the broker-dealer of the future
DESCRIPTION
Changes in Compensation Will Move Focus Away from Payouts ................................ 17 The Looming Investment Professional Shortage Threatens Success .................................. 15 Shrinking Margins Demand Greater Operational Efficiency ................................................... 25 Distributions Drive Demand for Tax-Efficient Solutions .................................................. 14TRANSCRIPT
Ideas Without LimitsSM
The Broker-Dealer of the Future
Our partners in developing this study:
InvestmentNews CAST Management Consultants, Inc.
IDEAS WITHOUT LIMITS i
Table of ContentsExecutive Summary ..................................................................................................................................... 1
The Critical Role of a Broker-Dealer ...................................................................................................... 5
Broker-Dealer Training....................................................................................................................... 8
Practice Management Support ...................................................................................................... 9
Bridging the Investor’s Evolving Needs .................................................................................... 11
Distributions Drive Demand for Tax-Efficient Solutions .................................................. 14
The Looming Investment Professional Shortage Threatens Success .................................. 15
Investment Professional Recruiting and Retention ............................................................ 16
Changes in Compensation Will Move Focus Away from Payouts ................................ 17
Technology Is a Powerful Recruiting Tool ............................................................................... 18
Value-Added Services Are Underutilized ................................................................................. 19
The Advisory Business Cannot Be Ignored ...................................................................................... 21
Broker-Dealers Resist Individually Owned RIA Firms .......................................................... 22
Who Is Managing the Assets Anyway? .................................................................................... 24
Shrinking Margins Demand Greater Operational Efficiency ................................................... 25
Technology ............................................................................................................................................ 27
Operational Efficiency ...................................................................................................................... 28
Conclusion ..................................................................................................................................................... 29
ii THE BROkER-DEALER OF THE FUTURE
IDEAS WITHOUT LIMITS 1
Executive Summary
Abraham Lincoln once said, “The best way to predict the future is to create it.” The future of the retail financial services industry is being created today and broker-dealers are the architects. Standing as the bridge between the investor, the investment professional, and the complexity of the investment markets, broker-dealers have the potential to lead the way. However, broker-dealers are in danger of getting lost in the labyrinth of competition, regulation, and operational challenges. The results of the Pershing LLC–sponsored research study unequivocally show that both growth and change are inevitable. Broker-dealers are projected to grow by 21% per year, doubling in size over the next five years. However, to turn the growth opportunity into long-term profitability, broker-dealers need to increase operating efficiency, retool their product and technology offerings, tackle the talent shortage, and find ways to deliver additional value to investment professionals.
To provide thoughtful leadership and guidance to broker-dealers across the industry, Pershing LLC, in
partnership with InvestmentNews, completed a qualitative and quantitative study of the broker-dealer
industry. The study combined an investment professional survey, a broker-dealer executive survey, and
interviews with the leaders of many of the most influential broker-dealer organizations and industry
influencers. The development of empirical data was performed by CAST Management Consultants, Inc.
The study reveals that four factors will drive the future: the investor-driven change in the investment process,
the shortage of experienced investment professionals, the new affiliation models driven by the trend toward
fee-based business, and the pressure on profitability already experienced by broker-dealer firms.
The Critical Role of a Broker-Dealer
A number of gaps exist between the evolving needs of the individual investor and the product line of a
typical broker-dealer. The shift in demographics will drive additional investor needs and dramatically alter
the product profile of the broker-dealer of the future. Investors are aging, and many will transition from
accumulating for retirement to receiving distributions from their retirement portfolios. Retirement
distribution demands will require more sophisticated solutions than the industry is currently prepared
to deliver. Furthermore, as tax efficiency becomes more visible to retired investors, broker-dealers will
need to educate investment professionals on lifetime income solutions to help investors better plan for,
and more effectively minimize, the risks of retirement.
2 THE BROkER-DEALER OF THE FUTURE
In addition, gaps exist between the desired support prioritized by investment professionals and the current
and future offerings of broker-dealers. Broker-dealers will need to evolve their technology, product, and
practice management strategies to address these gaps.
Investment professionals face challenges of their own. Their needs are quickly evolving, with an increasing
focus on the economics of their practices and the technology provided by broker-dealers. Broker-dealers
that add value to the practices of their affiliated investment professionals will find a growing opportunity.
However, the market will be increasingly competitive as the supply of experienced and productive investment
professionals shrinks.
The Looming Investment Professional Shortage Threatens Success
It takes more than ten years to train a productive investment professional, and today’s demand exceeds
the available supply. The investment professionals of tomorrow should have been recruited five years ago.
Therefore, the time required to incubate an investment professional’s practice creates a significant challenge
for broker-dealers. The industry continues to face a shortage of high-quality, top-producing investment
professionals—only 12% of investment professionals produce in excess of $500,000 and 64% produce less
than $75,000.1 Simply increasing the recruiting budget will not lead to long-term success, yet broker-dealers
continue to prioritize recruiting over the development of existing investment professionals. To address the
talent shortage, broker-dealers will need to reprioritize resources, empower investment professionals to recruit
and develop talent on their own, and adopt strategies beyond traditional recruiting.
In the race for top talent, differentiation will be critical. The survey indicates that investment professionals
rank payout first when asked what they value about their relationships with their broker-dealers—signaling
that the other benefits of affiliation are not resonating as strongly as broker-dealers would hope. We found
that more than half of the firms surveyed do not focus on a specialized market. Creating a niche strategy
may present an opportunity for broker-dealers to differentiate themselves.
Alternative recruiting strategies must be adopted. Broker-dealers could consider supplementing their
recruiting efforts by targeting second-career individuals with relevant backgrounds in areas such as tax,
accounting, and legal. These individuals come with established networks and will add an element of
specialization to the broker-dealer.
Succession planning is also becoming an increasingly important consideration for broker-dealers. With the
average age of an investment professional approaching the mid-50s, succession planning will allow senior
investment professionals to monetize the value of their customer relationships, while providing the broker-
dealer with the opportunity to skillfully transition the customer relationships and retain the associated assets
within the organization.
With proven talent becoming scarce, it has never been more imperative for broker-dealers to get the most from
their existing investment professionals. While the product suite is important, many investment professionals
are looking for broker-dealers to provide more robust practice management support.
1 Race for Top Talent, Moss Adams LLP, 2007.
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The transition from transaction-oriented to fee-based practices is a good example of the type of practice
management support desired by investment professionals, yet it ranks as one of the lowest in satisfaction
scores. There is no doubt that fee-based revenue is an area of growth for broker-dealers, but it presents
somewhat of a paradox. The fee business, driven by the registered investment advisor (RIA) market, is
also an area of increasing competition for the broker-dealer.
The Advisory Business Cannot Be Ignored
Today, advisory fees are the number one source of revenue for broker-dealers. The various fee programs,
from separately managed accounts and advisor-directed discretionary accounts to turnkey asset management
platforms, typically generate higher revenue than mutual funds or commission-based transactions. In five
years, the proportion of revenue represented by fees may exceed 50% of a broker-dealer’s total revenue.
However, with the growth in fee-based business comes a perceived competitive threat. It is a fact that some
of the most successful investment professionals in the country have left their broker-dealer licenses behind
and now practice as independent, fee-only advisors.
