The Broker-Dealer of the Future by Jim Cannon

The Broker-Dealer of the Future Ideas Without LimitsSM

Our partners in developing this study: InvestmentNews CAST Management Consultants, Inc.

Table of Contents Executive Summary...................................................................................................................................... 1 The Critical Role of a Broker-Dealer....................................................................................................... 5

Broker-Dealer Training....................................................................................................................... 8

Practice Management Support....................................................................................................... 9

Bridging the Investorâ&#x20AC;&#x2122;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

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the broker-dealer of the future

Executive Summary Abraham Lincoln once said, â&#x20AC;&#x153;The best way to predict the future is to create it.â&#x20AC;? 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, brokerdealers 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 LLCâ&#x20AC;&#x201C;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.

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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 brokerdealer 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.

Race for Top Talent, Moss Adams LLP, 2007.

the broker-dealer of the future

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.

Cerulli Associates Quantitative Update, Intermediary Markets, 2007.

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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 groupsâ&#x20AC;&#x2122; 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.

the broker-dealer of the future

The Critical Role of a Broker-Dealer Investor 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 DEGREE OF INFLUENCE

REASON Less COMPENSATION TECHNOLOGY EASE OF DOING BUSINESS CULTURE INERTIA PRODUCT ACCESS BRAND SUPPORT TRAINING BENEFITS SALES SPECIALIZED FOCUS

12.6 11.9 10.7 9.8 8.3 5.7 4.8 2.9 2.5 2.4 1.6

IMPORTANCE IN 5 YEARS More

Less

18.5

3.0% 3.1% 4.3% 10.1% 26.3% 6.7% 12.8% 7.3% 4.8% 14.7% 19.3% 6.5%

More 47.5% 76.0% 69.1% 51.7% 44.7% 58.9% 42.3% 57.3% 38.7% 36.8% 24.6% 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.

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Figure 2: Broker-Dealers’ Perceived Differentiators DEGREE OF DIFFERENTIATION

ATTRIBUTE Low CULTURE OF FIRM COMPENSATION BRAND/REPUTATION OF BD EASE OF DOING BUSINESS TECHNOLOGY SUPPORT PRODUCT ACCESS SPECIALIZED FOCUS TRAINING SALES LEADS BENEFITS

IMPORTANCE IN 5 YEARS High 20.2

14.8 12.4 12.3 8.9 8.5 8.1 4.2 4.0 3.3 3.3

Less 5.3% 15.8% 5.6% 10.0% 0% 6.7% 0% 12.5% 11.1% 6.7% 15.4%

More 42.1% 21.1% 55.6% 50.0% 65.0% 53.3% 58.1% 37.5% 44.4% 53.3% 23.1%

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.

the broker-dealer of the future

Figure 3: Investment Professionals’ Ratings of Service Quality Versus Importance

Low

High

Continuing Asset Asset Continuing professional allocationallocation professional software education softwaret education Specialty enablemen nttax planning) Specialty enableme (wills, trusts, ) planning Investment professional (wills, trusts, tax portal 4 professional Investment CRM tools portal RIA – Technology 4 CRM tools Product Customer RIA – Technology technical training acquisition/prospecting CaseProduct support Unified product techology Customer technical training 3 PC help desk acquisition/prospecting Onboarding/transition assistance Case support Unified product techology Proprietary research

IMPORTANCE TO INVESTMENT PROFESSIONALS

High

Sales concept

Low

WITH IMPORTANCE LEVEL

SERVICE QUALITY EXCEEDS IMPORTANCE LEVEL SERVICE QUALITY EXCEEDS

IMPORTANCE LEVEL

Broker-dealer brand General sales training Proprietary research

Broker-dealer brand General sales training

Low 1

SERVICE QUALITY ALIGNS SERVICE QUALITY ALIGNS WITH IMPORTANCE LEVEL

PC help desk

training Onboarding/transition assistance Sales concept 2 training

SERVICE QUALITY BELOW SERVICE QUALITY BELOW IMPORTANCE LEVELLEVEL IMPORTANCE

QUALITY OF SERVICE

High

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.

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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 underappreciated 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

QUALITY OF BROKER-DEALER TRAINING

High

Low

Product 3

Transition to fee business Trading

Executive coaching 2

Prospecting

Low

Lifetime income solutions

CRM

Practice management Advanced financial planning Estate planning

Tax planning

IMPORTANCE TO INVESTMENT PROFESSIONALS

High

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.

