Sirianni: Zero Com just gave RIAs a 21% increase in Comp overnight
Unlevel Playing Field— I’ve spoken with many industry leaders over the past few weeks, from regionals to top 10 brokerage firms, and the mantra from the top is that Zero Com is no big deal, or its someone else’s problem. Their rationale stems from the last great Commission meteor that struck on May 1, 1975—Mayday/Deregulation day. The thinking goes, the industry was supposed to come to an end in ‘75 with the introduction of discount brokerages, and all feared that clients would flee full-service advisors in droves. This didn’t happen, and the advisor relationship retained its primacy. Clients stuck with their advisors and the world didn’t end, primarily because clients got what they paid for, and discount brokers gave discount style advice and service.
That’s not to say there was no impact at all. Let’s be clear, ’75 Mayday was a seminal moment. Commissions went down, and continue to go down (in thirty years in the business I have never seen them go up). Zero Com is of the same magnitude, and has some very real and basic math advantages that no one can ignore or dismiss.
History will show the ramifications of Zero Com and its effect on the Indy vs Wire war, but arguments and opinions on which models are better for clients, or better for advisor comp, just took a major leap towards an RIA victory accomplished by mathematical fact.
The ability of today’s advisor to take advantage of Zero Com however, will be heavily dependent on the platform they use and model they employ and if they wrap their brokerage costs into their 1% fees, or pass trading costs to clients, or are in a captive system. Every platform and trading style is different. If every platform and every firm magically went to Zero com tomorrow, we would have a level playing field, zero sum game. We are not there.
For starters, those in an RIA, or running an RIA, eliminate 10% (at the low end) and up to 70% (in an extreme trading model) of the costs of running money in an RIA thanks to Zero Com. It gives them not only a significant raise, but enough capacity to beat the competition on price EVERY time. Remember, RIAs are not discounters. They are among the most sophisticated advisors in the country. The massive growth of the RIA/ Independent space has occurred in great part because some of the largest advisors and their teams left wirehouses to join or start RIAs. Simply put, those RIAs who had commissions or ticket charges for equity or fixed income imbedded in their advisory costs as of a few weeks ago, no longer have them, they can now pass the savings on to clients, or invest them in their business, or both. For a 500-million-dollar practice it could be $750,000 extra revenue as based on the example below.
Let’s examine a very simple example of Managed Money. Wirehouse advisors may not have commission/ticket charges to contend with like their counterparts at RIAs. But let’s assume for the moment that both charge the same client, using the same exact money managers at 1%. For illustrative purposes we will also assume that both advisors produce the same revenue, with the average wire house advisor payout of 40% and average RIA, triple net of about 55% (To be fair, there is no such thing as a 90% payout where the roof under which an independent resides pays for rent, legal, staffing, marketing and all other costs associated with running a practice and a business).
A closer examination reveals there’s 1%, and then there’s 1%. At a big firm 47bps expenses goes to the Money Manager and your firm (usually 35 bps to MM and 12 bps to firm). What’s remaining of the 1% is then split 60-40. I don’t have to remind anyone who gets the 60.
RIA trading costs are tiered, there’s a low turnover charge of 6-8bps, and a high turnover charge (read managed money) of 12-15bps.
At an RIA, the cost of a money manager can range from 30 bps to 50 bps. Included in those costs are transactions which can be 6-15 bps. If both advisors are paying 47 bps (regardless of how it breaks down) and one has the ability to eliminate 5-15 bps, well you get the idea. Immediately 10 to 30 percent of the 47 bps is eliminated. Pre and Post Zero Com, the Wirehouse advisor nets 21 cents on the dollar (40% of 53 bps). Pre Zero Com, Identical RIA advisor nets 29 cents on the dollar (55% of 53 bps). Post Zero Com rollout, RIA gets 35 cents per dollar (55% of 63 bps). For RIA advisors who don’t wrap fees they will also gain an embedded price advantage because their clients net cost is lower and Alpha higher.
Yes, math is a universal language — that’s an immediate pay increase of 21%! Spread over their entire practice that could be passed onto clients, used to grow their business or any combination of both. All things being equal, relatively speaking, clients gain an immediate alpha advantage for the same exact portfolio. How much alpha and how the savings are allocated is a decision made between the RIA advisor and their clients. It is a discussion and decision not available to wirehouse advisors. Regardless of investment model, in a zero-sum game, there’s an overnight distinct advantage to the clients and RIAs themselves with less costs now a mathematical certainty.
While it took some time for Mayday ’75 to shake out, the impact of Zero Com will be felt much sooner.
While it took some time for Mayday ’75 to shake out, the impact of Zero Com will be felt much sooner. Any graph plotting commission payouts over time will show commissions cratering. With Zero Com, any new graph charting RIA revenue will look like a hockey stick. Zero Com takes significant costs out of the RIA equation period. With two businesses occupying the same space, with those disparate graphs, there can be only one outcome.
Industry leadership is caught flatfooted. They are ignoring what happens “over there” as if there’s no connection between our industry channels. Yet, there’s more connectivity today than there ever was. We are all swimming in the same pool. It’s called a shared client base!
The same old arguments regarding this new threat, that there’s a lack of sophistication and quality, used in ’75, won’t work today. It’s going to be hand to hand fighting among seasoned pros to get the best clients. All things being equal, if one advisor can cut his bill by just 5% or add some exclusive concierge services, while maintaining/expanding an advantage in payout, who is going to win that battle in the long run? If you are at a big firm, after paying the house, commission splits, and the money managers, how much is left for discount sharing or innovating? You are in a tight spot. The RIAs are coming, and they are bringing a tank to a knife fight.
Solution: Advice model. Let’s face it, most advisors today are acting in a fiduciary capacity. If you polled wirehouse clients they would say they are getting good advice from their advisors, they wouldn’t look at them as salespeople first. All the leaders I speak with are firmly agreed that the advisor relationship is what drives client retention, and that advice is the one commodity that is not threatened by technology, industry change, or pricing compression. They are recognizing an advisor’s core strength, but failing to make the necessary leap towards using it to the client’s/advisor’s advantage.
Advice is the future. Commissions are the past. Firms are going to have to figure out how to move forward in a non-commission structure, because long term they can’t compete. The friction between client and Advisor that commission creates will come to an end someday either by regulation or client choice. I feel that this is ultimately great news for advisors, and that our profession will elevate, once lifted from the morass of commissions, to be on par with other financial experts like attorneys and CPAs, who can make a great living through advice. But, the journey to get there will be more painful for some than for others.
Michael Maurer contributed to this article.