Convergence is upon us. The worlds of broker-dealers and RIAs are no longer separate and distinct.
Today, more than 5,000 dually registered advisors have a Financial Industry Regulatory AuthorityTM
(FINRATM) registration (as a registered representative) and a Securities and Exchange Commission (SEC)
registration (as an independent RIA).2 Dually registered firms (those affiliated with a broker-dealer and
also operating as an independent RIA) pose several critical issues for broker-dealers: will they be embraced
or merely tolerated, and are they merely in transition or looking to stay in the dually registered model as
a long-term strategy?
At the same time, broker-dealers have found their growth and highest profitability in the corporate RIA
platform. The platform has consumed significant time and energy with the goal of developing a robust yet
carefully controlled advisory offering. At the same time, broker-dealers have to decide what risk tolerance
they have for dually registered firms that wish to hold their advisory assets away and concurrently develop
compelling strategies to keep them on their platforms. The approach to the fee-based business may be a
decisive factor for the growth and viability of the broker-dealer of the future.
Shrinking Margins Demand Greater Operational Efficiency
The competing demands of servicing investment professionals, increasing capabilities, and growing through
recruiting have taken their toll on the income statements of broker-dealers. In an environment of increasing
payouts, scale and efficiency are paramount. From full-service to independent firms, all broker-dealers are
continuously evaluating processes and systems that promise to improve efficiency. In the search for scale, the
clearing relationship is the great equalizer—the scalable platform that allows the firm to “borrow” efficiency.
The rate of innovation in the industry is high, with new technology continuously being adopted. Efficiency
will hinge on smart investments in technology, process enhancements, operational restructuring, staffing
optimization, and outsourcing.
2 Cerulli Associates Quantitative Update, Intermediary Markets, 2007.
4 THE BROkER-DEALER OF THE FUTURE
Preparing for the Future Today
The broker-dealer of the future will be an organization that listens and responds to the needs of its investment
professionals and helps them address a changing investor market. It will be an organization that values and
develops talent in the home office as well as in the field. The advisory business will fuel the growth, but
efficiency and productivity will translate the growth into profitability.
Most of all, the broker-dealer of the future will be in synch with its investment professionals. The survey
data points at distinct disconnects between these two groups’ opinions on several key topics. The goal of
this study is to deliver a framework for identifying and evaluating how these gaps can be closed and to equip
broker-dealers with the insight they need to plan for future success.
IDEAS WITHOUT LIMITS 5
The Critical Role of a Broker-DealerInvestor demographics are changing while the investment industry is becoming more complicated. Investment
professionals still look to their broker-dealers to help them navigate this challenging landscape; however, there
are significant gaps to fill between the services broker-dealers currently provide and the services investment
professionals seek in order to optimize their performance.
Investment professionals and broker-dealers have different expectations of each other. When a comparison
is made between what investment professionals and broker-dealers consider important, we find a significant
disconnect, as the next four graphs will show.
Figure 1: Investment Professionals’ Reasons for Staying with a Broker-Dealer
REASONMoreLess
IMPORTANCE IN 5 YEARSMoreLess
DEGREE OF INFLUENCE
18.5
12.6
11.9
10.7
9.8
8.3
5.7
4.8
2.9
2.5
2.4
1.6
COMPENSATIONTECHNOLOGY
EASE OF DOING BUSINESSCULTURE
INERTIAPRODUCT ACCESS
BRANDSUPPORT
TRAININGBENEFITS
SALESSPECIALIZED FOCUS
19.3%
3.0%3.1%4.3%
10.1%26.3%
6.7%12.8%
7.3%4.8%
14.7%
47.5%76.0%
69.1%51.7%
44.7%58.9%
42.3%57.3%
38.7%36.8%
24.6%6.5% 45.2%
Note: “Degree of Influence” is an average weighting based on a distribution of 100 points across all reasons.
Broker-dealers were asked how they differentiate themselves from other broker-dealers, and investment
professionals were asked why they stay with their current broker-dealers. Investment professionals want a
broker-dealer with maximum compensation and minimum hassle, whereas broker-dealers rank the influence
of their culture and their brand above compensation and the ease of doing business. This discrepancy is
almost dramatic in its disconnect—while one side is trying to establish a relationship, the other side turns
a cold shoulder and focuses on the facts of the transaction.
6 THE BROkER-DEALER OF THE FUTURE
Figure 2: Broker-Dealers’ Perceived Differentiators
ATTRIBUTEMoreLess
IMPORTANCE IN 5 YEARS
15.4%
5.3%15.8%
5.6%10.0%
0%6.7%
0%12.5%11.1%
6.7%
42.1%21.1%
55.6%50.0%
65.0%53.3%58.1%
37.5%44.4%
53.3%23.1%
HighLow
DEGREE OF DIFFERENTIATION
20.2
14.8
12.4
12.3
8.9
8.5
8.1
4.2
4.0
3.3
3.3
CULTURE OF FIRMCOMPENSATION
BRAND/REPUTATION OF BDEASE OF DOING BUSINESS
TECHNOLOGYSUPPORT
PRODUCT ACCESSSPECIALIZED FOCUS
TRAININGSALES LEADS
BENEFITS
Note: “Degree of Differentiation” is an average weighting based on a distribution of 100 points across all attributes.
The reasons investment professionals gave for why they stay with their broker-dealers reveal a relationship
between a vendor and its customer rather than a relationship between strategic partners. Such categories
of evaluation, namely price, ease of doing business, and inertia, are more typical for commodity businesses.
What is more, those are categories of competition that tend to favor large and heavily scaled (but impersonal)
businesses. It is difficult to accept such a future, but the results call for action. It appears that the lack of
differentiation and value-added services may be driving skepticism in the investment professional’s mind.
It seems investment professionals are saying, “If we can’t find the value added, at least give us the money.”
In the areas of service that are critically important to investment professionals, we find gaps between the
expectations and the delivery. Figure 3 shows the quality of the service on the horizontal axis and the
importance of the service to investment professionals on the vertical axis. Thus, a service with a high level of
importance and high quality of delivery will be in the upper right corner, while a service with a low level of
importance and low level of quality will be in the lower left corner. The upper left corner represents the most
important services with the lowest level of service (problem area), and the lower right corner represents the
least important services with the highest level of service (cases of overinvesting in an unimportant service).
Generally, any service where the importance score exceeds the quality score (e.g., importance of 4 but quality
of 3) is an area of concern.
IDEAS WITHOUT LIMITS 7
Figure 3: Investment Professionals’ Ratings of Service Quality Versus Importance
General sales training
Specialty enablement(wills, trusts, tax planning)Investment professional
portal
Case supportPC help desk
Proprietary research
Continuingprofessional
education
Broker-dealer brand
CRM tools
Assetallocationsoftware
Low High
IMPO
RTAN
CE TO
INVE
STM
ENT
PRO
FESS
ION
ALS
QUALITY OF SERVICE
High
Low
Producttechnical training
RIA – TechnologyCustomer
acquisition/prospectingUnified product techologyOnboarding/transition
assistanceSales concept
training
SERVICE QUALITY BELOWIMPORTANCE LEVEL
SERVICE QUALITY ALIGNSWITH IMPORTANCE LEVEL
SERVICE QUALITY EXCEEDSIMPORTANCE LEVEL
1 52 3 41
5
2
3
4
It is important to note that none of the value-added services received a quality score of 4 or higher (very
good). Most clustered around 3 (good). There are many areas on which investment professionals placed
significant importance (high score on the vertical axis) and the quality was below 3. In order of importance,
it seems that broker-dealers can improve in:
> Specialty planning: tax, trust, and estate
> Registered investment advisor (RIA) technology
> Customer relationship management (CRM) tools
> Customer acquisition and prospecting support
> Unified product technology
Also interesting is that the broker-dealer’s brand and proprietary research are the only two areas that exceed
the expectation of investment professionals.