> T here 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.

the broker-dealer of the future

> T ax 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. > P roduct training, the least important to investment professionals, was rated the most robust by brokerdealers, suggesting current product training is adequate. To address these gaps, broker-dealers are advised to enhance their training curriculum in the following areas: > A dvanced 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. > E state 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. > L ifetime 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. > T ax 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 professionalsâ&#x20AC;&#x201D;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.

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Figure 5: Practice-Related Benefits That Are Most Important to Investment Professionals 67% 63% 57% AMONG TOP THREE

53% 45%

43%

41%

28%

EQUITY SHARING

PRACTICE SUCCESSION

PROFIT SHARING

MEDICAL ACQUISITION RETIREMENT INSURANCE FUNDING ACCOUNTS

WAIVED SIGN-ON ACCOUNT BONUS TRANSFER FEES

27%

FORGIVABLE SIGN-ON LOAN

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 brokerdealers, waived account transfers fees, appears to be low on the investment professionalsâ&#x20AC;&#x2122; 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. 10

the broker-dealer of the future

Bridging the Investorâ&#x20AC;&#x2122;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 Professionalsâ&#x20AC;&#x2122; Customers by Type Corporate Small business 3.2% 6.3% Beginners 2.5% Young families 6.8% Maturing families 17.6%

Other 1.2%

Retired 32.1%

Pre-retired 30.3%

Investor demographics are changing, with close to one-third of the average investment professionalâ&#x20AC;&#x2122;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.

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Figure 7: Investment Professionals’ Perceptions of Important Customer Needs CUSTOMER NEED

IMPORTANCE Low

RETIREMENT PLANNING POST-RETIREMENT ASSET MGT & DIST TAX MITIGATION ESTATE PLANNING/WEALTH TRANSFER DEATH PROTECTION (LIFE INS) LONG-TERM CARE PROTECTION COLLEGE TUITION FUNDING DISABILITY PROTECTION ASSET CUSTODY CHARITABLE GIVING FAMILY GOVERNANCE BUSINESS SUCCESSION PLANNING

IMPORTANCE IN 5 YEARS

(Average % of Clients)

High 57.3%

46.9% 45.2% 42.6% 38.5%

Less 7.6% 0.0% 2.4% 3.0% 9.2% 2.3% 17.1% 13.5% 9.2% 4.6% 5.5% 5.8%

28.5% 23.0% 22.3% 20.5% 16.0% 11.5% 10.1%

More 60.9% 87.6% 62.9% 78.9% 41.0% 73.8% 34.8% 27.1% 30.5% 56.1% 34.6% 49.4%

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 $5,000,000$9,999,999 3.8% $1,000,000$4,999,999 12.8%

$500,000$999,999 21.9%

the broker-dealer of the future

$10,000,000 or more 4.7%

<$100,000 23.3%

$100,000$499,999 33.6%

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

EMERGING

CURRENT

products important for professionals

today

in 5 years

IRAs

4.4

4.6

Mutual funds

4.6

4.5

401(k)s

3.6

4.3

Life insurance

3.3

4.3

Discretionary portfolio management

3.1

4.2

Variable annuities

4.3

4.4

Trust accounts

2.5

4.0

Health insurance

2.6

3.1

Note: “Quality Rating” is based on “1–5” scale with “5” being of the highest quality.

> T rust 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. > D iscretionary portfolio management is rated only 3.1 today, but broker-dealers anticipate bringing this to a score of 4.2. > A lternative 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.

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Figure 10: Product Importance as Rated by Investment Professionals 5

TODAY 4.1 4.2

IN 5 YEARS

4.1 4.0

IMPORTANCE

3.5 3.3

3.2

3.1

3.0 2.7

3.1

3.0 2.7

2.6

3.1 2.7 2.5

2.5 2.3

2.2 2.0

2.0

IRAS

MUTUAL FUNDS

401(K)S

LIFE DISCRETIONARY VARIABLE INSURANCE PORTFOLIO ANNUITIES MANAGEMENT

TRUST ACCOUNTS

PRODUCT

HEALTH INSURANCE

DISABILITY GUARANTEED DEPOSIT INSURANCE INCOME ACCOUNTS MANAGED ACCOUNTS

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 massmarket 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.

the broker-dealer of the future

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.

