I’m writing a new version of the Custodial Alternatives white paper, which profiles some less-well-known options that advisory firms caught up in the Schwabitrade acquisition, or firms that are suffering long hold times, could consider. In that context, I’m also thinking about how digital onboarding is becoming more seamless and, if Nest Wealth is a harbinger of things to come (see previous article), much more convenient for advisors and clients to navigate.
The key takeaway is that changing custodians, and repapering clients, is becoming less painful—and easier to contemplate. Following this logic a bit further, we might see custodial relationships become less sticky, which would require custodians to become more competitive if they want to retain their advisory firm relationships.
Where does that lead us? The key differentiator is service. It becomes clear from our annual software survey that the smaller custodians are getting better user ratings than their larger competition—which I think means they’re providing better and more responsive service. I’ve reported elsewhere that advisors are routinely experiencing half-hour (sometimes longer) hold times when they call their service teams at Schwab and TD Ameritrade. That isn’t a problem with some of the less-well-known competitors.
Dig a bit deeper, and you are beginning to see another irritant for many advisory firms: the disparate pricing between larger and smaller firms is becoming more visible. Fidelity has been telling smaller advisory firms that they will need to include Fidelity products in their client portfolios or, alternatively, pay a monthly fee for access to its custodial platform. Larger firms, meanwhile, tend to be more profitable relationships, and are certainly more efficient than the same assets scattered among 20 or 30 state-registered firms. These larger firms have the leverage to demand pricing and services that the smaller firms will never see.
Dig just a bit deeper, and it’s not hard to imagine that, at some point in this easy-repaper, increasingly visible disparate fee marketplace, smaller firms will move away from the largest custodians, and the custodians will not be unhappy to lose these less profitable relationships.
But what would be the long-term implication of this potential resettling of custodial market share? It’s not easy to predict the future, but my instincts tell me that the smaller firms are more likely to adapt to the rapidly changing dynamics of the marketplace than their larger brethren. An advisory firm with hundreds or thousands of offices begins to look, to me, like a wirehouse organization, with standardized, rigidly controlled service models across all offices. A firm like that can only adapt to change with great difficulty. The typical analogy is turning around a battleship
What changes would prove difficult? One obvious change would be a shift—which I think is already underway—away from the AUM revenue model. Another would be an increasing tendency to work with a focused, target clientele—what some would call a niche, what I would prefer to call a specialty. The smaller firms will focus, while the larger firms will become the equivalent of general practitioners.
My guess is that, just like the wirehouses, these larger firms would eventually be staffed with younger advisors who, as they gain more skill, expertise and experience, would find it more profitable to develop a specific client expertise and go out on their own.
The center of gravity, in terms of skill, expertise and experience, would shift to the smaller firms competing with the larger ones, and eventually these larger firms could experience a long leak of market share comparable to what the wirehouses are experiencing today. I might argue that the wirehouses are better at promoting fictional views of independence, and have benefited from a different regulatory structure and difficult repapering options—which means the leaking from larger to smaller RIA firms could be faster (or more efficient) in the future than it is today. And it’s helpful to remember how many once-robust wirehouse firms are no longer with us. Would the same happen, perhaps more catastrophically, with the giant advisory firms?
This possible (plausible?) future rests on a fairly long chain of assumptions, but if we suppose for a moment that something like this occurs, we could see a gradual normalization, where the largest custodians become smaller and tied to a diminishing customer base, while today’s smaller custodians become larger and start to force some competitive changes. The closed custodian software environment becomes more open, the pricing disparities become normalized, custodians will have to provide larger and better service teams, and none of them will have the luxury of feeling comfortable with their advisor relationships.
The new Schwabitrade consolidation has been described as a reduction in the competitiveness of the advisor custodial marketplace. But it’s equally possible that it will bring about more competition, by driving more advisors to seek out better (or at least more personalized) alternatives. We may, after all the sturm and drang and hand-wringing, be in the early stages of a much more democratized—and some would say better—custodial landscape.