Some of the gaps identified by the survey stem from investors’ evolving needs and must be closed before
investment professionals can optimize their potential. To bridge these gaps and help drive investment
professional growth and productivity, we suggest broker-dealers focus on the following two areas: investment
professional training and practice management support.
General sales training
Specialty enablement(wills, trusts, tax planning)Investment professional
portal
Case supportPC help desk
Proprietary research
Continuingprofessional
education
Broker-dealer brand
CRM tools
Assetallocationsoftware
Low High
IMPO
RTAN
CE TO
INVE
STM
ENT
PRO
FESS
ION
ALS
QUALITY OF SERVICE
High
Low
Producttechnical training
RIA – TechnologyCustomer
acquisition/prospectingUnified product techologyOnboarding/transition
assistanceSales concept
training
SERVICE QUALITY BELOWIMPORTANCE LEVEL
SERVICE QUALITY ALIGNSWITH IMPORTANCE LEVEL
SERVICE QUALITY EXCEEDSIMPORTANCE LEVEL
1 52 3 41
5
2
3
4
8 THE BROkER-DEALER OF THE FUTURE
Broker-Dealer Training
General sales training and investor-focused training received the lowest quality scores in the investment
professional evaluation. While their importance score was also low, we believe that training may be under-
appreciated by investment professionals because of the quality of the current solutions. It appears that
broker-dealers have an opportunity to take the lead in providing investment professionals with solutions
to address emerging investor needs. While investment professionals are very close to investors, at times
this position prevents them from seeing challenges that investors themselves have trouble identifying.
Many of today’s investment professionals will appreciate learning more about key investor needs that will
become increasingly relevant.
When asked to rate the training they receive in terms of importance and quality, we found that investment
professionals place high importance on increasing their knowledge in specialized areas of planning. These
areas are noted in the lower right quadrant of Figure 4 below. The graphic plots the value investment
professionals place on various training topics versus the broker-dealers’ assessment of how well they are
delivering on these topics.
Figure 4: Training Valued by Investment Professionals Versus Training Provided by Broker-Dealers
Low High
QUA
LITY
OF
BRO
KER-
DEA
LER
TRAI
NIN
G
IMPORTANCE TO INVESTMENT PROFESSIONALS
High
ProductTransition
to feebusiness
Trading Practicemanagement
Advancedfinancialplanning
EstateplanningTax
planning
Lifetimeincome
solutions
Prospecting
Executivecoaching CRM
Low1 52 3 4
1
5
2
3
4
Note: “Quality of Broker-Dealer Training” is an average weighting given by broker-dealers based on a “1–5” scale, with “5” representing the most robust training program.
> There is a need to improve overall training, as none of the broker-dealer’s offerings received a rating
of 3 or higher. More than 42% of broker-dealers do not even offer training in the areas shown on the
lower half of the chart.
IDEAS WITHOUT LIMITS 9
> Tax planning is the fifth most valuable type of training for investment professionals but is deemed
the least robust by broker-dealers. This is especially worrisome given the increasing investor need for
support in this area.
> Product training, the least important to investment professionals, was rated the most robust by broker-
dealers, suggesting current product training is adequate.
To address these gaps, broker-dealers are advised to enhance their training curriculum in the following areas:
> Advanced financial planning, considered by investment professionals as the single most valuable form
of training, received only a 2.5 quality rating. Although complexity makes it challenging to build
meaningful and consistent advanced financial planning training programs, this is an area that should
not be ignored.
> Estate planning, rated the second-most-important form of training by investment professionals, received
only a 1.9 quality score. With baby boomers retiring and the tax laws facing potential revisions after
2010, this will become an increasingly important issue in the coming years.
> Lifetime income solutions received a quality score of only 2.2 based on the completeness of currently
provided programs. This product class is new and rapidly evolving. Broker-dealers must properly
train investment professionals to provide investors with the appropriate guidance. Guaranteed income
solutions were rated as most likely to gain in importance over the next five years, underscoring the
significance of training as soon as possible.
> Tax planning received the lowest overall quality score, at 1.6. More than 60% of broker-dealers offer no
tax planning at all. Tax mitigation will become increasingly vital as 401(k) accounts and retirement funds
are rolled over into distribution vehicles. Also, the tax implications for the wealthy or complex investor
create many options for income distribution and capital preservation. Broker-dealers must improve their
in-house capabilities, or partner with outside tax planning experts, to satisfy the needs of their customers.
Practice management occupies a special place in the training curriculum because of its importance for
independent investment professionals—those who own their own businesses. For independent investment
professionals, being successful in developing new business is not enough; the practitioner must also manage
the business he or she has created to maximize profitability.
Practice Management Support
Building value in the practice, creating liquidity for the owners, and recruiting and retaining talented
employees are the highest priorities for investment professionals. With the success investment professionals
have experienced in the past five years and the growth they anticipate over the next five years, come the
challenges of managing a larger organization. Investment professionals often find they need help managing
their businesses because they were never trained in business management, yet it has become critical for their
success. Broker-dealers are naturally positioned to support these needs.
10 THE BROkER-DEALER OF THE FUTURE
Figure 5: Practice-Related Benefits That Are Most Important to Investment Professionals
MEDICALINSURANCE
EQUITYSHARING
67%
PRACTICESUCCESSION
ACQUISITIONFUNDING
RETIREMENTACCOUNTS
WAIVEDACCOUNT
TRANSFER FEES
SIGN-ONBONUS
FORGIVABLESIGN-ON
LOAN
63%
57%53%
45%43%
41%
28% 27%
AMO
NG
TOP
THRE
E
PROFITSHARING
PRACTICE-RELATED BENEFITS
Note: Investment professionals were asked which practice-related benefit ranked among their top three.
Practice management presents another opportunity to bridge the gap between the expectations of investment
professionals and what broker-dealers currently support. For example, investment professionals cited assistance
in equity sharing (i.e., providing a means by which investment professionals can add new partners to their
practices), as the most important practice-related benefit. While two-thirds of investment professionals placed
equity sharing among the top three most important benefits, only 46% of broker-dealers currently offer it.
Further, among those broker-dealers that do not currently offer support in this area, 57% do not anticipate
offering it in the next five years.
Practice succession closely relates to equity sharing, and therefore it is no surprise that it was rated second in
importance by investment professionals. Still, slightly fewer than half of broker-dealers provide support in this
area. However, a strong majority (83%) plan to address this issue and offer practice succession support in the
coming years. The traditional notion of retirement from the business of providing financial advice may be
redefined for many investment professionals currently in the business. Successful broker-dealers may need to
consider providing alternative environments for aging investment professionals who wish to work at a modified
pace while transitioning their customer relationships to the next generation of investment professionals.