PERCENTAGE OF INVESTMENT PROFESSIONALS

Figure 11: Distribution of Investment Professionals by Years Worked in Investment Industry

26.7%

20.4% 17.7% 15.9%

9.6%

1-5

9.7%

6-10

11-15

16-20

NUMBER OF YEARS

21-30

>30

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.

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Figure 12: Broker-Dealers’ Top Priorities 5

AVERAGE IMPORTANCE

4.0 3.6 3

2.7 2

2.2

2.2 1.8

RECRUITING

INVESTMENT PROFESSIONAL RETENTION

COMPLIANCE REQUIREMENTS

INCREASE INVESTMENT PROFESSIONAL PRODUCTIVITY

MEET INVESTMENT PROFESSIONALS’ TECHNOLOGY NEEDS

COST CONTROL

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 brokerdealer 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).

the broker-dealer of the future

PERCENTAGE OF BROKER-DEALERS

Figure 13: Distribution of Broker-Dealers by Number of Investment Professionals, Current and Expected Average: 631

Average: 1,013

10.3% 8.8%

19.0%

2,001+

14.7%

13.2%

1,001 – 2,000

7.4%

501 – 1,000

17.7%

201 – 500

13.2%

101 – 200

11.8%

51 – 100

17.7%

<50

13.2% 11.8% 11.8%

29.4% TODAY

IN 5 YEARS

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 brokerdealers, 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.

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PERCENTAGE INDICATING 5-YEAR CHANGE

Figure 14: Expected Change in the Importance of Compensation 5%

LESS IMPORTANT

SAME IMPORTANCE

50%

53%

MORE IMPORTANT

42%

47%

BROKER-DEALERS

INVESTMENT PROFESSIONALS

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 IMPORTANCE

ATTRIBUTE Low OPEN TECHNOLOGY PORTFOLIO MANAGEMENT TOOLS PAPERLESS STATEMENTS CONSOLIDATED STATEMENTS INDIVIDUALLY OWNED RIA WEB-BASED PORTAL FOR CUSTOMERS EXTERNAL AGGREGATED REPORTING CORPORATE RIA CALL CENTER MULTIPLE TRADING PLATFORMS BRAND DEVELOPMENT

IMPORTANCE IN 5 YEARS High

Less

15.0

2.0% 4.0% 1.6% 4.0% 8.0% 4.0% 3.0% 15.0% 20.0% 10.0% 13.0%

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.

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More 72.0% 72.0% 77.5% 75.0% 57.0% 62.0% 67.0% 31.0% 35.0% 42.0% 42.0%

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

BENEFIT WAIVED ACCOUNT TRANSFER FEES MEDICAL INSURANCE PRACTICE SUCCESSION PROGRAM RETIREMENT ACCOUNT SIGN-ON BONUS EQUITY SHARING FORGIVABLE SIGN-ON LOAN PROFIT SHARING ACQUISITION FUNDING

PERCENTAGE OF BROKER-DEALERS THAT CURRENTLY PROVIDE 80.0% 64.3% 53.9% 53.3% 50.0% 46.2% 41.7% 33.3% 21.4%

WILL PROVIDE IN 5 YEARS Likely

Unlikely

33.3% 66.7% 60.0% 40.0% 83.3% 16.7% 42.9% 57.1% 42.9% 42.9% 28.6% 57.2% 57.2% 42.9% 75.0% 25.0% 36.4% 54.6%

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. > B roker-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. > B roker-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. > B roker-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: > B roker-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. > B roker-dealers that specialize in enhancing the effectiveness of their investment professionalsâ&#x20AC;&#x2122; 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.

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> B roker-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.

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The Advisory Business Cannot Be Ignored The 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 brokerdealers 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%.

PERCENTAGE OF BROKER-DEALERS

Figure 17: Distribution of Broker-Dealers by Advisory Revenue, Current and Anticipated

1.6%

$100M+

4.9%

11.5%

14.8%

8.2%

13.1%

14.8%

11.5%

9.8%

$40M–$69.9M

18.0%

$20M–$39.9M $10M–$19.9M

31.1% 18.0% 23.0%

14.8% 4.9%

TODAY

$70M–$99.9M

IN 5 YEARS

$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.

