Advisors with large books of business sometimes consider joining a smaller broker-dealer to ensure that they rank in the top 10 or 20 in production (or yearly fees and commissions).
Getting the extra attention, service level and admiration from BD staff, management and peers certainly has its attractions. But the ground is shifting under these advisors — with many unaware of the dynamics affecting smaller broker-dealers as well as some midsized firms.
Recently, I was at our cabin property, where we have a small pond stocked with several fish species. After a very dry winter, the pond level dropped so low that it's doubtful any of the fish have survived due to oxygen deprivation.
For small broker-dealers, a similar situation is unfolding — with multiple factors drying up smaller firms' ability to compete in the marketplace. One of these factors, recruiting, disproportionately favors larger BDs. Here are some of the factors at play.
A Struggle to Attract Advisors
Lacking the ability to offer forgivable note money, which advisors increasingly assume is part of the transition equation when they switch firms, smaller broker-dealers are frequently left out of consideration — because they don't have the discretionary capital to offer transition notes.
Besides their struggles to bring advisors into the firm, these BDs find their advisors retiring at an increasing rate or going fee-only. This means small broker-dealers are becoming ever smaller. Besides a drought in recruiting, their profit centers are being affected by regulatory and industry trends.
Declining Profit Centers
A broker-dealer executive who recently sold his firm told me that with the Securities and Exchange Commission's Regulation Best Interest (or Reg BI) in place, variable annuity revenue — which had accounted for a substantial portion of his firm's revenue — would drop dramatically going forward. He felt fortunate to sell when he did.
Smaller broker-dealers may only make one or two basis points on the sales of mutual funds and variable annuities, as well as on handling the assets themselves. Large broker-dealers will earn five to 10 basis points on both the assets and the sales of these products, leveraging their size to gain bargaining power.
Another profit center drying up is mutual fund sales, as advisors increasingly shift to ETFs, which have much smaller revenue-sharing agreements from product vendors. Many smaller broker-dealers have higher concentrations of mutual funds and variable annuities than larger firms, which have greater concentrations of advisory assets.
Besides the fact that these profit centers are on the decline, smaller broker-dealers lack the ability to be rainmakers on services that drive growth.
A Lack of Quality Services
In a recent ThinkAdvisor interview, Michael Rose, associate director of wealth management research at Cerulli, summed up the state of large firms versus small firms: "BDs need to invest significant amounts of capital to operate and maintain brokerage and advisory platforms and increasingly sophisticated advisor-facing technology tools, in addition to other areas of their business, while facing increasingly competitive threats."
In addition, Rose explained, "Greater scale enables firms to increase these relatively fixed investments, and returns on those investments can increase significantly when they support a larger number of advisors and assets under management. Investments made in these areas can significantly increase the appeal of a broker-dealer to prospective advisors, better positioning firms to increase market share."
So, larger scale makes these firms more appealing and more likely to grow. Advisors are starting to appreciate this — and it's influencing their perception of small broker-dealers.