Employee benefits are also a high priority for investment professionals, as illustrated by the importance the
investment professionals place on items such as medical insurance and profit sharing. Medical insurance is the only
practice-related benefit that has been addressed by most broker-dealers, while the benefit most offered by broker-
dealers, waived account transfers fees, appears to be low on the investment professionals’ list of important benefits.
Broker-dealers, particularly within the independent ranks, should consider offering their investment
professionals guidelines and best practices for enhancing the productivity and effectiveness of their practices.
The support could consist of planning tools and training, best-of-breed practice management techniques
(e.g., operations, fiscal management, human resources, and sales practices), and access to technology tools
(e.g., web-based customer and account interfaces, image and workflow management, investor segmentation,
and data mining). These tools, technology, and management techniques, if adopted, will measurably improve
investment professional performance.
IDEAS WITHOUT LIMITS 11
Bridging the Investor’s Evolving Needs
Investors need guidance from their investment professionals to make the right decisions for their financial
lives. Investment professionals need training on new ways to deal with emerging investor challenges. The
broker-dealer is a logical center of education and thought leadership to help investment professionals become
proficient in solutions that address these changes in the market.
Figure 6: Average Distribution of Investment Professionals’ Customers by Type
Other1.2%
Small business6.3%
Corporate3.2%
Beginners2.5%
Young families6.8%
Maturingfamilies17.6%
Pre-retired30.3%
Retired32.1%
Investor demographics are changing, with close to one-third of the average investment professional’s
customer base approaching retirement and another one-third already retired. If we fast-forward the
demographic profile in Figure 6 five years, retirement income solutions will dominate the service needs.
The pre-retiree category, defined as customers between 55 and 65 years old, will be 60 to 70 years old,
which means at least half of them will be retired, bringing the total percentage of retirees even higher.
It is no surprise that pre-retirement accumulation and post-retirement distributions dominate the mix of
services provided by investment professionals (Figure 7). When asked about the top needs of their customers,
investment professionals indicated that accumulation is important for 57% of all customers and distribution
is important for 47%. In addition, investment professionals anticipate that retirement distribution services
will only increase in importance over the next five years. A strong majority of the investment professionals,
88%, foresee that trend. The wave of pending baby boomer retirements is also evident in the increasing
importance investment professionals assign to estate planning and long-term care.
Our interview results tell us that broker-dealers are thinking ahead to how investment professionals can
replenish their customer base with younger customers who are still in the accumulation stage. Without a process
to replenish the customer base, practices are in danger of facing declining revenues and increasing service
needs, leading to lower profitability and less opportunity for staff. Executives frequently tell us that the natural
tendency of investment professionals is to work with customers who are near their own age. Furthermore,
working with younger customers does not always yield immediate profits for an investment professional but
can be critical for the long-term health of the practice. Encouraging and accelerating the development of junior
investment professionals has been an important strategy for adding younger customers to practices.
12 THE BROkER-DEALER OF THE FUTURE
Figure 7: Investment Professionals’ Perceptions of Important Customer Needs
HighLow
5.8%
MoreLess
7.6%0.0%2.4%3.0%
9.2%2.3%
17.1%13.5%
9.2%4.6%5.5%
60.9%87.6%
62.9%78.9%
41.0%73.8%
34.8%27.1%30.5%
56.1%34.6%
49.4%
CUSTOMER NEED IMPORTANCE IMPORTANCE IN 5 YEARS
57.3%46.9%
45.2%42.6%
38.5%28.5%
23.0%22.3%20.5%
16.0%11.5%10.1%
(Average % of Clients)
RETIREMENT PLANNINGPOST-RETIREMENT ASSET MGT & DIST
TAX MITIGATIONESTATE PLANNING/WEALTH TRANSFER
DEATH PROTECTION (LIFE INS)LONG-TERM CARE PROTECTION
COLLEGE TUITION FUNDINGDISABILITY PROTECTION
ASSET CUSTODYCHARITABLE GIVING
FAMILY GOVERNANCEBUSINESS SUCCESSION PLANNING
Note: “Importance” represents the average percentage of customers for which the need is important.
When discussing the needs of investors, we should not forget that many investment professionals focus
on different segments of the market and are likely to use different solutions. The average American is not a
high-net-worth individual who needs family governance help and business succession planning. The typical
(median) customer serviced by investment professionals in our survey has between $100,000 and $500,000
in assets (Figure 8). Thus, a typical customer is primarily focused on his or her retirement portfolio, most
likely held inside a tax-deferred account such as an IRA or a 401(k). The nature of the investment solutions,
therefore, is biased toward more automated and user-friendly programs.
Figure 8: Average Distribution of Investment Professionals’ Customers by Investable Assets
$10,000,000or more4.7%
$5,000,000-$9,999,999
3.8%$1,000,000-$4,999,999
12.8%
$500,000-$999,99921.9%
$100,000-$499,99933.6%
<$100,00023.3%
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Broker-dealers are fairly in tune with the product needs of investment professionals. For their most
important needs, broker-dealers believe their product offerings are relatively strong. However, with respect
to emerging needs, broker-dealers have plans to shore up their offerings. The gaps that appear between
investment professional needs and current broker-dealer support relate primarily to trust accounts, health
insurance, and discretionary portfolio management. Broker-dealers indicate that they will be enhancing the
quality of these offerings over the next five years.
Figure 9: Broker-Dealers’ Ability to Meet Investment Professionals’ Most Important Product Needs
BROkER-DEALERS’ QuALITy RATING
PRODuCTS IMPORTANT FOR PROFESSIONALS TODAy IN 5 yEARS
CuRR
ENT
1. IRAs 4.4 4.6
2. Mutual funds 4.6 4.5
3. 401(k)s 3.6 4.3
4. Life insurance 3.3 4.3
EMER
GIN
G
5. Discretionary portfolio management 3.1 4.2
6. Variable annuities 4.3 4.4
7. Trust accounts 2.5 4.0
8. Health insurance 2.6 3.1
Note: “Quality Rating” is based on “1–5” scale with “5” being of the highest quality.
> Trust accounts are currently only rated 2.5 by broker-dealers but are forecast to increase to 4.0. This
will be critical to meet the estate planning needs of investors.
> Discretionary portfolio management is rated only 3.1 today, but broker-dealers anticipate bringing this
to a score of 4.2.
> Alternative investment products (e.g., private equity, hedge funds, structured lending) were reported
to become more important in the next five years. However, many of these products were not seen as
becoming core products in the near future.
14 THE BROkER-DEALER OF THE FUTURE
Figure 10: Product Importance as Rated by Investment Professionals
IRAS MUTUALFUNDS
401(K)S LIFEINSURANCE
DISCRETIONARYPORTFOLIO
MANAGEMENT
VARIABLE ANNUITIES
TRUSTACCOUNTS
HEALTHINSURANCE
DISABILITYINSURANCE
GUARANTEEDINCOME
MANAGEDACCOUNTS
DEPOSITACCOUNTS
IMPO
RTAN
CE
TODAY
IN 5 YEARS4.1
4.24.1
4.0
3.33.5
3.03.2
2.7
3.1
2.7
3.0
2.6
3.1
2.5
3.1
2.3
2.5
2.0
2.7
2.0
2.2
PRODUCT
1
5
2
3
4
0
Note: “Importance” is based on a “1–5” scale with “5” being of highest importance.