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PERCENTAGE OF REGISTERED INVESTMENT PROFESSIONALS

Figure 18: Distribution of Broker-Dealers’ Investment Professionals by RIA Use, Current and Expected

23.0% 17.2%

INDIVIDUALLY OWNED RIA AFFILIATED WITH BROKER-DEALER’S CORPORATE RIA NO RIA

54.0% 45.0%

37.8%

23.0%

TODAY

IN 5 YEARS

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 brokerdealer 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

Cerulli Associates Quantitative Update, Intermediary Markets, 2007.

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Some facts to consider: > T he number of RIA firms grew by 28% between 2001 and 2004, while the number of FINRAregistered broker-dealers decreased 2% over the same time period. > T he 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-Dealersâ&#x20AC;&#x2122; View of the Independent RIA Marketplace

Threat 14.9%

Opportunity 85.1%

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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 feebased 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 change in 5 years

Current percentage of total

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%

type

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.

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Shrinking Margins Demand Greater Operational Efficiency The 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 onethird 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.

PERCENTAGE OF BROKER-DEALERS

Figure 22: Distribution of Broker-Dealer Profit Margins, Current and Expected 7.9%

3.2%

9.7% 6.5%

25%+

35.5%

11% – 20%

21% – 25%

25.4%

6% – 10%

31.7%

0% – 5%

30.6%

<0%

25.4% 16.1%

1.6%

6.3% TODAY

IN 5 YEARS

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

PERCENTAGE OF BROKER-DEALERS

5.3% 15.8%

15.8%

100% CERTAINTY

10.5%

VERY LIKELY

5.6% 15.0%

21.1%

16.7% 36.8% 55.0%

55.5%

SOMEWHAT LIKELY

35.0% 47.3%

31.6%

42.1% 50.0%

NOT AT ALL LIKELY

36.8% 30.0% 31.6%

NOT VERY LIKELY

27.8% 45.0%

36.8%

36.8% 27.7%

26.4% 15.0%

16.7% 5.0%

LOWER STAFF AUTOMATION PROCESS INVESTMENT REDUCTION OF MANUAL IMPROVEPROFESSIONAL ACTIVITIES MENTS COMPENSATION

5.3%

IMAGING RELOCATION LOWER CONSOLIDATION AND COST WORKFLOW TECHNOLOGY

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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 brokerdealer 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

> Analytical tools

> Compliance

> Practice management

> Commission processing > Trading

> General occupancy and administration attributable to the above

> Marketing assistance > 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-mostimportant 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.

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Figure 25: Broker-Dealer Tendency to Outsource or â&#x20AC;&#x153;Insource,â&#x20AC;? Current and Expected today

in 5 years

Account aggregation

In/Out

Back-office processing

Insource

In/Out

Call center

Insource

Mail/image

Insource

PC help desk

In/Out

Product due diligence

Insource

Product training

Insource

In/Out

Recruiting

Insource

Research

Outsource

Insource

In/Out

Insource

Outsource

In/Out

Insource

Outsource

In/Out

Sales training Sales, marketing, and fulfillment Systems development Systems support Trade clearing Web administration

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 valueadded 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.

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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: > S treamlining 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. > A chieving 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. > L everaging investment professional productivity: There is obviously a strong correlation between the productivity of investment professionals and a broker-dealerâ&#x20AC;&#x2122;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.

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Conclusion The 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, brokerdealers 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 taxefficient 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.

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About Us Pershing LLC (member FINRA, NYSE, SIPC) is a leading global provider of financial business solutions to more than 1,150 institutional and retail financial organizations and independent registered investment advisors who collectively represent over five million active investors. Financial organizations, investment professionals, and independent registered investment advisors depend on Pershingâ&#x20AC;&#x2122;s depth of experience and consultative approach to provide them with forward-thinking solutions that help them to grow their businesses. Located in 19 offices worldwide, Pershing is committed to delivering dependable operational support, robust trading services, flexible technology, an expansive array of investment solutions, practice management support, and service excellence. Pershing is a member of every major U.S. securities exchange and its international affiliates are members of the Deutsche BĂśrse, the Irish Stock Exchange, and the London Stock Exchange. Pershing LLC is a subsidiary of The Bank of New York Mellon Corporation. Additional information is available at www.pershing.com.

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