each one is trying to reinvent itself to address these issues. Before we close this section, the Bank of New York stepped up to become a real player by acquiring the privately held parent company of the Lockwood Financial family of companies (Lockwood).
Based in Malvern, Pennsylvania, Lockwood is the industry’s largest provider of individually managed account services to independent financial advisors (Table 4.1).