Distributions Drive Demand for Tax-Efficient Solutions
In our interviews, we found that broker-dealer executives understand the increasing need for more
distribution solutions, which would ideally include tax-efficient solutions that can be offered to a mass-
market investor. As tax efficiency becomes more visible to retired investors, broker-dealers have an
opportunity to help investment professionals deliver lifetime income solutions to help investors plan
for, and more effectively minimize, the risks of retirement.
Given the additional risk inherent in guaranteeing lifetime income, distribution costs will likely diminish
as product manufacturers look for ways to improve profitability, further squeezing broker-dealer margins.
However, opportunities will be available to proactive broker-dealers that are adept at helping investment
professionals understand how to package and sell lifetime income solutions leveraging emerging products.
New high-value, lower-cost products will emerge as the product landscape becomes more efficient.
Working with retired investors, especially mass-market and emerging affluent investors, will require efficient
processes at the investment professional and the broker-dealer levels. As a result, investment in technology
platforms that support advisory activities will distinguish many firms and bring them to the next level
of competitiveness and investor satisfaction. The compression of the overall fees attached to providing
investment advice will drive the creation of better cost-versus-return product usage and a higher level of
portfolio analytics and reporting. Advanced advisory platforms will allow broker-dealer-owned RIAs to
capture an increasing share of the overall value chain.
IDEAS WITHOUT LIMITS 15
The Looming Investment Professional Shortage Threatens Success“The biggest issue for the brokerage community is the lack of qualified people. There’s a shortage of investment
professionals at all levels in the industry now,” says the CEO of an independent firm. “It’s caused by the aging
of the population, but also, everyone gave up on training about five years ago. You don’t have new people
coming in, so you have record prices being paid for experienced, mature investment professionals,” says the
CEO. The results of the study provide strong support for that statement. More than 35% of the participants
started in the business in the 1970s or earlier, implying that many are approaching retirement age, while
fewer than 10% of the participants started in the industry between 2002 and 2007.
Figure 11: Distribution of Investment Professionals by years Worked in Investment Industry
>3021-3016-2011-156-101-5PERC
ENTA
GE
OF
INVE
STM
ENT
PRO
FESS
ION
ALS
9.7%
26.7%
15.9%17.7%
20.4%
9.6%
NUMBER OF YEARS
The aging of investment professionals is not the only factor driving the shortage of talent. The lack of
training of new investment professionals makes it difficult to hire young talent profitably. In addition,
during the past ten years, we have seen many investment professionals convert to an RIA model, reducing
the available recruiting population even further. Ultimately, demand exceeds supply. There is no one source
of new investment professionals left in the industry except the training and development of new investment
professionals. For most firms, however, the priority still appears to be recruiting from other firms, which is
a short-term, if not shortsighted, approach.
16 THE BROkER-DEALER OF THE FUTURE
Figure 12: Broker-Dealers’ Top PrioritiesAV
ERAG
E IM
PORT
ANCE
RECRUITING
1.8
2.2
2.7
3.6
40
COST CONTROLMEET INVESTMENTPROFESSIONALS’
TECHNOLOGYNEEDS
INCREASEINVESTMENT
PROFESSIONALPRODUCTIVITY
COMPLIANCEREQUIREMENTS
INVESTMENTPROFESSIONAL
RETENTION
2.2
4.0
1
5
2
3
4
0
TOP PRIORITIES
Note: “Importance” is based on a “1–5” scale with “5” being of highest importance.
If we consider the graph above, we can see that growing the number of investment professionals is still
overshadowing every other strategic priority.
As an industry, broker-dealers are aware that recruiting is a zero-sum game—the gains of one broker-
dealer are the losses of another. For the entire industry to address its acute talent shortage, training of new
investment professionals has to become more commonplace and has to be prioritized. This is particularly
true for the independent broker-dealers that traditionally do not recruit or train inexperienced investment
professionals. Training is a process that is risky (as investment professionals may leave after they are fully
trained) and requires tremendous scale or specialized training resources. As a result, recruiting continues
to be the highest priority of most firms.
Investment Professional Recruiting and Retention
Recruiting budgets are healthy. Most broker-dealers in the survey project a substantial increase in the base
of investment professionals in the next few years. More than 32% of the participants expect to have more
than 1,000 investment professionals in five years, versus fewer than 20% that have greater than 1,000 today.
Further, even among the smallest firms that have fewer than 50 investment professionals, 12% project
moving up to the next category (Figure 13).
IDEAS WITHOUT LIMITS 17
Figure 13: Distribution of Broker-Dealers by Number of Investment Professionals, Current and Expected
2,001+
1,001 – 2,000
501 – 1,000
201 – 500
101 – 200
51 – 100
<50
TODAY
10.3%
14.7%
IN 5 YEARS
PERC
ENTA
GE
OF
BRO
KER-
DEA
LERS
11.8%
11.8%
8.8%
29.4%
17.7%
13.2%
19.0%
7.4%
17.7%
11.8%
13.2%
13.2%
Average: 631 Average: 1,013
To address the talent shortage, we estimate that the 69 broker-dealers in the study will have to collectively
recruit as many as 22,000 investment professionals. If we consider that almost 10% of the existing
investment professionals will likely retire in the next five years, as we saw in Figure 11, the net number
of new hires will need to exceed 30,000—a formidable number.
At present, the competition for top talent is focused on compensation, technology, and ease of doing
business. For such dramatic recruiting results to materialize, broker-dealer differentiation will be critical
and alternative recruiting strategies must be adopted.
Changes in Compensation Will Move Focus Away from Payouts
While compensation is cited as the number one reason why investment professionals stay with their broker-
dealers, it is difficult to believe that it is truly the underlying driver of retention. After all, it is highly unlikely
that 69 broker-dealers all offer the same compensation package. Some are bound to have higher payouts than
others, which means that even within the category of compensation, other factors ultimately influence the
investment professional’s decision. Further, it is likely that compensation in the next five years will focus less
on the cash component, which appears to be maxed out. Rather, we are likely to see increased use of deferred
compensation and equity as a means of attracting and retaining investment professionals.
The understanding that compensation is not likely to increase in importance is shared by investment
professionals and broker-dealers. Note that while investment professionals give compensation an
overwhelming importance in their reasons to stay, only 47% believe that it will increase in importance.
18 THE BROkER-DEALER OF THE FUTURE
Figure 14: Expected Change in the Importance of Compensation
BROKER-DEALERS INVESTMENTPROFESSIONALS
PERC
ENTA
GE
IND
ICAT
ING
5-Y
EAR
CHAN
GE
53%
42%
3%
47%
5% LESS IMPORTANT
SAME IMPORTANCE
MORE IMPORTANT
50%
Similarly, broker-dealers also understand that while investment professional compensation is their largest
expense, it is not likely to be reduced. Only 5.3% of broker-dealers assign any probability to decreasing
compensation costs.
Technology Is a Powerful Recruiting Tool
Technology takes the number two spot in terms of importance to the investment professional and creates
additional opportunities for broker-dealers to distinguish themselves. We already noted that RIA and
customer relationship management (CRM) software are both on the list of critically important services
that fall below the desired level of quality. There are many other differentiators on the technology list,
namely paperless statements, consolidated statements, and a web-based portal for customers.
Figure 15: Investment Professionals’ Perceptions of Important Broker-Dealer Attributes
BRAND DEVELOPMENTMULTIPLE TRADING PLATFORMS
CALL CENTERCORPORATE RIA
EXTERNAL AGGREGATED REPORTINGWEB-BASED PORTAL FOR CUSTOMERS
INDIVIDUALLY OWNED RIACONSOLIDATED STATEMENTS
PAPERLESS STATEMENTSPORTFOLIO MANAGEMENT TOOLS
OPEN TECHNOLOGY
ATTRIBUTE
13.0%
MoreLess
2.0%4.0%1.6%4.0%
8.0%4.0%3.0%
15.0%20.0%
10.0%
72.0%72.0%77.5%75.0%
57.0%62.0%67.0%
31.0%35.0%
42.0%42.0%
IMPORTANCE IN 5 YEARSHighLow
IMPORTANCE
15.0
12.4
11.6
10.7
9.3
8.7
7.2
6.3
6.0
5.3
5.2
Note: “Importance” is an average weighting based on a distribution of 100 points across all attributes.
IDEAS WITHOUT LIMITS 19
Value-Added Services Are underutilized
Beyond compensation, in the next five years, broker-dealers are looking to increase the priority of a number
of currently underutilized opportunities. Succession planning leads the list of services, with 84% of firms
looking to increase their level of succession planning support for investment professionals.
Figure 16: Broker-Dealer Provision of Practice-Related Benefits
PERCENTAGE OF BROKER-DEALERSTHAT CURRENTLY PROVIDE
80.0%64.3%
53.9%53.3%
50.0%46.2%
41.7%33.3%
21.4%
LikelyUnlikely
WILL PROVIDE IN 5 YEARS
33.3%60.0%
16.7%42.9%42.9%
57.2%57.2%
75.0%54.6%
66.7%40.0%
83.3%57.1%
42.9%28.6%
42.9%25.0%
36.4%
BENEFIT
WAIVED ACCOUNT TRANSFER FEESMEDICAL INSURANCE
PRACTICE SUCCESSION PROGRAMRETIREMENT ACCOUNT
SIGN-ON BONUSEQUITY SHARING
FORGIVABLE SIGN-ON LOANPROFIT SHARING
ACQUISITION FUNDING
Successful models of guiding investment professionals in the transitioning of their practices to the next
generation will not only aid in recruiting and retention efforts, but also will lead to superior economic results.
> Broker-dealers should design structures and processes to retain the customer relationships of retiring
investment professionals. One option is to pair older investment professionals with younger up-and-comers
and provide financing to help facilitate the ultimate transition. Furthermore, these team arrangements
will create an insurance policy against the unexpected death or disability of an investment professional.
> Broker-dealers should develop continuity plans for all practices, but particularly for investment
professionals over the age of 55. Each plan should include a designated successor.
> Broker-dealers should develop succession guidelines based on specific criteria. There is much interest in
the broker-dealers providing financing for succession, but many are concerned that they will be saddled
with too much financial risk and may end up overpaying for the practices.
In addition to practice management solutions, there are other areas where firms can stand out, including these:
> Broker-dealers should consider supplementing their recruiting by targeting second-career individuals
with relevant backgrounds in areas such as tax, accounting, and legal professionals. Broker-dealers should
provide them with technical training and up-front financing. These second-career individuals offer access
to high-net-worth customers and provide the specialized skills likely to flourish in a team environment.
> Broker-dealers that specialize in enhancing the effectiveness of their investment professionals’ practices
should recruit lower-producing investment professionals who have been displaced at the larger firms
because their production failed to meet the new, heightened revenue targets.
20 THE BROkER-DEALER OF THE FUTURE
> Broker-dealers should explore offering the following types of transition assistance for those investment
professionals moving from other firms, including:
– Waiver of account transfer fees
– Single point-of-contact transition resource
– Automated account transfers
– Administrative assistance
– Investment professional orientation program
While broker-dealers are aggressively competing with each other for talent, a new threat poses greater
competition for some of the most experienced and talented investment professionals. The prominence of
the RIA segment of the industry has increased dramatically and threatens to upstage broker-dealers as the
primary channel for the delivery of advice to investors. However, broker-dealers are best positioned to take
advantage of the movement to fee-based advice. Broker-dealers can adopt corporate RIAs to retain these
investment professionals within the broker-dealer—allowing an investment professional to operate in
a commission-and-fee-based environment.
IDEAS WITHOUT LIMITS 21
The Advisory Business Cannot Be IgnoredThe investment advisory business represents the fastest growth opportunity for broker-dealers, with many
organizations reporting they expect to double their advisory assets in the next five years. At the same time,
the exact structure for servicing the advisory business and the regulatory setup chosen by the investment
professional and the broker-dealer diverge. While broker-dealers have a strong preference for using their
corporate RIAs, many investment professionals already own or would like to own their own RIAs. The
role of the investment professional in managing the account is also somewhat unclear. Some investment
professionals actively manage the assets, while most rely on outsourcing that expertise. The dynamic changes
in the industry are perhaps well exemplified by the presence of the fee-based brokerage accounts in our
survey. At the time of the survey data gathering, a substantial amount of assets were still in such accounts.
At present, this option is no longer available and the assets have been converted to other types of accounts.
Survey participants have high expectations for growth in their advisory revenue. Two-thirds of all broker-
dealers project growth in advisory assets under management (AUM). The percentage of firms with annual
advisory revenues of more than $20 million is also expected to double from 21% to 44% over five years.
Advisory AUM is also expected to double, from 31% of firms holding more than $1 billion to 61%.
Figure 17: Distribution of Broker-Dealers by Advisory Revenue, Current and Anticipated
TODAY
4.9%
13.1%
IN 5 YEARS
PERC
ENTA
GE
OF
BRO
KER-
DEA
LERS
31.1%
14.8%
23.0%
18.0%
14.8%
11.5%
9.8%
4.9%14.8%
18.0%
11.5%
1.6%8.2%
$100M+
$70M–$99.9M
$40M–$69.9M
$20M–$39.9M
$10M–$19.9M
$5M–$9.9M
$1M–$4.9M
<$1M
At present, the industry is divided in the way it delivers advice. Of all investment professionals surveyed,
17% own their own RIAs, while 45% affiliate with a corporate RIA. Finally, a surprising 38% of the
investment professionals have no RIA affiliation, meaning they are not licensed to deliver advice. Over
the next five years, fewer than 25% of the investment professionals expect to still have no advisory license.
22 THE BROkER-DEALER OF THE FUTURE
Figure 18: Distribution of Broker-Dealers’ Investment Professionals by RIA use, Current and Expected
TODAY IN 5 YEARS
PERC
ENTA
GE
OF
REG
ISTE
RED
INVE
STM
ENT
PRO
FESS
ION
ALS
45.0%
37.8%
23.0%
23.0%
17.2%
INDIVIDUALLY OWNED RIA
AFFILIATED WITH BROKER-DEALER’SCORPORATE RIA
NO RIA
54.0%
Almost 25% of the investment professionals surveyed plan to have their own RIAs. This is an option only
available to investment professionals affiliated with an independent broker-dealer. The question is whether
that means that they will terminate their broker-dealer relationships or become dually registered firms.
Broker-dealers are not currently very receptive to allowing dual registration. In our survey, 50% of the
firms currently allow dual registration. However, when asked about the future, 75% of the firms believe it
is unlikely that they will continue to offer it in the future. Chances are they may not have a choice. Dual
registration will likely become an industry standard. As long as one sizeable firm offers it, other firms have
to either match that offering or risk losing investment professionals.
Broker-Dealers Resist Individually Owned RIA Firms
The issue dually registered advisors may have with corporate RIAs is perhaps more economic and emotional
than regulatory. It is clear that broker-dealers have a compliance responsibility for the individually owned RIA,
so investment professionals who choose to have a dual registration remain under broker-dealer supervision.
In other words, they do not decrease their compliance burden in any way. What they gain is control over the
contract with the customer. In a corporate RIA the contract is between the customer and the broker-dealer,
with the investment professional named as the person servicing the customer on behalf of the firm. In an
individually owned RIA, the contract is between the investment professional and the investor—the broker-
dealer is not involved. This creates a sense of control and portability for investment professionals, in that
they can more easily change the relationship and have more control. This clearly appeals to many investment
professionals as evidenced by the existing number of dually registered firms. Today, more than 5,000 dually
registered advisors have a FINRA registration (as a registered representative) as well as an SEC registration
(as an independent RIA), representing more than $700 billion in total assets. Average profitability at these
dually registered firms is very competitive with the pure RIA model.3
3 Cerulli Associates Quantitative Update, Intermediary Markets, 2007.
IDEAS WITHOUT LIMITS 23
Some facts to consider:
> The number of RIA firms grew by 28% between 2001 and 2004, while the number of FINRA-
registered broker-dealers decreased 2% over the same time period.
> The survey results show revenues increasing across the board in the next five years, but both investment
professionals and broker-dealer executives expect the strongest growth will be among advisory accounts.
> Within five years, 77% of surveyed firms plan to offer an RIA solution, compared with 62% today.
Figure 19: Comparison of RIA-Only and Dually Registered Firms
RIA-ONLy FIRMS DuALLy REGISTERED FIRMS
Pricing structure Fee-based Fee-based and/or commission-based
Account minimum $408,000 $75,000
Number of customers 314 420
Revenue per professional $660,000 $691,000
Revenue per customer $4,600 $5,000
Operating profit margin 28% 29%
The growth in the RIA industry has not gone unnoticed. The RIA market is seen as an opportunity, not
a threat, by 85% of surveyed broker-dealer executives. The impact on the industry seems clear: advisory
models present an opportunity for broker-dealers to drive recurring annual revenue, meet investor preference
for advice delivery, and build long-term customer relationships. In order to do this, broker-dealers need
to make major investments in advisory platform capabilities and in training investment professionals to
maximize their opportunities.
Figure 20: Broker-Dealers’ View of the Independent RIA Marketplace
Threat14.9%
Opportunity85.1%
24 THE BROkER-DEALER OF THE FUTURE
It is not clear how this opportunity will be captured. The value proposition that a broker-dealer can offer
to an investment professional wishing to operate as an RIA is yet to be formulated. The traditional role
of providing scale and infrastructure has already been fulfilled by the custodians. To create a meaningful
affiliation, broker-dealers will have to identify new factors.
While the RIA issue is specific to the independent broker-dealers, it affects the entire industry, as many
investment professionals also leave banks and full-service firms to establish their own businesses.
Who Is Managing the Assets Anyway?
The role of the investment professional in the advisory business is also dramatically and rapidly changing.
Different affiliation channels seem to use varied approaches to managing assets. Investment professionals
affiliated with banks and credit unions are currently heavily skewed toward mutual funds, but they project
a more balanced portfolio in the future. Investment professionals affiliated with independent broker-dealers
see modest shifts in the portfolio mix. Primarily, this is a shift away from mutual funds and toward more fee-
based managed accounts. Modest portfolio allocation changes were anticipated for investment professionals
at full-service regional firms, primarily in a shift toward managed accounts. Investment professionals across
all affiliations project a reduced focus on mutual funds and an increase in fee-based managed accounts.
Figure 21: Advisory Program Assets, Current and Change Expected
CuRRENT PERCENTAGE
OF TOTAL
ChANGE IN 5 yEARS
TyPE INVESTMENT PROFESSIONALS BROkER-DEALERS
Mutual Fund Advisory 34.9% -6.1% -2.3%
Fee-Based Brokerage 20.8% +2.5% +1.6%
Separately Managed Accounts (SMAs)
14.7% +5.5% +3.7%
Investment Professional as Portfolio Manager
14.5% -1.9% -5.2%
Unified Managed Accounts (UMAs)
3.0% +2.9% +6.7%
Other 12.1% -1.8% -4.5%
To manage the shift from transactions to advice, broker-dealers must embrace the advisory model and
support their investment professionals in a fee-based environment. For those broker-dealers that choose
to utilize their corporate RIAs to address this trend, a focus on the implementation of packaged investment
solutions will simplify and streamline delivery. The packaged approach provides integrated financial
planning, product selection, and investor communications. This approach improves the economics for
customer acquisition and servicing, while allowing flexibility and customization.
IDEAS WITHOUT LIMITS 25
Shrinking Margins Demand Greater Operational EfficiencyThe operating profit of broker-dealers is being squeezed by growing payouts and the increased costs of
compliance and service. The competition is also fierce, and requires even higher levels of scale in order to be
profitable. Many broker-dealers already operate on very thin margins. When surveyed, approximately one-
third of broker-dealer management personnel indicated they have a less-than-5% profit margin. Another
third indicated operating margins of 6%–10%. However, fewer than 20% of respondents indicated their
operating margins would be less than 5% in the next five years.
Figure 22: Distribution of Broker-Dealer Profit Margins, Current and Expected
25%+
21% – 25%
11% – 20%
6% – 10%
0% – 5%
<0%
TODAY
7.9%
25.4%
IN 5 YEARS
PERC
ENTA
GE
OF
BRO
KER-
DEA
LERS
3.2%
31.7%
30.6%
6.5%9.7%
35.5%
16.1%6.3%
25.4%
1.6%
Despite thinning margins, however, cost control was ranked the lowest among the list of broker-dealer
priorities, as noted previously in Figure 12. While it is not the highest of priorities, many broker-dealers are
very likely to make some attempts at cost control. Most likely among the measures are process improvements,
imaging and workflow, and automation. Staff reduction is the least likely measure, with lower investment
professional compensation a close second.
Figure 23: Broker-Dealer Likelihood of Cost-Reduction Activities
PERC
ENTA
GE
OF
BRO
KER-
DEA
LERS
100% CERTAINTY
SOMEWHAT LIKELY
NOT VERY LIKELY
NOT AT ALL LIKELY
VERY LIKELY
LOWERINVESTMENT
PROFESSIONALCOMPENSATION
5.3%
15.8%
47.3%
31.6%
STAFFREDUCTION
21.1%
42.1%
36.8%
AUTOMATIONOF MANUALACTIVITIES
36.8%
36.8%
26.4%
PROCESSIMPROVE-
MENTS
55.0%
30.0%
15.0%
IMAGINGAND
WORKFLOW
55.5%
27.8%
16.7%
RELOCATION
5.6%
16.7%
50.0%
27.7%
LOWERCOST
TECHNOLOGY
5.0%
45.0%
35.0%
15.0%
CONSOLIDATION
15.8%
10.5%
31.6%
36.8%
5.3%
26 THE BROkER-DEALER OF THE FUTURE
One critical decision that broker-dealers need to make with respect to cost-reduction initiatives is which
activities benefit from an outsourced versus proprietary solution.
The cost of operating as a broker-dealer consists of two primary components that are difficult to separate,
but nonetheless should be separately analyzed. If we focus on the necessary functions of a broker-dealer to
operate in regulatory compliance with, and facilitate the business of, affiliated investment professionals, we
will find a cost structure significantly below the average operating cost reflected in the income statement of
most broker-dealers. The difference comes from the fact that today, a very significant portion of the broker-
dealer expenses relate to value-added functions that are offered to affiliated investment professionals as part
of the broker-dealer value proposition (Figure 24).
Figure 24: Broker-Dealer Service Activities
CORE SERVICES VALuE-ADDED SERVICES
> Accounting and record keeping> Commission processing> Compliance> Trading> General occupancy and administration
attributable to the above
> Analytical tools> Marketing assistance> Practice management> Research> System support> Trading and reporting technology> Training
It is fair to say that close to half of the expenses of the broker-dealer relate to value-added functions of
the organization. Without the value-added components, the broker-dealer will be unable to retain (not
to mention recruit) investment professionals.
Back-office processing had the greatest number of broker-dealers anticipating an increase in outsourcing,
followed closely by product training. Sales, marketing, and fulfillment represented the greatest source of
insourcing, along with research and sales training. The most outsourced activities today are trade clearing,
research, and account aggregation.
It is important to note, investment professionals ranked a paperless environment as their third-most-
important broker-dealer attribute. Although more than half of the broker-dealers surveyed do not currently
offer this, every broker-dealer surveyed believed this would be offered within five years.
IDEAS WITHOUT LIMITS 27
Figure 25: Broker-Dealer Tendency to Outsource or “Insource,” Current and Expected
TODAy IN 5 yEARS
Account aggregation In/Out In/Out
Back-office processing Insource In/Out
Call center Insource Insource
Mail/image Insource Insource
PC help desk In/Out In/Out
Product due diligence Insource Insource
Product training Insource In/Out
Recruiting Insource Insource
Research Outsource Outsource
Sales training Insource Insource
Sales, marketing, and fulfillment In/Out Insource
Systems development Outsource In/Out
Systems support Insource Insource
Trade clearing Outsource Outsource
Web administration In/Out In/Out
Technology
Innovative technology, whether delivered internally or through outside providers, will be critical to success.
The strength of the technology platform will differentiate broker-dealers by creating more satisfied, productive
investment professionals and by increasing margins. Many of the technological solutions viewed today as value-
added services will become must-haves.
Successful broker-dealers will wisely invest in enterprise systems to lower costs, increase operating
effectiveness, enable investment professionals, and support the ease of doing business. Most will forge
strategic partnerships with outside providers, including scale players with enough market presence and
negotiating clout to be rewarded with proprietary customization at nonproprietary prices.
28 THE BROkER-DEALER OF THE FUTURE
Operational Efficiency
In an environment where payouts reach as high as 98% for independent broker-dealers, operational
efficiency is no longer something for which broker-dealers should strive; it is a critical component of their
survival. To be able to afford the high payouts, broker-dealers need to have tremendous scale and efficiency.
The executives we interviewed focused on three primary sources of efficiency:
> Streamlining of operations: Efficiency at the broker-dealer is a function of streamlining processes, as a
typical broker-dealer organization processes thousands of transactions every day. Excessive exception
handling that requires manual processing results in high costs. The same is true for acquiring specialized
systems to process relatively small amounts of business.
> Achieving scale: Economies of scale play a significant role in the total cost structure of a broker-dealer
organization. The scalable portions of the income statement include technology, compliance, research,
due diligence, and general administration. Larger organizations with their own advisory departments
benefit from scale in their portfolio reporting and due diligence functions.
> Leveraging investment professional productivity: There is obviously a strong correlation between the
productivity of investment professionals and a broker-dealer’s profitability. Low-revenue investment
professionals tend to tax the operating systems of the broker-dealer through inexperience and demand
for support.
Every organization will find its own combination of factors. Ultimately, efficiency is not a goal in itself and
needs to be integrated with the strategy of the broker-dealer. Achieving the lowest level of overhead is not
necessarily the goal of every organization, as some may focus on delivering a higher level of boutique services.
One thing is clear: the combination of high payouts and a low level of efficiency is unfeasible.
IDEAS WITHOUT LIMITS 29
ConclusionThe evolution of the industry is directed by changes in investor behavior, regulation, and technology. The
changes we have discussed —changes in investment professional expectations, investor behavior, and advisory
business models—are not merely opportunities to fine-tune the strategy of broker-dealer organizations, but
rather require dramatic shifts in strategy.
There are many paths that can lead to success. Regardless of the path, certain factors will be critical for all
broker-dealers: improving investment professional productivity; supporting fee-based advisory models; and
improving margins through outsourcing, expense controls, and operating efficiency. Not one of these is
possible without astute investments in technology.
In order for broker-dealers to optimize investment professional performance, they must close the gaps
between their current value proposition and the needs of the investment professional. In addition, broker-
dealers need to help investment professionals learn about the forthcoming changes in their customers’ needs.
A conscious investment of financial and human capital will be required, but the investment will pay off by
way of attracting and retaining top talent and supporting streamlined investment professional practices that
are reflective of the needs of investors. Those firms that empower their investment professionals with robust
training programs, efficient technology, and practice management support will be among the leading firms
of the future.
Competition will only intensify. There are few signs of decreasing regulatory pressure or a decline in investment
professional compensation. Broker-dealers must sustain and revive their profitability by selectively outsourcing
noncore functions and capitalizing on the increasing demand for advice to drive fee-based revenues. Successful
broker-dealers will utilize technology to drive better investor outcomes, particularly with regard to the tax-
efficient distribution of assets and income solutions.
The broker-dealer of the future will be an organization that is well differentiated from the competition and
capable of attracting and retaining talented investment professionals. The conditions for success are there—
the investor demand for financial advice is higher than ever, and the changes in the industry allow smaller
firms to find successful ways of competing with large, well-established firms. Although it is easy to become
overwhelmed by the challenges, the goal of this report is to have laid the groundwork that combined with
the vision and passion of a leadership team, will allow broker-dealers to set their own course for the future.
30 THE BROkER-DEALER OF THE FUTURE
Ideas Without LimitsThis study is part of Pershing’s thought-leadership program, Ideas Without LimitsSM. Ideas Without Limits
provides financial services firms and their investment professionals with strategic insights, ideas, and
best practices delivered through independent studies and white papers. It is a component of our unique
practice management program designed to help firms drive growth, optimize human capital, and maximize
operational efficiency—going beyond high-level guidance to offer actionable information, personalized
consulting, and ready-to-execute solutions.
IDEAS WITHOUT LIMITS 31
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